Podcast: Larry Summers breaks down the banking crisis

TRANSCRIPT: Larry Summers breaks down the banking crisis

Larry Summers:

In many ways the financial system is a little bit like an anesthesiologist, nobody much notices the job they're doing until something screws up.

Ian Bremmer:

Hello. And welcome to the GZERO World Podcast. This is where you'll find extended versions of my interviews on public television. I'm Ian Bremmer and on today's episode I'm sharing some tips and some tricks for how you, yes, you, can be first in line at your next local bank run. I'll demonstrate the proper way to stuff all your cash under your mattress without making your bed lumpy. Lower back pain is real, my friends. Now I'll leave that for MyPillow, but we are going to talk about the recent bank failures that have roiled global markets and spooked investors from Silicon Valley to Switzerland. Are we in the midst of a banking crisis? Not really. How much is inflation to blame for the banking mess we find ourselves in and how long will the latest turmoil last? To talk about all that and more, I'm joined by inflation whisperer and former US Treasury Secretary, Larry Summers. Let's get to it.

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Ian Bremmer:

Larry Summers. Larry, good to have you back.

Larry Summers:

Good to be back, Ian.

Ian Bremmer:

So much to talk about. I want to start with the banking crisis and ask you to explain just for a moment to our audience why these two banks have failed, Silicon Valley Bank and Signature Bank.

Larry Summers:

Like any big accident, there are multiple causes and multiple things that if they'd happened differently, we wouldn't have seen this failure. But the essence of it is a coming together of two different things. The first is that we now live in a digital world with high interest rates and that means that people are going to be much more reluctant to keep their money in places that are paying them zero interest rate when they could get 4 or 5% interest somewhere else, and they're going to be much more quickly moving to adjust, particularly if they become alarmed about whether they're going to get their money back. That's the first part. The second part is that the banks that held these accounts that were subject to being moved around, invested their money in assets that went way down in value. They made risky loans and much more importantly, they invested in long-term bonds and when interest rates went up, the value of those long-term bonds went down.

So depositors looked around and they saw that the assets backing their deposits were going down in value. They saw that it was easier than ever before to move their money somewhere else and they saw that they could get higher returns elsewhere and they saw that because of digital procedures, it was easier to open accounts elsewhere and all of that came together to cause mass of withdrawals. And just as a hundred people all trying to get out of a theater at the same time in a big hurry would cause the other thousand people in the theater even if they didn't really know what was going on to try to rush out as well. That kind of mob bank run psychology took over at these banks, and then we had the situation that we did of a mass run that required the government to step into the situation.

Ian Bremmer:

Larry, that could have almost been Schoolhouse Rocks, so thank you for that. Let me ask you, for most of the people that are watching this right now who don't have money directly at stake in either of those two banks, why should they care?

Larry Summers:

Well, they should care because they have a stake in the broad economy and when there are challenges to the banking system that affects the flow of credit, which affects everything from their mortgage, to the financing of the inventory at the stores where they shop, to the ability of their employer to get credit. In many ways, the financial system is a little bit like an anesthesiologist, nobody much notices the job they're doing until something screws up and then it becomes highly salient and highly visible and that's what happened for people who were worried about meeting payroll at SVB a couple of Mondays ago. And that's why we regulate an insurer, financial institutions so that people can go about their business without worrying about whether they're going to be major failures.

Ian Bremmer:

Who has acted most irresponsibly around this?

Larry Summers:

It's a race. There are a variety of candidates, but I would say the gold medal for incompetence goes to the management of SVB, which grew its deposit at a spectacular rate, didn't have a chief first officer for nine months, ignored the multiplicity of warnings about its interest rate mismatch, didn't engage in the most basic kind of bank planning that junior analysts are taught with respect to maturity mismatches and had the hubris to regard itself as a heroic worthy institution. I think the silver medal for incompetence probably goes to the Federal Reserve System in its regulation of Silicon Valley Bank and beyond. Because that regulation didn't stop this accident that was waiting to happen, and the authorities had plenty of authority to have forced it to raise capital much earlier, to have stopped it from paying dividends, to have forced it to interest rate hedge, to have done a whole variety of things. The progressive critics are right, that almost everything in the Trump era legislation, that Congress passed, moving to later touch regulation was misguided.

