Lawrence H. Summers's Blog

On Thursday, May 7, 2015, Summers talked with Bloomberg’s Stephanie Ruhl and Erik Schatzker at the Salt Conference in Las Vegas, NV.  They discussed Treasury yields, Europe, China and concerns about growth in the United States.  Summers talked of the “dawning and growing awareness in the market of the idea we may have a chronic excess of savings over investment in the economy — a phenomenon known as secular stagnation.” 

On May 4, 2015, on the 40th anniversary of Okun’s Equality and Efficiency book, Summers provided remarks at a Brookings Institute celebration. Summers wrote, “Art’s capacity for well rounded wisdom regarding the most important issues of the day was nowhere better illustrated than in Equality and Efficiency: The Big Tradeoff, the book whose 40th anniversary we celebrate today.  I still remember the excitement with which I read it as a first year graduate student.”  

Brookings Institute

May 4, 2015

I am told that I first met Art Okun days after my birth though I confess to not remembering.  I do remember calling him “Uncle Art” and playing baseball with his sons, my brothers, Art and my father at the playground near the house where I grew up.  And I remember as a 14 year old hearing his Fels lectures on stabilization policy at Penn and finding the idea that scientific analysis could lead to better policies which would prevent people from being unemployed to be incredibly exciting.  Not long after I started pressuring my parents to teach me economics—and was lucky to have parents who could do a splendid job of it.

I’ll talk in just a moment about the great book that we are here to discuss.  But first I want to say to say something about Art was part of the highlight and one of the lowest lights of the early part of my career.  The first significant paper I wrote was my paper with Kim Clark on Labor Market Dynamics published in the BPEA in 1979.  We were graduate students and Art was a leader of the profession but he and George Perry put tens of hours into getting our paper right, relevant and clear.  Never before or since have I received a critique of my work that was as penetrating or as constructive.  It was an immense gift and one that established standards I have tried to live up to ever since.

That was the highlight.  The low light came a year or two later when not too long after Art died, I propounded a somewhat half baked argument at the MIT economics department lunch table.  Skepticism was expressed.  I persisted.  Finally Paul Samuelson ended the conversation by remarking in words I have never forgotten—“Larry, I recently wrote a eulogy for Art Okun.  In it, I observed that I had never heard him say a stupid thing.  Well Larry, it looks now like I will not be able to say that about you.”

I learned something from Paul’s putdown and even more from Art’s example.  The stakes in economic policy making are enormous.   Economics is not physics—economic theories do not just describe the world—they can change it.  Rigorous modeling, effective polemic, or elegant mathematics can be very dangerous when they are not informed by wisdom and good sense and a willingness to learn from experience.

Art’s capacity for well rounded wisdom regarding the most important issues of the day was nowhere better illustrated than in Equality and Efficiency: The Big Tradeoff, the book whose 40th anniversary we celebrate today.  I still remember the excitement with which I read it as a first year graduate student.  It was the antithesis of the first year economic theory sequence in which I was mired: a thoughtful engaging rigorously logical analysis of real issues that were crucial to the wellbeing of the American people.

Rereading the book in preparation for writing a new forward for it, I was struck at one level by how well it reads today.   If a very bright student or policymaker or expert in another field was seeking an understanding of how economists think about the role of markets and issues of fairness, I would even today recommend Okun’s book.  While recognizing the many virtues of markets, he anticipates the arguments of subsequent critics like my Harvard colleague Michael Sandel when he discusses why it would be wrong to allow citizens to buy their way out of jury duty or sell themselves into bondage.

Okun is acute on the philosophical questions.  I suspect he would have rejected the terms of the debate slated to follow these remarks.  He would have said of course there are opportunities starting from where America is today to take measures like increasing access to higher education which would promote both efficiency and equity.  And he would have had many more examples that likely would have included closing tax shelters, attacking monopolies and fostering international economic cooperation.  At the same time, he would have recognized that there were likely limits on the amount of inequality reduction that could be achieved with policies that also accelerated growth.  And so he would have recognized that as usual in economics there are tradeoffs.  The more of one objective you achieve, the less you are likely to achieve of some other objective.  Substantial increases in redistribution are likely to come at some debatable cost in terms of economic efficiency.  So his balanced advice would have been to first implement policies that increase growth while increasing equality, and then consider those measures that involve trading off efficiency and equality.

At another level rereading Okun’s book reminds one of how much the economy has changed since the 1970s or even since the 1990s and as a consequence how much a sensible progressive policy agenda today is different than the one that was appropriate in the 1970s or 1990s.  In my forward to the reprinting of Equality and Efficiency I describe the major changes in the economy, and speculate about what Art would be recommending if he were with us today.  Rather than reprising that discussion here, let me conclude by noting how in areas relating to equity and efficiency my thinking has changed in response to a changing economy over the last 40 years.  This is not I believe because my values have changed but is rather because of changes in the economy and our understanding of it.

