Sent to you by jcase via Google Reader: Summers Remarks at Council on
Foreign Relations via WSJ.com: Real Time Economics on 6/12/09
Full text of prepared remarks by top White House economic adviser
Lawrence H. Summers at the Council on Foreign Relations
Reflections on Economic Policy in Time of Crisis
INTRODUCTION
Good Morning. I’m glad to be back here at the Council on Foreign
Relations. I have had the great privilege of speaking here many times
in the nearly 20 years since I became a member. Perhaps no moment in
that period is as pivotal in the economic arena as the current one.
President Obama inherited an economic crisis more serious than any
President since Franklin Roosevelt. It has been an enormous honor to
work with the President as he has provided an unprecedented response to
unprecedented problems. This morning I want to reflect on the economic
policies that the Obama Administration has pursued.
Before turning to those policies, let me just say a word about where
the economy stands right now. The President’s program appears at this
moment to be having many of its intended effects. While we still have a
long way to go, the sense of free-fall that surrounded any reading of
economic statistics a few months ago is no longer present. Now when we
brief the President each morning on economic indicators, they exceed
expectations about as often as they do not. I can assure you this was
not the case in the first couple of months of the Administration.
However, no one should minimize the loss of 345,000 jobs last month—a
figure comparable to the highest-loss months in the last two
recessions. But, it also bears emphasis that the loss of 345,000 jobs
is only half as many as the economy was losing each month just a few
months ago. Consumer and business sentiment is increasing. And in what
is perhaps an important predictor over a slightly longer term, the
fraction of Americans, who feel the country is on the right track, has
more than doubled. This strength has been matched by the strong
performance of most financial markets in recent months, as the stock
prices of financial institutions have risen and credit spreads have
come down sharply.
To be sure, we cannot be complacent. There have already been several
false dawns during this crisis and the history of major financial
crises, whether during the Depression or Japan in the 1990s, suggests
that there were periods of optimism and market strength even in the
midst of the worst downturns. What can be said with confidence,
however, is that we are closer to the end of the crisis than we were
six months ago.
Many things have contributed to the improvement of the economy.
Macroeconomic expansion has been pursued more rapidly in response to
economic downturn than ever before in both the fiscal and monetary
dimensions. Financial policy has taken many forms ranging from the very
substantial expansion of the balance sheet of the central bank to the
direct infusion of capital into financial institutions. Financial
policy has also been bolstered by significant efforts to support and
accelerate adjustment in the housing market. These areas of policy have
been extensively discussed and debated.
In my remarks this morning, I would like to concentrate on policies
towards individual institutions. The events of the last two years have
been remarkable. The broader U.S. government has been forced to take
extraordinary actions, including significant equity positions in such
companies as Citigroup, AIG, and General Motors.
Inevitably, these steps have generated substantial debate. Some believe
that government has been insufficiently intrusive in the economy,
holding that banks should have been nationalized or that government
should be taking a much heavier handed role with respect to the
institutions in which it has intervened. Others suggest that these
interventions represent an overreach, a kind of back door socialism
that may threaten the very underpinnings of our market-based economic
system.
Let me be absolutely clear at the outset about two aspects of President
Obama’s approach about which he has been particularly consistent and
firm since the crisis began while he was campaigning for president:
• The first is an unequivocal recognition that we only act when
necessary to avert unacceptable –and in some cases dire –outcomes.
Barack Obama ran for president to restore America’s role in the world,
reform our health care system, achieve energy independence, and prepare
our children for a 21st century economy.. He did not run for president
to manage banks, insurance companies, or car manufacturers. The actions
we take are those of necessity, not choice.
• The second point on which the President has been unambiguous is that
any intervention go with, rather than against, the grain of the market
system. Our objective is not to supplant or replace markets. Rather,
the objective is to save them from their own excesses and improve our
market-based system going forward.
WHY INTERVENTION WAS NECESSARY
In the long sweep of history, Franklin Roosevelt’s policies, denounced
by many at the time as a radical attack on capitalism, are today
understood to have helped preserve the market system. So, too, the
approaches taken today are directed at protecting and strengthening,
rather than replacing, the market system.
While the causes of today’s crisis will be debated for many years to
come, I believe that history will confirm this moment to be one of
those rare occasions that Keynes wrote of where self-equilibrating
markets break down. In these rare moments, vicious cycles replace
self-correcting markets. Instead of falling prices leading to more
demand and less supply, falling prices lead to more supply, driving
prices down and creating a downward spiral. Nowhere has this been more
evident than in our housing market, where lower prices led to increased
foreclosures leading to less demand – because no one wants to buy a
house whose price is about to fall.