Ian Bremmer:

On not the biggest banks, this was on like the medium-sized-

Larry Summers:

On the medium-sized bank. That was bad, misguided legislation. That having been said, if that legislation had never been passed, there's very little reason to suppose that the outcome at SVB would've been any different, nor is it right just to blame this on the particular supervisors of SVB or even on the San Francisco Fed. Incredibly, in the spring of 2022, when it was obvious that the major economic and financial issue facing the country was inflation, it was obvious that the Fed was going to be embarked on a rate hiking cycle. The Federal Reserve did stress tests on its most sensitive clients, the biggest banks, and those stress tests paid no attention to the possible stress from rising interest rates. So it is a big kind of problem.

Ian Bremmer:

We've done some shows on Europe recently, when Liz Truss came out with, what looked like at the time, incredibly irresponsible fiscal policies, no taxation to ride against them and the markets just blew her out of the water over the course of a couple weeks. Is that kind of the geopolitical equivalent of what we've just seen happen to SVB?

Larry Summers:

I think you're reaching for that one a bit. I guess at a broadest level, they're two different situations where somebody made a big mistake and then a market blew them out. But I think the nature of what Liz Truss did and the nature of the particular problem that was present in British pension funds was rather different than the problem that exists at SVB. That was a case involving cascading liquidations, where there was a lot of forced selling and then that forced selling pushed prices all along. This was a rather different kind of situation, but I suppose in some ways there's the similarity that when you do sufficiently unsound things, you tend to be punished by the market.

Ian Bremmer:

Well, I'm wondering... The reason I'm asking is because I'm wondering if this is a time. I mean, given that interest rates have just gone way up, given all the challenges post pandemic, if you're now sort of in the big leagues, in other words, if mistakes that otherwise might not have had the same sort of backlash right now are going to get hit really hard and that we should expect that there's going to be a lot more of this in this environment going forward.

Larry Summers:

I think this is less about the same size mistake being punished more severely and more about this really being an epic size mistake. On the other hand, I think your point is a fair one in that when you have a very large and unexpected increase in interest rates, you are more likely to see mistakes than when you don't. In general, all of us are more likely to make big mistakes when we're in territory that's uncharted for us, than in territory where we have extensive experience, and that's true of bankers as well.

Ian Bremmer:

So let me turn for just a couple of moments to the policy response so far. I guess one question I'd want to ask is how do you rate Biden Administration, Yellen Fed, broadly speaking in response to this? And let's extend it to the EU and the ECB as well given what we're seeing not in the EU, but nonetheless on the continent with Credit Suisse.

Larry Summers:

These days at Harvard University, 68% of the grades are A, and the average grade point average of Harvard students is 3.8. So grades have sort of lost their meaning and getting an A doesn't do much. I think on the positive side, the decision to guarantee the depositors in SVB was very much a proper action and to have not taken it would've been to have courted substantial risks. I think something had to be done about Credit Suisse, and in that context, it was probably natural to expect something like what did happen to Credit Suisse to happen. And I think Madame Lagarde and Jerome Powell, in somewhat different contexts, both did the right thing by raising interest rates even though this was happening and making clear that they would deal separately with issues around financial stability.

I was not so enthusiastic about the way the SVB bailout has been handled 20 billion of... And let's face it, banks aren't people. When banks pay taxes, people ultimately pay taxes and fees. So $20 billion for the resolution of SIVB seems like an extraordinary sum and I wonder if that couldn't have been done considerably more inexpensively. I'm concerned that there's still too much ambiguity out there in the system about what will happen to uninsured bank deposits. And I wish there were a bit more stepping back to think about the final set of developments.

Ian Bremmer:

You referred to this as a bailout. Just a quick question for you. Biden, of course, strongly rejected that, was that just performative politics on his part or is there a difference between when the bankers are made whole and when they're not?

