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Summers Criticizes Handling of Crises

Lawrence H. Summers, speaking at The Washington Post, says the Fed is focused too much on fighting inflation and not enough on preventing recession.
Lawrence H. Summers, speaking at The Washington Post, says the Fed is focused too much on fighting inflation and not enough on preventing recession. (By Linda Davidson -- The Washington Post)

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By Neil Irwin
Washington Post Staff Writer
Thursday, December 20, 2007

President Bush and the Federal Reserve aren't taking aggressive enough action to prevent a recession, former Treasury secretary Lawrence H. Summers said yesterday, as Democrats ramped up their attacks on the administration's handling of the housing downturn and credit crises.

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Summers, who worked in the Clinton administration, said the risk of a prolonged recession is higher than most economists recognize. He said it is "distinctly possible" that the nation will experience its worst economic conditions since the stagflation of the 1970s and severe recessions of the early '80s.

"For the last year, the economic consensus, and the policy actions that have flowed from it, has been consistently behind the curve in recognizing the gravity of the problems in the housing and financial sectors and their consequences for the overall economy," Summers said in a speech at the Brookings Institution.

At the same event, Sen. Charles E. Schumer (D-N.Y.), chairman of the Joint Economic Committee, lambasted the administration. "As our country teeters on the edge of recession . . . the Bush administration is just whistling into the wind. They seem to be unable to get the government moving quickly, decisively and competently to address a serious economic crisis."

The Bush administration has undertaken a series of actions to ease the damage to the economy from the mounting foreclosure crisis, though much of this response came after the scope of the problem became clear this fall. Among other steps, it persuaded mortgage lenders to delay a rise in interest rates on hundreds of thousands of subprime loans, a step that Schumer said is "too little, too late, and too dependent on the voluntary goodwill of the private sector."

"President Bush and the administration have taken aggressive, positive steps, working with others in the private and nonprofit sectors to prevent avoidable foreclosures," said Jennifer Zuccarelli, a spokeswoman for the Treasury Department. She added that Congress has not passed key legislation to deal with the problem, notably overhauls of a government mortgage insurer and the way housing finance companies Fannie Mae and Freddie Mac are regulated.

Summers, a Harvard economics professor and former president of the university, said the president and Congress should use fiscal policy -- the government's taxing and spending abilities -- to help goose the economy in 2008. The best way to do that, he said, would be to temporarily lower taxes equally among taxpayers, extend unemployment insurance and increase food-stamp benefits. He stressed that such tax cuts and spending increases should be temporary, so as not to increase long-term budget deficits.

Later, in a conversation with editors and reporters of The Washington Post, he argued that even if he turns out to be wrong about the fate of the economy, it would be better for the government to respond with vigor.

"The right thing to do is to err on the side of doing too much," said Summers, who consults for a hedge fund. "It's really easy to imagine waking up three years from now and saying, 'God, why didn't those guys get ahead of this thing when they could have in the same ways that people didn't get ahead of the problems in Japan in the 1990s, that people didn't get ahead of the S&L crisis when they could have?' "

Summers also said the Federal Reserve is too focused on preventing inflation to respond adequately to the risk of a slower economy. "It is much more important to establish credibility that policy is ahead of the credit-crunch spiral than to reassure yet again that it is not behind the inflation curve."

The Fed has cut a key short-term interest rate by one percentage point since August, when markets for credit worldwide entered a period of distress. Many market participants were disappointed Dec. 11 when the Fed did not cut rates more than it did. A bigger cut would have stimulated the economy more but would have done so at the risk of prompting higher inflation down the road.

Banks in recent months have become more fearful about the losses they are exposed to and thus are more reluctant than normal to lend money to one another. That has pushed up the short-term interest rate that many consumers and businesses pay, counteracting some of the benefit of the Fed rate cuts.

Summers said the Fed should target its policy toward lowering that market rate, not just the rates it directly controls. The central bank made one such effort to do that this week with a special auction of cash to banks.

A Fed spokesman declined to comment on Summers's criticisms.


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