When Okun wrote and for some years afterwards economists believed that the distribution of income as reflected either in the profit share or the share of income going to different quintiles of the population was relatively constant.  It followed that the dominant determinant of the growth rate of middle income families was the overall economic growth rate or essentially equivalently that average wages would track productivity growth.  This led to great emphasis on measures that could be expected to raise productivity or productivity growth.

For many years now, it has been the case that the income distribution has been growing much more unequal.  In particular, the share of income going to the top 1% has risen rapidly from about 8% of income in the late 1970s to around 20 percent today.  And the share of capital income in total income continues to rise.  Updating a calculation performed a few years ago by Jason Furman and me, I recently calculated that if the income distribution were the same as it was in 1979, about $1 trillion more would be going to the bottom 80 percent of the population increasing their income by almost 25 percent and that about $1 trillion less would be going to the top 1 percent reducing their incomes about in half.

In this context unlike the one in which Okun wrote, it is clear that influencing the distribution of income and its trend has the potential to have a major impact on the well being of the middle class.  How?  With inequality higher and progressivity lower the case for progressive reform is strong. Certainly because of what has happened in the economy, I would in thinking about tax policy put much more emphasis on distributional issues relative to efficiency issues than I would have during much of my career.  Similarly, I believe that concern with issues relating to the cost of capital and the adverse effects of taxes in increasing it has been very legitimate at points in the past.  At present, when zero interest rates make capital costs as low as they have ever been but corporate profits are at record levels, there needs to be much less concern with capital costs and more concern with the distributional aspects of capital taxation.

The same basic idea that rising inequality tips the balance between fairness and efficiency applies in other areas of policy as well. So also does the emergence of deflation or lowflation as a threat to the  American economy.   Okun recognizes the minimum wage can be dangerously high and excessively strong unions can do damage if jobs are taken away and inflation is promoted.  These risks are remote today.  Indeed, more income for workers would likely contribute to more spending which would in turn increase employment.   When the minimum wage is actually lower in real terms than it was when Okun wrote, and when only 6.6 percent of private sector workers are covered by unions, I would judge that he benefit cost ratio seems tilted towards minimum wage increases and towards relaxation of the rules regarding the rights of private sector workers to bargain with management.

Another area where conditions have changed over the years is with respect to policy directed at the financial sector and corporate governance.  The financial sector has shown itself to be less of a source of diversification and stability and more of a source of instability than most judged a generation ago.  At the same time compensation levels in the sector, and in firms engaged with the sector has gone up rapidly.  The simultaneous emergence of high profits and low interest rates raises the question of whether monopoly power is on the increase.  So the question of regulatory actions looms much larger than it has for many years.

I could go on and talk about the equity benefits of a high pressure economy, mandated paid leave for those with family responsibilities and a range of issues.  I will though have made my point if I have whetted your curiosity with respect to Art Okun’s most influential book and made the case that in economic policy with regard to issues of equity, Abraham Lincoln had it right when he said “As our case is new, so we think anew, and act anew.”

Former Treasury Secretary Larry Summers said regulators should make a priority of addressing the problems of bond market liquidity, brought on by their very efforts to make institutions safer after the financial crisis.

Summers, speaking Thursday on “Squawk Box,” responded to comments made by JPMorgan CEO Jamie Dimon who said recent volatility in the currency and Treasury markets was a “warning shot across the bow.”

The drumbeat about liquidity questions in the corporate bond market but also Treasury market has gotten louder, and Dimon used his annual letter to shareholders as soap box to warn about the issue.

Bond market participants blame post-financial crisis regulations aimed at making the activities of financial institutions safer by restricting capital use. In the Treasury market, they point to the fact that the Fed holds a massive amount of Treasury supply on its more-than-$4 trillion balance sheet, keeping it off the market. Another issue often discussed by traders is the reduced head count at Wall Street’s primary dealers.

Watch the full interview here.

In an interview on April 19. 2015, with CNN’s Fareed Zakaria, Summers said, “This is a moment for us, as a country, to do what a business would do, which is to take advantage of low borrowing costs to invest in our future.” Summers told Zakaria, “This is not the right moment for a lurch to austerity.”

A ‘maddening’ situation: Larry Summers, the former U.S. Treasury Secretary under President Bill Clinton, had a similar take.

He warned that America’s economy is entering a period of stagnation — he dubs it “secular stagnation” — where it won’t be able to achieve its full growth potential because everyone is saving too much and not spending.

“We are doing less investment in infrastructure than at any time since the Second World War on a net basis,” Summers told Zakaria.

He went as far as calling the situation “madness” since it’s incredibly cheap to borrow money right now when interest rates are at a record low.

“[This] is a moment for us, as a country, to do what a business would do, which is to take advantage of low borrowing costs to invest in our future,” said Summers, who worked as a top adviser to President Obama. “This is not the right moment for a lurch to austerity.”

