Extracurricular Activities: How Wall Street’s Grasp Extends Past Washington and into the Classroom

Alex Mabie, JHU:

The financial services industry set aside over $5 billion for lobbying efforts and campaign contributions between 1998 and 2008 (Opensecrets). This staggering figure far exceeds any other industry and accentuates the revolving door between Washington and Wall Street. There are numerous cases in which prominent individuals who served at some of the world’s biggest banks decide to relocate to D.C. to and take up the responsibility of “regulating” their former workplaces.

However, the financial industry also wields its power in a more subtle way; it has intimate ties with the world of academia. Business school professors and economics professors discreetly accumulate substantial sums of money while helping the financial industry form public debate and government policy. There are a number ways that these individuals can make extra cash outside of the classroom (Ferguson).

Companies and special interest groups pay reputable financial economists to give speeches, participate in conferences, and serve as consultants, advisers, or corporate directors. There are even cases in which professors have received outside compensation for testifying before Congress. Firms such as Compass Lexecon, Charles River Associates, and the Analysis Group form a multi-billion dollar industry that provides knowledgeable academics for hire (Ferguson). Regardless of the specific setting, this practice introduces the potential for massive conflicts of interest when economists publish work relating to firms to which they may have financial connections.

Perhaps nobody embodies what is wrong with financial economics and academia in the U.S. more than Lawrence H. Summers. He is a world-renowned economist who served as Secretary of the Treasury under the Clinton administration. Mr. Summers played an instrumental role in the consolidation and deregulation of the U.S. financial system.

Congress enacted the Glass-Steagall Act after the Great Depression. The law prohibited commercial banks with consumer deposits from owning investment banking arms. In 1998, Citicorp acquired Travelers to form Citigroup, the world’s largest financial conglomerate. The merger violated the Glass-Steagall Act. However, Alan Greenspan, the Chairman of the Federal Reserve, exempted Citigroup from Glass-Steagall for one year. During that time, Larry Summers put strong pressure on Congress to pass the Gramm-Leach-Bilely Act, which repealed Glass-Steagall. 1999 came, and Citigroup was a legal entity. (Ferguson).

Mr. Summers also took a strong stance in the fight to deregulate financial derivatives.   Derivatives are complex securities that derive their value from underlying assets, such as stocks, bonds, or currencies. These financial instruments essentially allow bankers to place bets on any type of movements in the market. For this reason, they have the potential to be highly risky destabilizing investment vehicles. Until 1998, nobody had attempted to regulate the market for derivatives. In that year, the Commodity Futues Trading Commision issued a proposal for derivatives regulation. Larry Summers, along with the Fed Chairman Alan Greenspan, shot down the CFTC’s efforts and suggested legislation to fully protect derivatives from any sort of regulation. In 2000, Congress passed the Commodity Futures Modernization Act, which did exactly that (Denning). After this, the use of derivatives and financial engineering exploded, only later to be proven one of the main causes of the 2008 financial crisis.

Mr. Summers continued his advocacy of financial deregulation after leaving government. He also became President of Harvard University in 2001. During his time as president, he grew enormously wealthy through many entanglements with several bulge bracket firms. Mr. Summers earned over $20 million between 2001 and 2008 consulting for and speaking at several of the biggest banks on Wall Street, including JP Morgan Chase, Merrill Lynch, Citigroup, and Goldman Sachs. In 2008, he reentered the public sector as the Director of the National Economic Council under the Obama administration (Ferguson).

Another faculty member of Harvard University, Martin Feldstein is one of the world’s most influential economists. He is a professor of economics and the former president of the National Bureau of Economic Research (NBER), where he served from 1978 to 2008. Mr. Feldstein, like Mr. Summers, gave critical support to aggressive financial deregulation while he served as the chairman of the Council of Economic Advisors and chief economic advisor to President Ronald Reagan. During all of this, Mr. Feldstein was a member of the board of AIG and AIG Financial Products. He served from 1988 to 2009, making over $6 million (Ferguson).

Dr. Laura D. Tyson is a very prominent voice in economics and currently teaches in the Walter A. Haas School of Business at University of California, Berkeley. She was dean of the London Business School prior to joining Berkeley. Dr. Tyson served as the President’s National Economic Advisor in the Clinton administration. However, she rarely discusses her role on the board of directors at Morgan Stanley, where she earns $350,000 annually (Chan).

Glenn Hubbard is currently the dean of Columbia Business School, where he teaches finance and economics. He was also the Chief Economic Advisor to President George W. Bush. Dr. Hubbard earns $250,000 a year as a board of director at MetLife. He is also on the board of the following financial services firms: BlackRock, Kohlberg Kravis Roberts Financial Corporation, and Ripplewood Holdings (Hubbard). In 2004, Hubbard co-authored a paper with the chief economist of Goldman Sachs, William C. Dudley. In the paper, the two incorrectly praised risky financial derivatives, citing that they improve the stability of the financial system and the economic system at large (Hubbard and Dudley).

In 2009, two Bear Stearns hedge fund managers, Ralph Cioffi and Matthew Tannin, were prosecuted for securities fraud. Investors in their fund, who were misled about the severity of their investment pools’ safety, lost $1.6 billion. Mr. Cioffi and Mr. Tannin were indicted in mid- 2008, a year after their funds failed. Bear Stearns collapsed less than a year later (Abelson). During their trial, the two men hired the Analysis Group to assist them in the litigation. The Analysis Group paid Glenn Hubbard $100,000 to testify in the defense of the two managers. The jury soon acquitted both of their charges (Ferguson).