When faced with such vicious cycles, the government has no alternative
but to respond strongly to restore economic health. The responses that
are most protective of the basic structure of the market system are
those of macroeconomic policy: the general provision of credit and
liquidity and the expansion of government demand support economic
activity, but these actions do not involve intrusions in particular
decisions that are usually reserved to the market. And that is why
macroeconomic policy was, and appropriately is, the first line of
response to crisis.
Macroeconomic policies can and have made a substantial difference.
Policies that have led to higher incomes have led to greater ability to
repay loans and a stronger financial system, leading in turn to more
economic activity and higher incomes. Direct provision of credit by the
Federal Reserve has led to lower capital costs, increased investment,
and more economic growth.
But in a modern economy suffering a crisis, direct general
macroeconomic policies, while necessary to assure economic recovery,
may not be sufficient. When institutions are substantially
interconnected, their failure can lead to the cascading failure of
other institutions as the experience of bank panics teaches. But the
idea that interconnections can lead to cascading failures is not only
confined to finance in a world of integrated supply chains during
exceptional circumstances such as the current recession.
Indeed the idea of vicious cycles is closely related to the idea of
self-fulfilling prophecies. Think about a bank or a company or indeed,
a country that is expected to fail financially. If it is expected to
fail, no one will want to be the last one to try to withdraw their
money, and the result will be that everyone seeks to remove their money
at once. Even a basically healthy institution cannot withstand that
pressure. And so it appropriate in extreme cases for the government to
intervene when the disorderly failure of sufficiently large and
interconnected institutions is a possibility.
What is crucial and where our focus has been as we have intervened when
necessary is on the intervention being temporary, based on market
principles, and minimally intrusive. Let me say a little bit about each
of these principles, and then turn to the broader question of how we
are going to prevent these types of crises in the future.
TEMPORARY
To ensure that government interventions in individual companies are
consistent with the President’s principle of preserving the private
market system, we must design them to be as temporary as possible. That
is why it is constructive that, in the wake of the stress tests, major
financial institutions were able to raise private capital to replace
the government’s capital infusions and repay the US Treasury
approximately $68 billion in just six months. It is also why the
President was clear and explicit that his objective is to exit the
government’s investments in auto companies as quickly and deliberately
as is practicable.
The person who inherits a structurally-deficient house faces a choice:
he can make only the necessary structural improvements so the house can
pass inspection or he can take on new renovation projects with the
ultimate goal of moving in? Our answer with respect to government
stakes in major enterprises is clear. It is the former. We do not want
to be owners; we want to be stewards to structural soundness and
nothing more. And that is why we will work to transfer government
holdings into private hands as soon as practicable.
BASED ON MARKET PRINCIPLES
Second, our interventions are based on market principles. Private
market transactions in situations of economic distress take many
different forms. They may involve a range of different types of
restructuring. They may involve private investors providing debtor in
possession finance or taking equity positions. This is also the case,
in situations of distress, where it is necessary for the government to
become involved.
Our approach has sought to parallel what would have been the private
sector process. Where possible we have provided secured loans where
possible, such as in the various Fed facilities to support the banking
system. Where this is not possible, we have sought to provide unsecured
debt or preferred stock investments without taking on control rights.
Where institutions are fundamentally insolvent and government has had
to provide the finance necessary in the context of bankruptcy, we have
sought to do so in the same way a private sector lender would have
done. I emphasize this point because a number of transactions,
including the Chrysler transaction, have generated some controversy. So
let me be clear: in a bankruptcy reorganization, each class of
creditors is entitled to more than they would receive in a liquidation.
I am aware of no serious argument that in any transaction in which the
government has participated, this criteria has not been met.
On the other hand, it is standard practice for those providing capital
–the lenders of last resort –to make purely commercial decisions that
end up treating some creditors more generously than they would be in
the context of a liquidation. For example, in the steel restructurings
that took place some years ago, the private providers of capital chose
to provide greater recoveries to the union health care trust than to
many of the companies’ other creditors. Those investors made a business
judgment that to run steel companies effectively in the future, they
needed to maintain a smooth ongoing relationship with the union. For
the same reason, certain creditors of various forms are often treated
much more generously than other creditors in bankruptcies. From this
perspective, there is nothing at all remarkable about the way in which
finance was provided during the Chrysler or General Motors transactions.
