Deputy Treasury Secretary Larry Summers was a little over halfway into his testimony in July 1998 when he acknowledged the degree to which his actions undermined the independence of the Commodity Futures Trading Commission (CFTC).
As Summers told a Senate committee, referencing his conflict with Brooksley Born over regulating derivatives: “We understood the seriousness of making this proposal. To question an independent agency's concept of its jurisdiction and then to propose legislation that would temporarily curtail that agency's ability to act is not something we do lightly. We concluded, however, that such legislation was necessary.”
The last two weeks have seen a flurry of commentary on the relative merits of Larry Summers and Janet Yellen as potential candidates for the next chair of the Federal Reserve. Some of the criticism about Larry Summers comes from his role in 1990s deregulation of finance. His fight with Brooksley Born of the CFTC over the regulation of derivatives particularly stands out.
People already have strong opinions about Summers’ culpability for the financial crisis as a result of his past support of deregulation. But what goes missing is the extent to which he sought to control and undermine an independent regulator given that he disagreed with them. If the next Federal Reserve chair, who will have immense power within the regulatory community, disagrees with another financial regulators during the implementation of Dodd-Frank, will he or she go after them equally as hard?
As documented in the PBS Frontline episode The Warning, as well as the Washington Post, in May 1998 Brooksley Born, then chair of the CFTC, announced she would be drafting and circulating a concept release paper investigating the new and rapidly growing market in a special kind of derivative known as a swap.
Today, people who support or oppose Born tend to exaggerate what she and the CFTC was trying to do at the time. The concept release Born put forward was basically just a set of questions, trying to figure out information about a market that regulators had virtually no information about. (That information would have come in handy in 2008.)
The CFTC clarified that they “no preconceived result in mind.” They were “open both to evidence in support of easing current restrictions and evidence indicating a need for additional safeguards.” The agency even welcomed “comment on the extent to which certain matters are being or can be adequately addressed through self-regulation” (see here for more details). The CFTC worked hard to reassure the market that it wasn’t trying to void any derivatives, noting that the release “in no way alters the current status of any instrument or transaction under the Commodity Exchange Act.”
Yet those reassurances didn’t stop the full-on assault from Alan Greenspan, then of the Federal Reserve, and Robert Rubin and Larry Summers of the Treasury Department. To say that the Treasury Department under Rubin went after Brooksley Born with everything they had would be an understatement. University of Maryland law professor Michael Greenberger, working at the CFTC at the time, told Frontline that Larry Summers called Born and said, ”You're going to cause the worst financial crisis since the end of World War II." Born's critics demanded the concept release not be issued, putting pressure on Congress to stop her.
Their attack worked. The concept release was pulled back, Congress and the administration stopped the CFTC under Treasury’s advice, and Born resigned.
So why is this relevant? The Federal Reserve is the most important and powerful of the financial regulators, both before and after Dodd-Frank. As Marcus Stanley of Americans for Financial Reform says, “the Federal Reserve regulates all large bank holding companies at the consolidated level and all designated non-bank SIFIs at the consolidated level as well.”
Stanley notes that the Federal Reserve has broad powers on requirements, examinations and enforcement, as well as the ability to grant exemptions and waivers for rule enforcement. Not only that, but the Fed is self-funded and still has enormous respect within the Washington establishment, both things which insulates it from Congressional and even judicial pressure. The Fed also carries a lot of influence on the newly created council of financial regulators, FSOC.
Summers’ background in the financial industry could raise concerns here. For instance, the Federal Reserve will have to determine whether or not to allow firms like Citigroup and Goldman Sachs to continue to run physical commodity businesses post-crisis. Given Summers’ background recent consultant work for Citigroup, this could raise eyebrows if exemptions are handed out.
A bigger question is what will happen if Summers disagrees with another regulator in another agency. This will almost certainly happen going forward, and this could be the dark side to the “really brilliant” issue that Ezra Klein and others have flagged as an argument for Summers. Will Summers defer to other regulators, or seek to constrain their independence all over again, when it comes to future disagreements over financial regulation?
It’s pretty clear that Summers has disagreements with other more aggressive, independent regulators. In 2011 Larry Summers said “I’ve been more cautious than many about constraining financial innovation.” He criticized actions by regulators investigating fraud over foreclosures in the servicing industry, noting that “negotiation over the past...creates overhangs of uncertainty.”
Summer is also reported to have been opposed to the Volcker Rule, one of the crucial remaining pieces of financial reform that the Federal Reserve will play a role in implementing. More broadly, as John Cassidy notes in the New Yorker, Summers has never acknowledged his errors from the 1990s.
The actual rule-writing that has become much stronger, and thus more frustrating for Wall Street, has come from agencies working within their own jurisdiction, headed by aggressive leaders. These are regulators like Cordray at the CFPB, Bair at the FDIC, and especially Gensler at the CFTC. This is also a description of Born in the 1990s.
Many have noted Summers’ temperament might prevent him from building a consensus within the FOMC. Equally important for the fate of our real economy is whether he’ll repeat his actions with Born when it comes to playing well with the other regulators.
Mike Konczal is a fellow at the Roosevelt Institute, where he focuses on financial regulation, inequality and unemployment. He writes a weekly column for Wonkblog. Follow him on Twitter here.