Why Larry Summers Shouldn't Be Fed Chairman

Why Larry Summers Shouldn't Be Fed Chairman

There's no question that Larry Summers, the former Treasury Secretary who is now on the short list to be the next Federal Reserve chairman, is both intelligent and politically savvy. If he's selected, however, we shouldn't delude ourselves into believing he'll be independent from Wall Street.

How Summers got rich
Despite spending most of his life in public service and academia, Summers has managed to amass a considerable net worth. According to The New York Times, his wealth soared from around $400,000 in the mid-1990s to between $7 million and $31 million in 2009, the year he joined the Obama administration. And since leaving public service once again at the end of 2010, it's likely to have grown significantly larger.

Much of Summers' newfound wealth comes from six-figure speaking engagements. Prior to 2009, for instance, it's estimated that he earned $2.7 million for speaking to the likes of JPMorgan Chase, Goldman Sachs, and Citigroup.

Beyond this, he's also worked directly for a number of the industry's biggest players. Between 2006 and 2008, he earned a purported $5.2 million from serving as an advisor to D. E. Shaw, a multibillion-dollar hedge fund based in New York City. And since his most recent Washington junket, he's been hired on by Citigroup, the megabank that owes its very existence to the federal government.

To be fair, assuming he's selected as the next Fed chairman, he wouldn't be the first public servant to have direct ties to Wall Street. Two recent Treasury Secretaries cut their teeth at Goldman Sachs, and both Paul Volker and Alan Greenspan came from within the financial industry.

People close to Summers claim this exposure won't impact his independence. "There has to be a distinction between talking to people, even for payment, and doing what they want you to do," a former colleague told the Times. "When it comes to Larry Summers, for good or for bad, he's uncontrollable when it comes to the positions he takes. He doesn't take them for that reason."

But while this sounds good in theory, there's little reason to believe it's actually true.

Conflicts of interest and decision-making
Over the last few decades, a growing body of research has documented the impact of conflicts of interest on decision-making. "Like a plant turning toward the sun," the authors of Mistakes Were Made (but not by me)say about researchers paid to conduct ostensibly impartial studies, "they turn toward the interests of their sponsors without even being aware that they are doing so."

The examples are legion. In one investigation cited by the authors Carol Tavris and Elliot Aronson, researchers examined 161 studies addressing the health risks of four separate chemicals. While 60% of the independently funded studies found harmful health effects, only 14% of the studies funded by the industry agreed.

Assuming the absence of outright fraud, Tavris and Aronson trace the disparity to confirmation bias. Discussing the effects of this in pharmaceutical trials, they note that "if you are motivated to show that your new drug is effective and better than older drugs, you will be inclined to downplay your misgivings and resolve the ambiguity in the company's favor. ... You will also be motivated to seek only confirming evidence for your hypothesis and your sponsor's wishes."

Approaching it from a slightly different angle, Robert Cialdini refers to this as the "rule for reciprocation" in his book Influence: The Psychology of Persuasion. "The rule says that we should try to repay, in kind, what another person has provided us." This is why Hare Krishna followers hand out flowers to weary travelers at the airport before requesting a donation.

"One of the reasons reciprocation can be used so effectively as a device for gaining another's compliance is its power," Cialdini writes. "The rule possesses awesome strength, often producing a 'yes' response to a request that, except for an existing feeling of indebtedness, would have surely been refused."

The bottom line
My point here is simple. Whatever you may think of Larry Summers as a policymaker, it's reasonable to conclude that he won't be unbiased toward Wall Street.

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John Maxfield has no position in any stocks mentioned. The Motley Fool recommends Goldman Sachs. The Motley Fool owns shares of Citigroup Inc and JPMorgan Chase. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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