The U.S. economy grew 2.4% last year. That’s good, but not great. Since the end of World War II, America’s economy has expanded over 3% a year, on average. It has yet to get back to that point after the financial crisis.

Related: Where you tax dollars went

What needs to change? Like Paulson, Summers believes the tax code needs changes, especially to aid the middle class. He also supports raising the minimum wage, an issue that is taking center stage in the 2016 presidential race.

Several major corporations, including Walmart (WMT) and McDonald’s (MCD), recently raised wages for workers.

As 2016 candidates begin to form their policy teams, Paulson and Summers gave a preview on what the top economic issues are likely to be.

Yes, the U.S. economy is growing again after the Great Recession, but it’s affecting people differently. Wages for many workers haven’t gone up much, if at all, and they feel the inequality with the top. How to change that is up for debate.

In an interview on April 19. 2015, with CNN’s Fareed Zakaria, Summers said, “This is a moment for us, as a country, to do what a business would do, which is to take advantage of low borrowing costs to invest in our future.” Summers told Zakaria, “This is not the right moment for a lurch to austerity.”

A ‘maddening’ situation: Larry Summers, the former U.S. Treasury Secretary under President Bill Clinton, had a similar take.

He warned that America’s economy is entering a period of stagnation — he dubs it “secular stagnation” — where it won’t be able to achieve its full growth potential because everyone is saving too much and not spending.

“We are doing less investment in infrastructure than at any time since the Second World War on a net basis,” Summers told Zakaria.

He went as far as calling the situation “madness” since it’s incredibly cheap to borrow money right now when interest rates are at a record low.

“[This] is a moment for us, as a country, to do what a business would do, which is to take advantage of low borrowing costs to invest in our future,” said Summers, who worked as a top adviser to President Obama. “This is not the right moment for a lurch to austerity.”

The U.S. economy grew 2.4% last year. That’s good, but not great. Since the end of World War II, America’s economy has expanded over 3% a year, on average. It has yet to get back to that point after the financial crisis.

Related: Where you tax dollars went

What needs to change? Like Paulson, Summers believes the tax code needs changes, especially to aid the middle class. He also supports raising the minimum wage, an issue that is taking center stage in the 2016 presidential race.

Several major corporations, including Walmart (WMT) and McDonald’s (MCD), recently raised wages for workers.

As 2016 candidates begin to form their policy teams, Paulson and Summers gave a preview on what the top economic issues are likely to be.

Yes, the U.S. economy is growing again after the Great Recession, but it’s affecting people differently. Wages for many workers haven’t gone up much, if at all, and they feel the inequality with the top. How to change that is up for debate.

Can government actually make us less innovative?

That may be what’s happening, according to former Treasury Secretary Larry Summers. “The most important scientific discoveries tend to get made by people who are young and at their most creative stage. And the average age when people get their first grant from the National Institutes of Health is now above 40.”

Summers, who also directed President Obama’s National Economic Council, says anemic funding from federal sources may be restricting promising scientists – and depriving America of once-in-a-generation breakthroughs.

“If you look back, the Internet came out of federal government efforts to connect physicists. The semiconductor was a product of federal government research. Going back a long time, Abe Lincoln provided the necessary support that made a transcontinental railroad possible.”

But with companies like Apple and Google sitting on mountains of cash, why not let private industry bankroll great ideas?  Summers balks at the prospect. “No private company would have ever supported Watson and Crick when they discovered the structure of DNA. And yet the fact that life expectancies continue to rise is a reflection of biomedical research.”

“A Long Way to Go” on Women’s Progress

Summers also looked back with us on the media maelstrom that surrounded him a decade ago, when he asked why there aren’t more female professors in elite science departments.

He had considered possible answers during an off-the-record session at the National Bureau of Economic Research. But soon The Harvard Crimson, The New York Times, and others began reporting that some female professors walked out of the room when he said that aptitude or unwillingness to work long hours might factor in.

The next year, Summers stepped down as President of Harvard. But the question he was trying to answer still nags.

Now, he says that hidden biases – “unconscious patterns that many of us engage in” – may be at the root of the problem.

“I think it’s incumbent on all of us,” Summers insists, to send “signals of maximum encouragement to every person of talent and drive to do everything that their talent and drive permits.” He notes that “there’s been a great deal of effort in that regard, and there have been some results,” though “the results are not as favorable as many would like them to be.”

But the former Treasury Secretary and Director of President Obama’s National Economic Council believes that mandating behavior wouldn’t provide an adequate solution. “I’m not a person who believes you make progress on issues like this with quotas or with absolute requirements. I’m a person who believes you address this by changing attitudes and by creating opportunities.”

