MARGARET WARNER: Last week, former Treasury Secretary Lawrence Summers created a stir in the financial world with an op-ed piece headlined “Wake Up To the Dangers of a Deepening Crisis.” In it, he wrote, “the odds now favor a U.S. recession that slows growth significantly on a global scale.”
His view was at odds with the assessment President Bush offered at his press conference today that, quote, “the basics in the economy are good,” despite the “headwind” caused by the housing price and mortgage crunch.
Is the U.S. headed for recession, and what should be done to avert it? For that, we’re joined by Larry Summers, treasury secretary in the Clinton administration from 1999 until 2001. He’s now professor of economics at Harvard University. And John Snow, former treasury secretary under President Bush from 2003 until 2006, he’s now chairman of Cerberus Capital Management, a private equity firm.
And welcome, both of you, Misters Secretary.
Credit markets point to recession
MARGARET WARNER: And, Larry Summers, let's begin with you and your Financial Times piece. What evidence led you to the conclusion that odds are we're headed for a recession?
LARRY SUMMERS, Former Treasury Secretary: You look at the force of the headwinds, Margaret, what's happening in housing, where some markets are forecasting that prices could decline 20 percent or more nationwide. You look at the strains in the financial system, where it's pretty clear that credit is going to have to contract, as there have been losses at major financial institutions, and also requirements that they make loans they were never planning to because of various standby arrangements.
You look at the set of forces bearing down on the consumer -- falling house values, reduced availability of credit, increased oil prices, increased prices coming from the decline in the value of the dollar -- and it seems to me that, while nobody can make predictions with certainty, and you have to view the economy always, and particularly at a time like this, with great uncertainty, that the balance of risks does point in the direction of recession at this point and that, certainly, as one thinks about the priorities for policy, the risks that the economy will decline too rapidly seem to me to dwarf any kind of risk that the economy will overheat.
It seems to me that we've got the kind of situation where we know what our primary problem is and have to really put a focus on it.
MARGARET WARNER: All right. Former Secretary Snow, how do you see the balance of risk? Do you see it as Larry Summers does, or do you share the more -- I say more upbeat view that President Bush expressed today?
JOHN SNOW, Former Treasury Secretary: Well, I think Professor Summers' assessment is fundamentally sound. There are an awful lot of headwinds or negatives in the economy today that he's outlined there for you.
The biggest one in my mind is the credit markets. And credit is the fuel of this economy, and the credit markets simply aren't working today for reasons he's outlined. But this economy of ours is pretty resilient.
At the very time that housing is down, we see exports up. We see jobs continuing to be strong. We see profits continuing to be strong. So it doesn't have to be a self-fulfilling prophecy. Good monetary policy, good fiscal policy, addressing the credit markets with sensible and vigorous approaches here I think will avoid that recession, at least up the odds that it will be avoided.
MARGARET WARNER: But, Mr. Snow, and we want to get to the remedies in a minute, but let me just press you on this point. Do you think, all things being equal, the way things stand now, the odds now favor a recession?
JOHN SNOW: Well, the odds have certainly shifted, shifted with more a downward sentiment, with the sensitivities to the downside, as I think the Fed has recognized, in statements by the chairman and the vice chairman very recently.
And fortunately, the Fed is on guard, prepared to be nimble and respond, and that response by the Fed, I think, will be very helpful in avoiding that very much unwanted result of a recession.
Monetary policy plays a role
MARGARET WARNER: Now, Professor Summers, one of the possible remedies you ticked off in your piece had to do with lowering interest rates further, but the Fed has already lowered rates a couple of times since August, and yet the confidence level seems to be declining, and the fourth-quarter projections for fourth-quarter economic growth are down. So what would a further interest rate cut at the next meeting really do?
LARRY SUMMERS: You know, Margaret, every time we have an economic problem, there's always the question of, will monetary policy matter? Will changes in interest rates matter? Or will people just not invest anyway because they're discouraged?
