Larry Summers says something silly

Robert Waldmann

According to Ezra Klein (who is very gentle in his criticisms) Summers wrote the following

As for [Milton] Friedman — I’m not so sure he looks bad. What is most screwed up today? GSEs, Citibank, regional banks. What is most regulated? Same list. What is least screwed up? Hedge funds and the like. What is least regulated?

Summers didn’t mention investment banks or non bank mortgage companies. Many of Them are not currently “screwed up” mainly because they no longer exist.

I mean he just overlooked the little problems at Lehman Brothers and Countrywide.

The argument about hedge funds is totally invalid. Look, I’m not regulated at all and I’m not bankrupt. Most individuals are in less financial distress than say citibank. The reason isn’t that individuals are not subject to regulation — it is that banks often have enough sense not to loan too much to individuals (notice I am just talking relative — most people aren’t in bankruptcy court and no individual has been bailed out yet).

The government doesn’t have to regulate us, because relatively few potential creditors trust us.

long rant after the jump

update: On non bank mortgage companies look at the mortgage lender implodometer

I stress I am criticizing 2 sentences. I trust Klein to not deliberately distort meanings by removing context, but I don’t know the context.

This goes for individuals who want to play the market. Our counterparties demand that we put up the money first and keep an account with them with a positive value. That goes for me you and hedge funds. They interact with the rest of the world in two ways
1) they have investors who invest at least $100 million each and who can’t stage a run as they can withdraw only on scheduled occasions
2) they have repo accounts at investment banks. Accounts, sortof like you and me. The investment banks make sure that the hedge fund never ever owes the bank money.

You can’t go bankrupt if no one will lend to you because no one trusts you.

However, we need some financial institutions that we trust (lets call them banks). If you want trust you need regulation.

Larry Summers is very smart. I found him to be a really excellent PhD supervisor who made outstanding constructive criticisms (and getting a dissertation out of me was not easy as it required extreme diplomacy, patience and kindness). Still the quoted passage is nonsense.