Larry Summers’ Bad Bet


The Argentine government has promised to make a payment on a US dollar bond in 2015. That obligation is part of a sophisticated derivative instrument…which is one of the key assets of Hedge Fund A. It borrowed the money to buy the derivative from Bank B. Now Hedge Fund A’s debt to Bank B is a critical part of Bank B’s capital.

But what happens if the Argentines don’t pay?

You see, the collateral in a credit system is debt. And when debt goes bad, the system cracks up. The only thing that can stop the crack-up is a gush of more credit.

That’s what happened in 2008–2009. But this kind of fix is only temporary…and always disastrous. Because it just stretches out the web of unsustainable credit connections even further.

And you — the holder of this credit-based money (check your wallet) — never know what your holdings are worth…or when they might become worthless.

That’s why ancient man, at the dawn of civilisation, came up with a better idea: money based on precious metals.

When you have a gold coin in your hand, you don’t care if Argentina pays or not. Your dimwit neighbour can’t pay his mortgage? Too bad for him! Your government can’t keep the money flowing to zombies? Too bad for the zombies!

But let’s turn back to Larry Summers — former dazzling academic…former US Treasury secretary…former president of Harvard…former director of the US National Economic Council…and now candidate to replace Ben Shalom Bernanke as the nation’s No. 1 money man.

On the surface, Summers has the right qualifications. He has no idea how an economy really works. Nor does he have any interest in finding out. He has never…as far as we were able to determine…had a job in the business or commercial world. Instead, he has passed his entire career giving bad advice in academia or government.

Here is Robert Scheer criticising Summers for the wrong reasons in The Nation:

Former US Treasury Secretary Lawrence Summers, the guy who tops the list of those responsible for sabotaging the world’s economy, is lobbying to be the next chairman of the Federal Reserve. But no, it makes perfect sense, since Summers has long succeeded spectacularly by failing.

Summers was one of the key players during the Clinton years in creating the mortgage derivative bubble that ended up costing tens of millions of Americans their homes and life savings. This is the genius who, as Clinton’s Treasury secretary, supported the banking lobby’s successful effort to make the sale of unregulated bundles of mortgage securities and the phony insurance swaps that backed them perfectly legal and totally unmonitored. Those are the toxic bundles that the Federal Reserve is still unloading from the banks at a cost of trillions of dollars.

Summers opined that “the parties to these kinds of contracts are largely sophisticated financial institutions that would appear to be eminently capable of protecting themselves from fraud and counterparty insolvencies.”

Summers didn’t understand how a credit-based economy works. In fact, he didn’t seem to understand interest rates. Bloomberg recounts:

During the financial crisis, Harvard lost nearly $1 billion because of some unusual and ill-judged interest rate swaps that Summers implemented in the early 2000s during his troubled tenure as the university’s president.

Interest rate swaps allow borrowers to lock in a fixed interest rate on floating-rate debt, which can be good to hedge against short-term uncertainty. The problem with Harvard was that Summers wanted to lock in interest rates for money that the university hadn’t actually borrowed and wasn’t planning on borrowing for a very long time.

There aren’t a lot of ways to interpret this exotic instrument except as a bet that the future level of interest rates would be higher than the market pricing implied at the time. That bet was wrong, and Harvard lost a billion dollars. Anonymous finance blogger Epicurean Dealmaker puts it well:

"I have rarely encountered a corporate client who feels confident enough about both their absolute funding needs and current and impending market conditions to enter into a forward swap starting more than nine months into the future. Entering into a forward start swap for debt you do not intend to issue up to 20 years in the future sounds like either rank hubris or free money for Wall Street swap desks."

Hey, anyone can make a mistake. But what sets Summers apart is his readiness to make mistakes on a colossal scale…with other people’s money.

But as far as we can see, that gives him all the qualifications you need to be America’s top banker.

A high IQ moron is just what you need for this kind of work.

You have to be smart enough to talk the talk, pretending that you know what you’re talking about. But you have to be stupid enough to believe it.

You must think you really can improve the financial decisions of 310 million people. And you have to be arrogant enough to contradict all of them — putting your own asinine plans into action even though they will almost certainly bankrupt the entire nation.

Summers is the man for the job!


Bill Bonner
for The Daily Reckoning Australia

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From the Archives…

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19-07-13 – Greg Canavan

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18-07-13 – Greg Canavan

A World Without Money?
17-07-13 ­– Bill Bonner

A Credible Threat to Gold?
16-07-13 – Greg Canavan

The Making of a Modern Debt Slave…
15-07-13 – Bill Bonner

Bill Bonner

Bill Bonner

Best-selling investment author Bill Bonner is the founder and president of Agora Publishing, one of the world's most successful consumer newsletter companies. Owner of both Fleet Street Publications and MoneyWeek magazine in the UK, he is also author of the free daily e-mail The Daily Reckoning.
Bill Bonner

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2 Comments on "Larry Summers’ Bad Bet"

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slewie the pi-rat
slewie the pi-rat
3 years 2 months ago
Robert Scheer is not fond of fascists. and for the right reasons, too, as far as i can see [given that i do not consider myself qualified to hold the man’s jock-strap]. as the Epicurean blogger does not fail to intimate: the politically-connected Summers simply bled Harvard of $1 Billion via the banksters’ swap-desks. in slewienomics, the NWO depends upon the BK and ‘receivership/liquidation’ of the ‘sovereign states’ by the UN Security Council Permanent Members [a.k.a. the Atomic MILFs*] acting under ‘international law’. debt? who cares? it grows the economy! Ha! debt-bubble problems? “hi! we’re from the troika and we’re… Read more »
3 years 2 months ago

Bob and Larry both ran Harvard.

Harvard was Obama’s 5th largest campaign contributor.

6 of Obama’s top 20 campaign contributors were universities, including his largest Uni of California.

4 of Obama’s top 20 campaign contributors were other USG identities.

Elena Kagan, the oft quoted supporter of extended central executive power is a Larry and Bob protege pulled up at Harvard Law School.

We’ve taken SCOTUS and POTUS, and we’ll do what we god damned please with the Fed; as we’ve always done.

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