The Compleat Summers

Obama’s new White House deregulator.

Former Senator — and former Democrat — Phil Gramm likes to say there are two kinds of Democrats on economics: those who want to milk the cow but so dislike the cow that they want to punish it, and those who want to milk the cow and thus want it to grow. The good news about Barack Obama’s emerging economic team is that most of them don’t hate the cow.

[Review & Outlook] AP

Larry Summers

Take Larry Summers, the economist who will run Mr. Obama’s National Economic Council at the White House. We have our differences with the former Harvard President, in particular on the incentive effects of high taxation and the growth impact of government spending. Mr. Summers thinks marginal tax rates can rise significantly — above 50% — before they deter risk-taking and reduce federal revenues. But at least he thinks that taxes matter at some point.

As for spending, Mr. Summers is one of those economists who believes in the Keynesian “multiplier.” This quaint notion holds that every dollar of federal spending yields something like 1.5 times that in economic growth. This ignores the fact that the $1 in spending has to come from somewhere, which means it is taken from the private economy in higher borrowing or higher future taxes. We thought we’d buried this Keynesian money illusion 30 years ago, but it’s now coming back to justify a half-trillion dollars in new spending.

On the other hand, Mr. Summers understands that government decisions can do real economic harm. And on financial regulation in particular, he has sometimes played a constructive role. At Treasury during the 1990s, he let his staff raise doubts about the taxpayer-subsidized risks of Fannie Mae and Freddie Mac. This summer, as Fan and Fred melted down, he explained what went wrong:

“The illusion that the companies were doing virtuous work made it impossible to build a political case for serious regulation. When there were social failures the companies always blamed their need to perform for the shareholders. When there were business failures it was always the result of their social obligations. Government budget discipline was not appropriate because it was always emphasized that they were ‘private companies.’ But market discipline was nearly nonexistent given the general perception — now validated — that their debt was government backed. Little wonder with gains privatized and losses socialized that the enterprises have gambled their way into financial catastrophe.”

Nicely put. With the companies now in conservatorship, Mr. Summers will have a chance to ensure that they aren’t merely restored to that perverse status. We look forward to his debate with Barney Frank, Chris Dodd, and Fannie’s other protectors.

Mr. Summers also helped to pass the Gramm-Leach-Bliley financial “deregulation” of 1999. His predecessor at Treasury, Robert Rubin, had resisted the necessary compromises. But upon taking the Treasury chair, Mr. Summers pressed ahead and agreed to changes in the Community Reinvestment Act, among other things.

In the loopy left telling, Gramm-Leach-Bliley caused the current mess by allowing commercial and investment banks to merge. Bill Clinton has himself debunked that myth (see “Bill v. Barack on Banks“), and in fact the reform has helped in the current panic by letting the likes of J.P. Morgan and Bank of America buy ailing investment banks. Mr. Summers’s contribution was to grant that regulation is not always virtuous — a useful lesson as Congress aims to remake the financial marketplace.

We realize that our praise here won’t help President-elect Obama or Mr. Summers with liberal critics. But don’t worry, gents. We promise to help on that score soon enough.

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