Larry Summers:

I think we're parsing a bit here. When banks have to pay extra fees, that means that people get less money on their deposits or people have higher yields on their mortgages or they get lower returns on their pension funds, but those are ultimately taxes that are paid by people in the economy. So to say that there's no burden on taxpayers when the burden is being placed on banks. I understand the point and there is a difference between banks paying and regular income taxpayers paying, but I think it's possible to exaggerate that point. And I also will want to look carefully at the details of that SVB transaction to see what's happening to the bond holders and whether they're in fact all being wiped out in the way that the White House suggested. But Ian, battlefield medicine is never perfect, and one of the things that I learned when I was in government was that I often did things for reasons that I'm pretty sure were fairly rational, but I couldn't explain to a broader public that was critical. So I don't want to make judgments about what's been done in an overly strong way.

Ian Bremmer:

So battlefield medicine is ugly. You also don't know when the next bodies are coming in, but if there were going to be some, where do you think those likely culprits are going to be? What is the next potential shoe to drop if this keeps going?

Larry Summers:

I think there may be issues in other banks that have very hot money deposits. I think those are less likely to take the form of bank runs than simply to take the form of substantially reduced bank profitability, which translates into reductions in the flow of credit. Looking across the economy right now, I'm probably particularly worried about real estate, and within real estate, about the office building sector, I've got considerable apprehensions about corporate lending to mid-size businesses. The activities that were heavy areas of emphasis for regional banks are, I think, particularly problematic.

Ian Bremmer:

Isn't it surprising that commercial real estate hasn't blown up given the fact that the biggest change in the economy in the US, post pandemic, is the fact that people just aren't going directly to their places of work the way they used to?

Larry Summers:

Remember Ian, that only about 20% of commercial real estate is office buildings. Remember, also, that if people come to work three days a week, that doesn't mean I only need 60% as much space as I did when they worked five days a week because I need to have the capacity to accommodate them all on the days when they're all coming in order to be together. After all, football stadiums are only used 10 times a year. And if you shed that the NFL teams were only going to play seven games a year, it wouldn't mean there was a lot less demand for football stadiums. And so I think it's a bit more complicated than one when it first supposed. But look, I think these things take time. Part of the reason they take time is that prior to COVID, people had signed longer term leases, and so even if they didn't need as much office space, they were still on the hook for lease payments and that was then protecting the office buildings.

But I do think as leases come due and don't roll over or roll over at substantially lower prices, you are going to see more and more pressure on the commercial real estate sector.

Ian Bremmer:

So we need to find some monster trucks to get in some of these commercial office spaces. That's pretty clear. Look, I want to ask you some other global questions, not take all of our time about the banks since I have you here. One, I know you're not an AI expert, but we're all talking about it, and I'm wondering if you were treasury secretary right now and you saw coming this AI explosion, what would you be watching for in terms of impact on jobs, impact on productivity in the United States? I mean, are you yet seeing anything that makes this feel truly transformative from an economic perspective?

Larry Summers:

I think I would be saying and reminding my colleagues of what I think is the most important aphorism with respect to technology. Things happen slower than you thought they would and then they happen faster than you thought they could. A good example of that is driverless cars. Six or seven years ago on shows like this, we would've been confident that they were going to be transforming the taxi and chauffeur industry by now, but they've really had almost no effect yet. Sooner or later, they will. And I think there are many examples like that. So I suspect there's going to be less impact than many people fear in most sectors over the next three years and more impact over the next 10 or 15 years. I think, ultimately, this is going to be very transformative on a large number of dimensions, and I think it's going to shake up a whole set of regular patterns.

For example, my guess is that AI will change what doctors do, diagnose people on the basis of complex information sooner and harder than it will change what nurses do by giving people basic medical treatments and giving them comfort and compassion. So I think there are a lot of traditional hierarchies and ways of thinking about the way organizations work that's likely to be quite profoundly changed here.

Ian Bremmer:

Should we be less concerned from a policy perspective since... I mean, if it's going to hit the high earners more and faster, those are also the people that have actually have access to the levers of political power so they can do things to help ensure that policies actually do address this in their favor, where if it's just about lower and middle class workers, these people can get hit for decades and no one's going to do anything about it.

Larry Summers:

That's a reasonable argument, Ian. It's also a reasonable argument though to suggest that because this is particularly threatening to some groups that are particularly influential, we may be even more likely to engage in restrictionist and protectionist policies that limit our ability to get benefit from these technologies or that slow down it's dissemination. It's very, very early, I think, to know what the impacts are likely to be. In general, I think it's better to let many flowers bloom than to overdo restriction on these kinds of things. But I think there's no question that... Questions of what's someone's own work, questions of what's real and what's unreal, these are all things that are going to be implicated by these technologies.