To that end, he points to a woman who might be his most famous former student: Sheryl Sandberg. Sandberg took Summers’ class on public economics as a Harvard junior, and made a lasting connection. “I was lucky enough to have Sheryl work with me at the World Bank and then at the Treasury. When I was Treasury Secretary, she served as my chief of staff… Perhaps most remarkable of the things she has done is the kind of leadership she has provided to so many other women with the set of concepts in her book, Lean In.”

This fall, a book by the writer Eileen Pollack will mark will mark the tenth anniversary of Summers’ divisive comments by delving into the sorts of subtle slights and assumptions that Sandberg often says cripple women on their rise to the top.

Summers has already read Pollack’s book, from which he “learned a great deal.”

“I think things are moving and they have a long way to go,” he says. “I don’t think any of us have any ground for complacency. I don’t think any of us should believe that all that can be accomplished has been accomplished.”

Hear our full interview with Larry Summers, including his concerns about inadequate federal funding for innovators and his look at higher ed’s moment of great transformation. Click here. 

 

In an interview with NPR’s All Things Considered on April 16, 2015, Summers discusses the new China-backed Asian Infrastructure Investment Bank. Summers says, ”We’re contemplating a major institution in which the United States has no role, that the United States made substantial efforts to stop — and failed.”

China says 57 countries have signed on as charter members of the new China-backed Asian Infrastructure Investment Bank. They include some of the United States’ closest allies, which added their names despite pressure from the White House not to join.

The Obama administration is concerned the new bank will compete with Western-led institutions like the World Bank and the International Monetary Fund, but leaders of those institutions don’t seem to be worried.

The AIIB,3 as it’s called, will be a chance for China to extend its influence by financing big infrastructure and development projects throughout Asia. World Bank President Jim Yong Kim told reporters Thursday that he welcomed the new bank. He said there is plenty of need for infrastructure spending.

“Our full expectation is that we’ll continue to work with them very closely and that there are many projects that I can foresee either cofinancing or working together on,” he said at the semi-annual meetings of the World Bank and IMF in Washington.

Meanwhile U.S. officials are taking a more cautious stance. They say they’re not averse to working with the new bank as long as the projects it finances observe environmental and worker safeguards. Still, the AIIB is being seen by some as a sign of diminished U.S. influence in the financial system.

“We’re contemplating a major institution in which the United States has no role, that the United States made substantial efforts to stop — and failed,” former Treasury Secretary Larry Summers says.

He says the creation of the AIIB will undermine the leadership role the U.S. has long enjoyed in global finance. And he sees it as something of a self-inflicted wound by the U.S. Summers says China acted in part because Congress refused to approve governance reforms that would have given Beijing more power at the IMF. Meanwhile, Washington has imposed tough standards on the World Bank that have dragged out the approval process for new projects.

“In a world where others have gained and in a world where we have had trouble meeting our obligations and living up to and ratifying our agreements, we have lost influence,” Summers says.

Harvard economist Ken Rogoff is more sanguine. He says China is already pouring money into development projects around the world. By lending money through a new multilateral institution, it will be forced to be more transparent.

“I think the right way of looking at it, is China’s doing this stuff anyway,” Rogoff says. “They’re going to normalize it, they’re going to have the British and others give them advice and I think it’s probably something we should welcome.”

Rogoff says that as a rising power, it’s natural for China to seek a bigger leadership role in the world. The AIIB could be a way to do so in a more constructive manner. He says the United States probably should have welcomed China’s move early on. Its failure to block the new bank has only underscored China’s growing financial might.

Listen to the full story here.

by Lawrence H. Summers

Lend It Conference, New York City

April 15, 2015

As delivered

It is a great privilege to be here, and I have to say, the size of this crowd, the entrepreneurial energy in this room, the extent of the dialogues and the deals being cut in these corridors gives me hope for the future of the lending industry, gives me hope for the renewal of the American financial industry, and gives me hope for the future of our economy, and the global economy.  And that is even without mentioning, Peter, my gratitude for having been introduced without the usual economist joke.  It was not so long ago that I was introduced by the guy who said, Larry, do you know what it takes to succeed as an economist?  And I said, no.  And he said, an economist is someone who’s pretty good with figures, but does not quite have the personality to be an accountant.  That was in Moscow and no one got the joke.

Here’s what I’d like to do today:  I’d like to talk to you about why I think this is a challenging time for the American economy, talk to you about why I think the conventional financial sector has, in important respects, let all its main constituents down over the last generation, talk to you about how I believe technology-based businesses have the opportunity to transform finance over the next generation, and reflect with you on the principles that should guide public policy with respect to the sector going forward.

This is a challenging time for the economy:

The American economy, at one level, we can take great satisfaction.  I can tell you I was there, that if you looked at any important economic statistic between the Fall of 2008 and the Spring of 2009, GDP, industrial production, unemployment, anything, it was worse than it had been after the fall of 1929.  The trend was faster and further down than it had been after the fall of 1929.  Depression was a real possibility.  Thanks to a combination of the vitality of the American economy and the policies that were put in place, we have not seen anything like a depression.