One of Dr. Hubbard’s colleagues at Columbia Business School is Frederic Mishkin, a professor of finance and economics and researcher at the NBER. From 2006 to 2008, he served on the board of governors of the Federal Reserve System. In addition, Professor Mishkin consults for the Federal Reserve Bank of New York, BTG Pactual, a Latin American investment bank, and four hedge funds (Mishkin). In 2006, Dr. Mishkin co-authored a report entitled Financial Stability in Iceland. The paper grossly exaggerated the health of the country’s economy, which would deteriorate into shambles just two years later (Mishkin and Herbertsson). Mishkin also chose not to disclose on the paper that the Icelandic Chamber of Commerce had paid him $124,000 to conduct the study (Ferguson).

The conflicts of interest in economics have certainly incited concern in some representatives in the field. Many have realized that without knowing who is funding economists, the public cannot trust their research. Until 2010, when instances like those mentioned above were first being discovered, the economics profession had no established ethical code. Other professional academic associations such as those in psychology, statistics, political science, and physics had adopted formal codes of ethics decades earlier (“Dismal Ethics”). Several hundred prominent economists sent a letter to the American Economic Association, urging the professional body to ratify a code of ethical standards for the field of economics (Casselman). Bill Allison put it well, saying “if someone is presented as a disinterested expert, but they actually have a financial relationship with someone with an interest in what they are talking about, that leaves the members of the public in the dark and sometimes members of the committee as well” (Cooke and Da Costa).

At the same time, others in the field are less troubled by its conflicts of interest. John Y. Campbell, the chairman of Harvard’s economics program, sees the connections between academia, government, and industry as merely irrelevant (Ferguson). Those who share this view argue that these professors are being paid to say what they would have said regardless of commission. However, this is unlikely. At least in the case of Dr. Mishkin, he showed no professional interest in the Icelandic economy until he was compensated to do so. In addition, his findings were completely wrong. It is rare that these professors reach conclusions that oppose the financial interest of their clients. Moreover, these individuals do not wish to disclose their funding.

Over the course of my research, I was looking for a way to shrink down this huge issue to a size that I could access. As a student interested in pursuing a career in the financial services industry, I think a lot about the ethical implications of entering the field. However, I know that I won’t be able to rid Wall Street of its vices from the seat of classroom. I will be better suited for that task once I have experience in a formal professional setting. I do, however, have an opportunity to address the issue from the opposite side of the spectrum: academia.

As I learned about the individuals above, one of their names kept ringing a bell as I read more and more: Hubbard. I couldn’t figure out why the name Glenn Hubbard sounded familiar to me until several days after I began my research. I was clearing out some of my old textbooks from the fall semester, and saw Macroeconomics my desk drawer. The author is Glenn Hubbard. While the elements of macroeconomics are fairly basic and undisputed, I still wonder to what degree my education suffered from the financial agenda of an unscrupulous economist.

 

Works Cited

Abelson, Max. “Ralph Cioffi, After the Fall.” Observer. N.p., 17 Aug. 2010. Web. 10 Mar. 2015.

Casselman, Ben. “Economists Set Rules on Ethics.” WSJ. The Wall Street Journal, 9 Jan. 2009.

Web. 10 Mar. 2015.

Chan, Sewell. “Academic Economists to Consider Ethics Code.” The New York Times. The New

York Times, 30 Dec. 2010. Web. 10 Mar. 2015.

Cooke, Emily Flitter Kristina, and Pedro Da Costa. “Special Report: For Some Professors,

Disclosure Is Academic.” Reuters. Thomson Reuters, 20 Dec. 2010. Web. 10 Mar. 2015.

Denning, Steve. “Big Banks and Derivatives: Why Another Financial Crisis Is Inevitable.” Forbes. Forbes Magazine, 1 Aug. 2013. Web. 11 Mar. 2015.

“Dismal Ethics.” The Economist. The Economist Newspaper, 08 Jan. 2011. Web. 10 Mar. 2015.

Ferguson, Charles. Inside Job. Sony Classics, 2010.

Ferguson, Charles. “Larry Summers and the Subversion of Economics.” The Chronicle of Higher

Education. The Chronicle of Higher Education, 3 Oct. 2010. Web. 10 Mar. 2015.

“Finance, Insurance & Real Estate.” Opensecrets RSS. Web. 11 Mar. 2015.

Hubbard, Robert G. “Robert Glenn Hubbard, Curriculum Vitae.” (n.d.): n. pag.

Www.gsb.columbia.edu. Columbia Business School. Web. 10 Mar. 2015.

Hubbard, Robert G., and William C. Dudley. “How Capital Markets Enhance Economic

Performance and Facilitate Job Creation.” Www0.gsb.columbia.edu.

Columbia Business School, Goldman Sachs, Nov. 2004. Web. 10 Mar. 2015.

Mishkin, Frederic “Curriculum Viate, Frederic Mishkin.”

Columbia University, May 2014. Web. 10 Mar. 2011

Mishkin, Frederic, and Tryggvi Herbertsson. “Financial Stability in Iceland.” Icelandic Chamber

of Commerce (2006): Web. 10 Mar. 2015.

Weidner, David. “Hiding, Harboring, Hoarding at Harvard.” WSJ. The Wall Street Journal, 23

Sept. 2010. Web. 10 Mar. 2015.

 

 

 

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