Ian Bremmer:

One of the fastest moving geopolitical sets of policies that could have massive economic implications is the decoupling of the United States and China on the technology front. I'm thinking specifically about semiconductors, export restrictions from the United States and increasingly aligned with allies. I'm also thinking, of course, about the CHIPS Act and significant efforts to build up those sectors in the United States and other friendly countries. Do you think this will be seen as a mistake? What do you think the impacts of it are?

Larry Summers:

Look, I think the impulses behind the restrictions are right, and I think the impulse behind the CHIPS Act is right. The question will really be around how well we execute. On exports controls, I think the right principle is small gardens, high walls, and I think there is a risk that we will try to restrict too much, and I think we need to think carefully about the fact that if we cut off all interdependence, we lose the leverage that comes from interdependence. And so I think we need to be careful about playing our card prematurely in a way with respect to leverage and influence on the Chinese. With respect to industrial policy, Ian, I have two views, I guess. One is, I think the best generals are the generals who hate war the most, not because they'll never fight it, but because they're reluctant to fight it.

And I think the best economists and policy thinkers in the industrial policy area are the ones who are most skeptical about industrial policy, not because they'll never do it, but because they'll do it in a way that goes with the market as much as possible and is oriented only to the areas like national security, like certain aspects of resilience where markets can be expected to fail. But when I hear people explaining that industrial policy is great because it's going to promote more jobs or it's going to promote particular categories of workers or it gives the opportunity for government to insist on daycare for certain employers, that's when I start reaching for my wallet and getting nervous about industrial policy. I would rather see a CHIPS Act that was solely focused on maintaining the resilience of the United States than a CHIPS Act that seems more broadly oriented to economic development in the United States. And I worry that that kind of thing can easily start to become corporate welfare.

Ian Bremmer:

I've got two more topics I want to ask you about quickly. One, on Russia, I've seen you talking a little bit about the idea that the frozen assets of Russia should be seized to help rebuild Ukraine. I've heard from Europeans that they think that that's legally not doable, and of course also if it is doable, it also leads to the possibility that these sorts of levers can be used against other countries, potentially freezing investments and causing unexpected knock on consequences, wondering your thoughts there.

Larry Summers:

So this is a rare case where the right thing to do and the expedient thing to do are the same thing. As between American taxpayers paying for Ukraine, and Russia, which has a debt to Ukraine having for all the damage it is done having its collateral on that debt, namely the frozen Russian assets seized. It seems to me very clear that the assets are the better means of supporting Ukraine. What I'm told by pretty authoritative lawyers like Larry Tribe who's argued more cases before the Supreme Court than anyone else is that the legal claim here is very strong. These are assets that are already frozen. Frozen assets in the context of the Iraq War were used for this purpose. Certainly, Russia has seized any number of foreign assets that are currently located in Russia. Russia certainly didn't have any compunction about German or Japanese assets in the context of the second World War.

So I think the legalities here are actually very clear. And if we set a precedent that the countries that engage in such want and aggression that their heads of state are labeled as war criminals, that the official state assets of those countries are going to be used to mitigate the damage that their aggression caused, that feels like a very good precedent to set in the world. And I don't believe that that's going to point towards the seizure of our country's assets. And even if it did, we don't have any significant level of foreign reserves that are currently held abroad.

Ian Bremmer:

I take that point and I appreciate you saying it. I think the Europeans are in a different position than you and the other, Larry Tribe. And of course, they've got a lot more of those assets right now at play than the US does, but it's important on the US side.

Larry Summers:

Some in Europe are make that argument. If you listen of late to the Swedish government, which is taking on the presidency of the EU, if you look at what Ursula von der Leyen, the European Commission president has said, I think there's a substantially divided opinion in Europe and this is a real time for American leadership.

Ian Bremmer:

Look, I think that it's interesting, there are a lot of people that are very happy to make the political points recognizing that that is going to make for good press coverage, but that they don't actually want to... They're not intending to actually push the policy when push comes to shove. Hey, the last question I want to ask you is one that disturbs me a lot, and this is.. These stats about US demographics and life expectancy, the US continues to slip farther and farther down the OECD league tables for so many reasons. And I'm just wondering what you think, if anything, the doable policy inputs to make a difference since... Here we're talking really about the future of the country, the future of the youth, strikes me as something doesn't get nearly as much play as it really should in the discussions of our policymakers.