On the other hand, on the other hand, one has to look with very considerable concern at what has happened to the economy.  Today, the GDP of the United States is about 10 percent, or $1.6 trillion less than people expected it to be in 2015, as of 2007.  That $1.6 trillion lost represents about $20,000 for the average family of four, and that loss is taking place each year, and that loss is taking place against a backdrop of a United States that is doing relatively well compared to the global economy and particularly to the economy of the rest of the industrialized world.

If you look at markets, something quite remarkable is the case.  In Europe, the 10-year interest rate in Germany is 18 basis points.  In Japan, it is comfortably below 50 basis points.  In the United States, it is below two percent, and if you look at real interest rates, that is, interest rates adjusted for inflation, they are negative in Europe and Japan and about 20 basis points in the United States for a 10-year period.

What does that tell us?  All of that sloshing, all of that money, sloshing into government bonds, to the point where their yield is negative, is telling us that, despite all the opportunities that exist in the modern world, markets are seeing some kind of chronic excess of saving that is not being effectively channeled into investment. That failure means less investment, which means less growth, and that lower growth, in turn, means more pessimistic expectations.

THE FINANCIAL SYSTEM IN A MODERN ECONOMY:

What is the function of the financial system in a modern economy?  The function of a financial system is to connect those who want to put off consumption, whether it is for a rainy day, to send a child to college, to accumulate wealth, to build a house, to prepare for retirement, or to look out for one’s children.  It is to take those who wish to defer consumption and save and, in order those, in order to put those resources to good use among the large number of people who should have good use for resources such as living in a house before they’ve accumulated the wealth equal to the value of the house, putting in place necessary public infrastructure, or doing productive investment that raises the productivity of large number of workers.

It is the task of the financial system to make that connection, and if what we see is that that connection is not being made – then we are seeing lower levels of investment, lower levels of interest rates – that has to raise a question as to how well the mainstream financial system is functioning.

But one can raise a question about how well the mainstream financial system is functioning in a more direct set of ways:  Is it meeting the needs of borrowers?

Well, small business lending is a much smaller fraction of total bank lending than it was 15 years ago, and small businesses, not just in the United States, but in most parts of the industrialized world, report themselves to still be experiencing a credit crunch.

Home ownership rates in the United States have fallen behind by a generation.  It is appropriate and right that credit is not nearly as available for mortgages as it was in 2005 or 2006 or 2004.  It might be appropriate and right that it’s not as available as it was in the early 2000s.  It is, surely, not appropriate that credit is not nearly as available for middle class potential homeowners, as it was in the late 1990s.  It is not appropriate that private equity firms are reaping huge profits by renting homes to homeowners who cannot get mortgage credit and charging them rent that equals eight or 10 percent of the value of those properties.  It could be that those people could be paying three, or four, or five percent of the value of those properties and enjoying the appreciation, as well, if our financial system was doing a better job of providing credit.

Credit is increasingly unavailable for those wishing to pursue higher education because of the great difficulties that the mainstream system has had in distinguishing better from worse risks.  Renaud Laplanche famously got the inspiration to start Lending Club by asking himself, why it was, in the modern technology age, that if he put money in the bank, he got two percent, and if he tried to take money, he tried to borrow money from the bank on his credit card, he paid 17 percent, and this was in the era of computers.   Since Renaud Laplanche had that insight, spreads, administers of costs in mainstream banks have risen not fallen.

So, the first disappointing aspect of the mainstream financial system is that it has not succeeded and is succeeding less well than it once did in its basic function of providing credit to people.

The second respect in which the mainstream financial system has let us down is that if you look over a long period of time, the returns earned by investors in large, mainstream financial institutions, have fallen way short of market returns.  For a number of investors, for those who invested 10 years ago or 20 years ago on a long-term buy-and-hold basis, in a number of institutions that we can all name, the return has been negative 100 percent because they lost all their money.  Those who invested in a number of other institutions that still function on a large scale today, have lost more than 80 percent of their money, given the losses and the dilution associated with the financial crisis.  On average, returns have fallen far, far short of the S&P 500.

So, the financial system hasn’t worked so well for the benefit of its customers.  Borrowing is hard.  It isn’t working so well for the benefit of its creditors.  You don’t earn any money anymore when you deposit money in a bank, and it hasn’t worked so well for the benefit of its, and it hasn’t, and it hasn’t worked so well for the benefit of its share owners, either.

It also hasn’t worked so well for the rest of us.  Think about the last long generation.  We saw the Latin American debt crisis that brought the major financial institutions to the brink.  We saw the 1987 stock market crash.  We saw the S&L debacle.  We saw the New York City real estate crash.  We saw the 1994-1995 Mexican financial collapse.  We saw the 1997 Asian financial crisis.  We saw the 1998 LTCM Russia episode.  We saw the 2000 Internet bubble.  We saw the 2001-2002 Enron long-term high yield bond debacle, and all of that was a prelude.

