We have read in the fawning American press and heard from various TV commentators, almost ad nauseum, have we not, that Larry Summers, ex Harvard President, is one of the smartest, sharpest economists of his generation.
The story here should, I hope, put an end to that kind of thinking. It was under his administration (2001-06) and with his approval that large bets were placed on interest rate trends using derivatives. Thanks largely to him, Harvard has taken a huge loss.
Here is an excerpt from Harvard Magazine, December 2008
...According the annual financial reports, Harvard has entered into various “interest-rate exchange agreements” at least since the early 1990s.
Their magnitude, though not their structure, is reported in the footnotes describing bonds and notes payable and the University’s overall investments.
Depending on their structure, on the volume of such agreements outstanding (which relates to the University’s aggregate financing activity), and on prevailing interest rates, the “fair value” of the agreements—how much Harvard would receive, or would have to pay, to terminate the agreements as of the date of its financial statements—is shown each year.
During the current decade, these are the reported figures for the fiscal year ended June 30, showing the “notional” amount of the agreements, and then the fair value the University would have received or (paid) to terminate the agreements on that date (dollars in millions):
2000 $ 443.1 $ 3.7
2001 341.1 ( 20.8)
2002 619.2 ( 41.4)
2003 720.5 (120.0)
2004 1,376.6 ( 58.4)
2005 3,723.8 (461.2)
2006 3,542.6 ( 17.9)
2007 3,533.9 ( 13.3)
2008 3,524.7 (330.4)
Summers was paid millions by a hedge fund, DE Shaw, to advise on financial matters. There could be only one purpose for a handsome consulting fee: how to make a profit for DE Shaw's funds.
Surely interest rate as an economic topic should have been right up Larry's alley? He being a professional economist, ex Secretary of Treasury, the youngest tenured Harvard professor in that famous department of economics and, again, we are told, one of the "brightest in his generation".
It has always been a source of mystery to many economists in the United States and abroad why President Obama is so captivated by the "brilliance" of Larry Summers.