Larry Summers:

I think that's right. I think it is not primarily about the healthcare system and access to healthcare. I think that the single most important thing we can do, and I'm not an expert on policy in this area at all, is find effective things to do about fentanyl, which is the single largest cause of the declining life expectancy. I think more broadly-

Ian Bremmer:

Yeah.

Larry Summers:

... this is related to what Angus Deaton and Anne Case called deaths of despair, and finding ways of generating more hope in some of the more depressed parts of the country is also a way in which we could make substantial progress. I think we do have to... I think in many ways the declining life expectancy in the United States is of a much smaller scale, but has some resemblance to what was happening in the Soviet Union in the 1980s. And the people who were quickest and were smartest and fastest to recognize what was happening to the Soviet Union, were not the military analysts and were not the economists, they were the demographers who were looking at that data, people like Murray Feshbach, people like-

Ian Bremmer:

Georgetown Prof, I remember Murray. Absolutely.

Larry Summers:

People like Nick Eberstadt.

Ian Bremmer:

Yep.

Larry Summers:

Their work was highlighted by the enormously present and perceptive, Senator Moynihan, and we have a bit of that going in the United States right now. It's tied up with the fraction of people who believe in patriotism having gone down the fraction of people who believe in community, having gone down the fraction of people who believe that their kids are not going to live as well as they did has gone way up. I confess, I've been thinking increasingly, Ian, that Jimmy Carter was perhaps 44 years too early-

Ian Bremmer:

On the malaise?

Larry Summers:

... when he decided to give a speech about the crisis of the national spirit. And I think it's something that our leadership class has to think a great deal about. It's something that I very much worry about in my world at Harvard where I spend a lot of my time and some of the places you spend a lot of your time. I'm worried about a disconnection with the concerns of a large number of our fellow Americans.

Ian Bremmer:

Larry, you fear that American society is in structural decline.

Larry Summers:

I think there is the risk of that, and I am corned between seeing a variety of disturbing indicators like the life expectancy that you mentioned, and also being aware that the history of American society, as with the example of the crisis of the national spirit declared in 1979 that I referenced, is that we Americans have a unique capacity for self-denying prophecy for Jeremiahs of doom, which then generate alarm, which then caused the prophecies to be wrong. That's how it was after Sputnik. That's how it was after Watergate. That's how it was after the crisis of the national spirit with inflation and the hostages in Iran. That's how it was after Patrick Henry declared in 1792 that the spirit of the American Revolution had already been lost.

And I wonder whether or not that may be happening again and that our best days are very much ahead of us, but that's not something that will happen automatically, and it's not something that any of us can take for granted. So I think what we need to do is find a balance in which there is warranted alarm, but that warranted alarm must never be allowed to become pessimism or fatalism or a source of encouragement and hope to our adversaries who I think have much more profound problems in most cases.

Ian Bremmer:

And a lot of willingness to amplify those sentiments as well. Larry, really important topic for us to close on, to be continued. Thanks so much for joining today.

Larry Summers:

Thank you.

Ian Bremmer:

That's it for today's edition of the GZERO World Podcast. Do you like what you heard? Of course you did. Why don't you check us out at gzeromedia.com and take a moment to sign up for our newsletter, it's called GZERO Daily.

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The GZERO World Podcast is brought to you by our founding sponsor, First Republic. First Republic, a private bank and wealth management company places clients' needs first by providing responsive, relevant, and customized solutions, visit firstrepublic.com to learn more. GZERO World would also like to share a message from our friends at Foreign Policy, an endangered purpose, a fish whose bladder fetches tens of thousands of dollars on the black market, the highly desirable and delicious, colossal shrimp. Travel to the Gulf of California on a new season of The Catch, a podcast from Foreign Policy and the Walton Family Foundation. You'll hear about the tension local fisherman face in providing for their families and protecting marine habitats and your role in returning balance to the environment. Follow and listen to the catch wherever you get your podcasts.

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