It is high time for reflection on the renewal of the financial system and the creation of a financial system that will work more viably for savers and borrowers, and will work more viably for the benefit of the economy.  Some substantial part of that effort involves public policy.  It involves government regulation.  It involves the kinds of issues that people dealt with in Dodd-Frank.  It involves thinking about too big to fail.  It involves capital requirements.  It involves thinking about resolution regimes, and the like.  That is not my topic today.

TECHNOLOGY-BASED BUSINESSES HAVE THE OPPORTUNITY TO TRANSFROM FINANCE:

Some other very substantial part of the solution to that problem, to the renewal of finance around benefiting people rather than benefiting money lies in technological innovation and its application.  Because if you think about it, finance is an information-intensive business.  It’s all about information, and we are living through an extraordinary period of information technology innovation.

My Smartphone right here – this device costs about $500.  It has more computing power than the Apollo project did that sent a man to the moon.   It has more accessibility of information. If you have this device, than you have access to all of the Harvard libraries.  I work at Harvard.  If you gave me my choice – no Smartphone and free access to the Harvard libraries 24 hours a day or full access to my Smartphone, but no longer any access to the Harvard libraries, that would not be a hard choice.

And if you think about the ability to be in touch and connect with people around the world, you would rather have this device than have the White House communication system as it stood when John F. Kennedy was President of the United States.

And here’s the remarkable thing:  there will be a date; it might be three years from now, it might be seven years from now, but it won’t be 10 years from now, when there will be more Smartphones on Earth than there are adults.  Now, admittedly, that’s, in part, because there’s going to be some people in Hong Kong who have four, but we are not far from the day when almost everyone on Earth will have a Smartphone.

That is a moment of extraordinary potential for information technology innovation.  We do not know and we cannot forecast all the forms that it will take.  There was a very good book, or at least at the time it was thought to be a very good book, that was written by a Harvard colleague of mine and a MIT professor, in 2004, and it was an attempt to look very carefully and very thoughtfully at what technology could do, but what would still be the domain of the human brain, and what it would be a long time before technology could replace, and they chose a canonical example of something that was easy for humans but hard for technology.  That canonical example was making a left turn in the face of oncoming traffic.  Google solved that problem within five years after those sentences were written.

We do not yet know all that technology will be able to do.  We do know this, and it’s a good law for thinking about the world, whether you’re thinking about the arrival of financial crises or you’re thinking about the dissemination of technologies, we know that things take longer to happen than you think they will and then they happen faster than you thought they could.  That’s the way it was with the housing bubble collapsing.  That’s the way it was with the pervasiveness of the personal computer.  That’s the way it was with the Internet becoming part of the fabric of all of our daily lives, and that will be the way it is with respect to the next set of innovations.

So, as a general proposition, I would suggest to you that technology has immense potential.  And I would suggest to you that it is an oddity, that until quite recently technology has not been disruptive of mainstream finance.  Yes, there have been huge amounts of financial innovation, derivatives, different kinds of derivatives, whatever, but they have been more for the benefit of money than they have been for the benefit of people.  Paul Volcker was not exaggerating very much, if he was exaggerating at all, when he said four or five years ago that there hasn’t been an important financial innovation since the ATM.

I joined the Lending Club board because I believe that the thrust and the strain that is represented by all of you in this room, the application of information technology, to take frictions out and make finance work better, and, in particular, though this is not the only sphere where this is important, to do so with respect to lending, I believe, has the potential to, over time, be transformative of the financial system and to address its infirmities that I described a few moments ago.

What were those infirmities?  Frictions that were too large, that represented too large a gap between what savers receive and what borrowers pay.  Banking without banks can take three percent, five percent, six percent out of the cost of intermediation. Taking the friction cost out is profoundly making finance better, but that is only one of the benefits.  A second benefit is that the systematic use of data on a large scale will permit better credit judgments, and that will permit the more accurate allocation of capital.  The more accurate allocation of capital means higher returns, which is good for the providers of capital.  It means that capital will be available to the previously unrecognized creditworthy.  It means that those who are creditworthy, but have not yet been able to prove themselves to be creditworthy, will now be given opportunities to prove themselves to be creditworthy and enter the mainstream and see their borrowing costs decline over time.  It means that capital will be allocated more wisely, which means that there will be more efficiency in its use, which, ultimately means more jobs and better products throughout the economy.

Some of that’s going to come from better use of existing data.  Some of that will come from harnessing data streams that were previously available.  I’m privileged to serve also on the board of Square.  Square has an important new product, Square Capital, that lends to small business but with the informational and enforcement advantages that come from handling all of their credit card processing, which permits them to make much lower cost loans available, and to make decisions more rapidly.

