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.