This idea of following market principles has shaped what we have done
in other respects. Reasonable financiers in the context of bankruptcies
do not provide finance so enterprises can repeat the mistakes that
caused them to go bankrupt in the first instance. That is why President
Obama rejected the first restructuring plans that were put forth by
both General Motors and Chrysler and insisted on much more radical
restructurings that provided for profitability even in severe recession
conditions in the car industry. That is why, despite sizable government
resources, more painful changes including plant and dealership closings
were necessary. And that is why it will be our objective to act in a
fashion that is consistent with protecting taxpayers by acting just as
a responsible market participant would.
MINIMALLY INTRUSIVE ON AN ONGOING BASIS
The third aspect of our approach is that we seek to be minimally
intrusive on an ongoing basis. While it is our objective to act as a
private sector financier would, in the context of intervention in
financial institutions, we cannot lose sight of the fact that the
government is very different from a private sector actor. The
government would be abdicating its responsibility to taxpayers if it
did not ensure that financial assistance was deployed in a way that
promoted growth and stability. Before providing tax-payer resources, it
is sometimes necessary –on an ex ante basis—for the government to
require that the company make significant changes or commitments to
justify the intervention.
Government officials involved with any company are subject to political
pressures of many different kinds. They have a much broader array of
objectives than do private sector actors. For this reason, while it
would not be uncommon for a private equity firm that invested in a
distressed company to take an active role in its ongoing management
over a long horizon, we have taken a very different approach.
Our approach focuses on ensuring, as a pre-condition of intervening,
that appropriate management and governance are in place. It focuses on
ensuring upfront that a credible and robust restructuring plan is
adopted. It is not to seek to manage companies or their operations and
certainly not on an ongoing basis.
We understand this approach is controversial. For example, here are
those who believe that the government should use its stake in
automobile companies to advance environmental objectives or to pioneer
new labor management practices. This is not the President’s approach.
The President believes that automobile companies, in areas like CAFÉ
standards or safety, should be regulated in the same way, by the same
agencies whether or not government has an economic stake in those
companies. It would be both politically improper and economically
unwise to view interventions in private companies as opportunities to
achieve broader policy objectives. On that the President has been clear.
Our approach has been to insist on a restructuring of the board of
directors in the case of troubled companies, and where appropriate to
insist on changes in management. But we have resisted, I believe
wisely, the temptation to intervene in day-to-day business decisions.
For example, in the restructuring of the auto companies, the government
insisted on strategic plans that would enable the companies to thrive
even if car sales do not rebound to former levels–but it did not decide
or dictate the specifics of those plans in terms of plant or dealership
closings. In the case of the TALF program, the governments set which
broad categories of asset-backed lending were eligible, but leaves the
particular decisions about which assets actually get funded each month
to the market.
These principles — maintaining investments as temporary, following
market principles, and being as non-intrusive as possible– do not
assure success. They cannot remove the need for judgment. But they
provide a framework in which necessary, painful actions can be taken
consistently. It is too early to know whether our policies have
succeeded. It is not even clear how we will know ultimately whether
they have succeeded because of the difficulty of knowing what would
have happened had we not intervened.
But, if you take one fact from today, take this: Only if government is
no longer a major presence in these companies in short order will it
have fully succeeded in achieving our critical objectives.
REFORM OF THE FINANCIAL REGULATORY SYSTEM
Frankly, it is no accident that there are countless TV dramas about
curative medicine and none, to my knowledge, about preventive medicine.
Brain surgery makes for better drama than blood tests. Though in terms
of the ultimate health of the population, the latter may be more
important. So I would be remiss if I did not conclude by talking about
what is in many ways a more important and more fundamental objective
than the necessary agenda of intervention that I have just talked
about. This is the agenda of crisis prevention through stronger
regulation.
In the last generation, prior to the current crisis, we saw the Latin
American debt crisis, the 1987 stock market crash, the commercial real
estate collapse and S&L debacle, the Mexican financial crisis, the
Asian financial crisis, the LTCM liquidity crisis, the bursting of the
NASDAQ bubble, and Enron. That is one major crisis every three years.
In each case, the financial system did not perform its intended
function as a bearer and distributor of risk, but instead proved to be
a creator of risk. Problems emanating from the financial sector in each
case profoundly disrupted the lives of hundreds of thousands or even
tens of millions of people. Surely our fellow citizens are right to
demand of those of us involved with the financial system greater
stability and safety. That is why President Obama has made financial
regulatory reform a central legislative priority of this early phase of
his Administration. While many of the details are complex, the
necessary fixes come from the application of common sense in an area
where complexity can blind sophisticated observers to the obvious.