The evidence is pretty overwhelming from American history, from the experience of many countries, that through a whole variety of channels, the provision of liquidity, more expansionary monetary policy does have an important effect on lending decisions, which in turn affects spending decisions, which in turn affects asset values, which in turn affects confidence, and feeds back to spending decisions, and the rest of it.
So I don't think that monetary policy is the only issue here by any means, but I think that monetary policy has to be used prudently, given the situation of the dollar, given the risks of inflation, which never are completely gone.
But I think the vast preponderance of professional opinion would be that monetary policy does have an impact. But, look, it's not the only issue. We've got to think about, on a standby, contingent basis...
Increased oversight may be needed
MARGARET WARNER: Let me just interrupt you there and ask you, then, just to follow up on what John Snow talked about, and you talk about in your article, which is the big problem of tightening of credit in general. What do you think needs to be done to continue the free-flow of credit?
LARRY SUMMERS: Well, I think you need to see institutions focus on raising capital to assure capital adequacy. And the moves by a number of institutions to issue new capital or to reduce dividends have, I think, been very constructive in that regard.
You need to see assets priced at levels that are realistic so that exchange can take place. And so I think the process of recognition and write-downs to real levels is a very important one. I think that process probably has some room to go, and I think it would be very dangerous if there were to be efforts made to inhibit that process, in the name of somehow restoring confidence.
I think that the central bank needs to be sure that it's in a position to provide liquidity, so as to assure that we don't get a situation where things are cramped up because banks don't feel they can get any access to funds. I think we need to address, in particular, the problems of homeowners.
MARGARET WARNER: Let me get John Snow's response, though, on that, in terms of the write-downs. Larry Summers in his piece said he thinks the $50 billion that's been announced so far by these big banks, the big financial institutions, is essentially the tip of the iceberg. It's going to be several times that.
Do you agree with that? What can be done to hasten the rate at which these write-downs occur and there's a sense that we really know the extent of the problem?
JOHN SNOW: I don't think we know the full extent of it, but I certainly agree that facilitating the marking of these assets to appropriate values makes an awful lot of sense. This may take some regulatory forbearance. I'm encouraged to see some of the banks doing it.
HSBC restructured their balance sheet and recognized losses. Citicorp has sought to bring capital in. We have a process here of both marking to market the assets that are overvalued and then recapitalizing the banks through new infusions of equity.
MARGARET WARNER: But I mean...
JOHN SNOW: That process is now underway, and it's a healthy and necessary process.
Role of government intervention
MARGARET WARNER: Let me finally end with the two of you asking you a broader question.
And, Larry Summers, to you first. There are critics out there, people who say -- I mean, you both seem to favor some sort of government intervention -- who say, you know, you can't bail out unscrupulous lenders or foolhardy borrowers or banks that took on risky loans and that we've just got to wring this excess out and let the system take its medicine. What do you say to that?
LARRY SUMMERS: Margaret, that was Andrew Mellon's philosophy in the late 1920s, and it made the depression great. It's not the right philosophy. There are people who have done wrong thing. They should be punished. There are people who've certainly lost very prominent positions as part of this. There are a variety of issues of prevention that we're going to have to look at when this is over.
But the right focus for public policy right now isn't the bankers. It isn't the balance sheets. It's doing what we can to make sure that regular Americans who've never heard of a mortgage-backed security, who don't know what an ABX tranche is, are able to live their lives and build on the great strength of the American economy. That's where we should be focused.
MARGARET WARNER: A quick, final word from John Snow on this, in terms of about whether we should be bailing people out.
JOHN SNOW: The key issue is no longer imprudent lending; that's been dealt with. The key issue now is getting the financial system to work again. And unless we get it working again, unless we get credit extended to credit-worthy borrowers, then Professor Summers' forecast of a possible recession is very hard to avoid.
MARGARET WARNER: All right, John Snow, Larry Summers, thank you both.
LARRY SUMMERS: Thank you.
JOHN SNOW: Thank you.