The use of technology has a third major benefit.  It provides a much more satisfactory kind of consumer experience.  We live in a society because of all the ways in which we are conditioned, when all of us are less patient than we would have been a generation ago.  One manifestation of that is that if you watch the evening news, the average film clip of somebody being interviewed is now eight seconds.  In 1968, it was a minute and eight seconds.  Well, that growing impatience means that if we apply for a loan, we want to know the answer, yes or no, now, not yes or no in the mail three weeks from now.  We want to interact with institutions who don’t ask for our trust, but earn our trust through the efficiency with which they deal with us.  And if you look at the performance scores of firms like Lending Club, in contrast to the favorability ratings from consumers of large banks, it is an ocean of difference.

And so these models offer a better consumer experience, more informed allocation of credit, substantially reduced frictions, and I believe they have the opportunity also to contribute to greater financial stability in our economy.  They have the ability to contribute to greater financial stability in several ways.

First, the basic lesson of this field of ecology; a lot of things you learn in the field of ecology, but if there’s one take-home less from ecology it is this:  Diverse ecosystems are much more resilient than beautiful ecosystems.  A financial system in which credit is provided by banks, credit is provided through traditional capital markets, credit is provided through platform lenders, and credit is provided through specialty finance vehicles supported by information technology – a financial system that is more diverse – will be a financial system that is more stable.  It is a financial system that will be more free of the positive feedback loops that happen when credit contracts and, therefore, asset values decline, and, therefore, credit contracts, and, therefore, asset values decline, and it happens again and again.

If we can have more resilience in the basic provision of credit through more diversity, we can have a more stable financial system.  Platform lending doesn’t have the central connection to leverage that traditional banking does.  There is no entity that carries a balance sheet with leverage.  There’s nothing there that is too big to fail.  There is nothing there that requires deposit insurance.  There is nothing there that is implicitly subsidized, and there is, therefore, a greater contribution to stability, to the kind of stability that we seek to achieve.  And better information technology and better credit decisions mean less risk of failure and that, too, is a contributor to stability.

So, I believe that the financial system, traditional financial system, given its performance, is ripe for disruption.  I believe that it is more than most sectors the moment for disruption, given success and informational technology, and I believe that the nature of the incipient disruption, the use of information technology to lend in new ways, is directly responsive to the problems that have caused such dissatisfaction with the financial system over the last generation, and that have contributed to our economic problems, and those slow growth forecasts, and those remarkably low interest rates.

FIRST PRINCIPLES THAT CAN GUIDE PUBLIC POLICY FOR NEW LENDING:

How should public policy view all of this? I would suggest four precepts.  It will not resolve every specific regulatory question, but I think if we are able to follow these four precepts, the future can be very bright, both for entrepreneurs and for almost everybody because almost everybody is a stakeholder, one way or another, in the success of our financial system.

What are those precepts?

First, permission not prohibition.  Let new business models emerge.  Regulators should allow new firms to operate, generate data on the outcomes created by novel business models before writing new rules.  Yes, regulation is necessary, but only when it is necessary.

I was privileged to serve as Secretary of the Treasury, and in the Treasury Department, under President Bill Clinton.  One of the much less remarked, but I think more important, developments during his Administration was the decision in the mid-1990s to establish a presumption of permission with respect to the Internet.  It was not, at that moment, entirely obvious what the right approach was to this new technology, and the decision that President Clinton made, advised, ironically, by Ira Magaziner, who had earlier been an advocate of a very substantially regulated healthcare system.  The decision was, yes, we will be vigilant with respect to privacy.  Yes, we will be vigilant with respect to monopoly.  Yes, we will be vigilant with respect to national security, but that the presumption would be of permission, rather than a presumption of prohibition, and I believe that is hugely important with respect to new information technology, businesses generally, and it is important, in particular, with respect to lending business.

Second principle:  Insist on transparency and disclosure, then let consumers decide.  As new lenders serve parts of the market that have historically not had access to credit, high rates may draw regulatory scrutiny.  Regulators should require full transparency and disclosure, and see how consumers react to new products and prices before writing rules.  Make no mistake, I am not arguing for laissez-faire.  Make no mistake, there have been multiple instances in the past of financial innovation, in which consumers were substantially exploited.  We saw that with respect to a number of the innovations in mortgage finance just a dozen years ago, but, but we need, also, to recognize that people are not going to improve their credit without getting credit.  That when they get credit, they have the opportunity to improve their credit, and we need to allow those with new business models, seeking to reach new populations, an opportunity to show what they can do, as long as they do it with full transparency and full honesty.

