Larry Summers's Billion-Dollar Bad Bet at Harvard
By Matthew C. Klein
July 18 (Bloomberg) -- President Obama
has only a fewmonths to pick a candidate to replace Ben Bernanke as
chairman of the Federal Reserve, and while the betting website Paddy Power
has Fed Vice Chair Janet Yellen leading the pack at 1:4 odds, Larry Summers
remains a strong contender at 11:2.
Despite an impressive resume that
includes stints as Treasury Secretary and chief economist of the World Bank,
there is a very good reason Summers shouldn't be in charge of
monetary policy: He seems to have trouble with interest rates.
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
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."
Why, back in 2004, did
Summers feel so confident that interest rates were going to be much higher
than they actually were? Reuters blogger Felix Salmon found one clue in a
speech Summers gave in October of that year. Among other he
things, Summers warned of the dangers created by the U.S. current account
deficit and highlighted the seemingly absurd fact that short-term borrowing
costs were lower than the rate of
inflation. Perhaps Summers's experience
with foreign-exchange crises in Asia and Latin America convinced him that
something similar could happen in a country that borrowed in its
Not only was Summers wrong in 2004 about where
interest rates would be -- he was willing to bet a lot of other
people's money that he knew better than everyone else. The damage
at Harvard was bad enough. Imagine what that sort of thing could do to the
(Matthew C. Klein is a writer for Bloomberg View.
CEO of the Parisian Family Office. Retired/Founder of CHIPPEWA PARTNERS, Native American Advisors, Inc., Registered Investment Advisor. White Earth Chippewa, educated conservative, raised on Indian reservations across Great Plains. Began Wall Street career in 1982. Always been, will always be, an optimist. Pureblood, clot-shot free. In a world on a dopamine binge, this is his take on life. Written at MT Ghost Ranch or Pamelot, TN farm or his winter camp in San Jose del Cabo, Mexico.
Thursday, July 18, 2013
Summer Time for the Fed? God help America!
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