There will be much to debate but here are some things with which I
think we should all be able to agree.
Systemic Risk
Any financial institution that is big enough, interconnected enough, or
risky enough that its distress necessitates government intervention is
an institution that necessitates oversight by an agency responsible for
managing the overall risk to the financial system. In a world where
financial innovation is, for good reason, pervasive and where market
conditions constantly change, public regulatory authorities need to
have the ability to perform what might be compared to the “free safety”
function in football: taking a holistic view of the playing field,
identifying gaps, pointing to unsustainable trends, and raising
questions about new kinds of interactions. Over-the-counter
derivatives, for example, have largely existed outside the regulatory
framework despite their explosive growth in recent years. Such markets
should be regulated (in new ways) and monitored:
• To prevent them from posing new systemic risks,
• To promote the efficiency and transparency of those markets,
• To prevent market manipulation, fraud, and other market abuses, and
• To ensure that they are not marketed inappropriately to inexperienced
parties
Resolution Authority
Whatever measures we put in place to manage systemic risk, we must also
be prepared to manage the failures of individual institutions. We have
long had tools of resolution with respect to banks. But as we
discovered last fall, painfully and expensively, a huge gap exists in
our system in the lack of resolution authority for bank holding
companies and non-bank financial institutions.
I would suggest to you that we will not have a financial system that is
failsafe until we have a financial system that is safe for failure.
Capital Adequacy
Perhaps most fundamentally, I would venture this generalization: There
has virtually never been a financial crisis in which leverage was not
centrally involved. Archimedes famously observed that if you gave him a
long enough lever, he could move an unbelievably large object, even the
Earth itself. We have seen it powerfully demonstrated in financial
markets that if you give people enough leverage, they can lose an
unbelievably large amount of their own money and that of their clients.
As Secretary Geithner has said when asked what’s most important for
financial stability, “The three most important things are capital,
capital, and capital.”
Looking forward, we intend to address capital adequacy in the financial
system as a central element of the Administration’s reforms.
Regulatory Arbitrage
There are some common sense points about the structure of regulation as
well. Can it surprise anyone that if institutions choose their
regulators and their regulators compete for institutions either
domestically or globally, that standards fall, and that there is a race
to the bottom. Instead of sponsoring races to the bottom, we need to
drive competition to the top by insisting on strong standards.
Consumer Protections
A corollary of the idea that regulators should not compete for
institutions is the idea that the regulation of consumer issues must
put the interests of consumers above the interests of regulated
financial institutions. The credit card legislation the President
signed into law provided an overdue correction with respect to some
serious abuses. Just as serious were the abuses in subprime lending
that preceded the current crisis. Fixing our regulatory framework
provides another opportunity to ensure that financial consumers are
adequately protected.
Monitoring systemic risk, implementing a resolution authority, ensuring
capital adequacy, eliminating regulatory arbitrage, enhancing consumer
financial protections – If we can reform our financial system, we will
minimize the recurrence of the situation we all find ourselves in today.
CONCLUSION
Since the first day of this Administration, I’ve often been asked what
the Administration’s most important economic objective is. I’ve usually
answered by noting that when my daughters studied U.S. History, they
learned a great deal about the Great Depression but that they were
taught nothing about the 1975 recession, the 1982 recession, or even
the 1987 stock market crash, exciting as those events were to many of
us in economic policy. We will have succeeded in our policies if
students who study U.S. history in 2040 are not taught about the
economic and financial crisis of 2009 but learn instead, about the
positive changes we’ve made.
Making the right choices is of immense historic importance, not only
for people’s immediate economic well-being, but for the longer-term
implications regarding the legitimacy of the market system.
America has faced this challenge more than once before. A Republican
Roosevelt, Theodore, and a Democratic Roosevelt, Franklin, both
presided over periods in which capitalism’s excesses and inadequacies
imperiled its very survival.
I would suggest to you that going forward we have an enormous challenge
of saving the market system from its current excesses and inadequacies.
If we can meet this challenge, there are more opportunities to create
more prosperity and better lives for more people than in any other time
in history. And when we look back on this period, we will look at it as
a period that was difficult and painful, but also a period when we made
profoundly important investments as a country, when we learned
profoundly important lessons about responsibility, and when we built a
foundation for an even greater prosperity in the future.
Thank you very much.
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