Third principle:  Maintain a level playing field.  Don’t give incumbents an unfair advantage, but discourage business models based on unfair regulatory arbitrage.  Regulators should strive to put entrants on equal footing with incumbents, but to do so without sacrificing consumer protection.  No lending business, on-line or off-line, should get a pass on usury laws, on fair lending requirements, on disclosure, or on other critical safeguards.  At the same time, the choice to operate in non-traditional form should not mean an exemption from principles that have been regarded as appropriate to apply to all lending.

It is essential that requirements that are not longer appropriate, like the requirements for the monitoring of the balance sheet of banks, are not enforced on institutions that do not have balance sheets, but serve only as platforms.

Fourth principle:  provide workable regulatory frameworks.  To date, regulatory authorities have generally maintained appropriate attitudes towards innovative lenders.  It will be important as the industry evolves and grows that regulators not create overhangs of uncertainty or burden excessively those attempting to innovate.

If we can adopt these precepts and other related precepts, I believe that the next decade can be a period of unprecedented financial innovation in lending businesses.  That innovation can be a source of entrepreneurial innovation for those in this room and many, many beyond.  That, more importantly, it can mean that the basic function of a financial system to provide higher returns to savers, lower costs to borrowers, while permitting investments that drive the economy forward can be performed better in the future than it has been in the past.

Innovation in lending, payments, funding, and allocation of risk, I believe, offers tremendous potential for making the American economy and the global economy not just more efficient, but more secure and more stable. And when I think about the magnitude of the problems, and they are many, and I think about what I had a chance to see somewhat closely – the tendency towards dysfunction, the occasional ossification of tradition in Washington – I know that while the right public policies are hugely important, that the task of renewal of our financial system is not primarily one for public policy.  It is primarily one for entrepreneurial innovation, and that is why the size and growth of the LendIt conference seems, to me, to be so positive a sign for our future, and I am so very glad to have had the opportunity to address you.

Thank you very much.

On April 15, 2015 at the LendIt Conference in NYC, Summers explained how new lending models can play a critical role in growing the economy and detailed his views on how regulators should approach the new sector. Summers made the case for how financial innovation in lending is serving broad social objectives and laid out first principles for how policymakers should view marketplace lending.

Click here for a transcript of remarks, as delivered.

PRESS RELEASE

April 15, 2015 New York City– At LendIt 2015, the largest-ever gathering of the online lending community, Lawrence H. Summers will explain why new lending models can play a critical role in growing the economy and will detail his views on how regulators should approach the new sector.

“We are finally seeing financial innovation for the benefit of people, not just financial institutions,” Summers will tell the audience of more than 2,400. “The merits of financial innovation are on full display in the rapidly growing marketplace lending industry. New lenders are promoting the flow of credit in the economy and increasing economic efficiency.”

In his speech, Summers cites the ability of businesses like Lending Club and Square Capital (Summers is a Director at both companies) to use technology to improve every step of the credit allocation process: from lowering operating costs and processing time, to using more and better information to underwrite, to making smarter credit decisions.

For new lenders to reach scale and fully realize their promise of improving the flow of credit throughout the economy, policymakers must develop a framework to understand and regulate the new sector.

“Marketplace lenders can actually make the financial system safer,” Summers will say. Policymakers should take the opportunity presented by marketplace lending as a starting point for their analysis, Summers will argue. A financial system with multiple pillars is a safer one, and unlike banks, new lenders are more likely to be able to continue making loans in a downturn. And because marketplace lenders perfectly match assets and liabilities in duration and in loss bearing, they benefit the whole system by extending credit without adding systemic risk.

As policymakers investigate the marketplace lending model in detail, Summers will call for the articulation of a set of ‘first principles’ that aim to maximize the benefits of marketplace lending and minimize the social costs.

Summers’ first principles for regulating the marketplace lending industry are:

• Permission not prohibition: let new business models emerge. Regulators should allow new firms to operate, generating data on the outcomes created by novel business models, before writing new rules. Regulation is necessary but only when necessary.

• Insist on transparency and disclosure: then let consumers decide. As new lenders serve parts of the market that have historically not had access to credit, high rates will draw regulatory scrutiny. Regulators should require full transparency and disclosure and see how consumers react to new products and prices before writing rules.

• Maintain a level playing field: don’t give incumbents an unfair advantage, but discourage business models based on unfair regulatory arbitrage. Regulators should strive to put entrants on equal footing with incumbents, but without sacrificing consumer protection. No lending business – online or offline – should get a pass on usury laws, fair disclosure and other critical safeguards.

• Provide workable regulatory frameworks: To date regulatory authorities have generally maintained appropriate attitudes towards innovative lenders. It will be important as the industry evolves and grows that regulators not create overhangs of uncertainty or burden excessively those attempting to innovate.

 

Summers talked with Joe Kernen from CNBC’s Squawk Box on Thursday, April 9, 2015 saying, “Pre-emptive wars don’t work and  pre-emptive wars on inflation would be a big mistake.”  Summers also told Kernen, “We need to be all over the inflation data.”