An Airport Store, Compared to the Founding of a Mutual Fund

Jacob Frenkel, 70, is the original economist-turned-policy-maker, the first to blaze a trail well-travelled now by Ben Bernanke and several others, from seminar room to chairman’s office of a central bank. A student of Robert Mundell and Harry Johnson, at the University of Chicago, Frenkel (and Rudiger Dornbusch and Stanley Fischer) of  effected a momentous change in the early 1970s in the way the balance of payments among nations is understood as mainly a monetary phenomenon.

He was the David Rockefeller Professor of International Economics at Chicago until 1987, when he became chief economist of the International Monetary Fund. He served two successful terms as governor of the Bank of Israel from 1991 to 2000, then went to Wall Street and made a small fortune, first as chairman of Merrill Lynch International, then as vice chairman of American International Group, the insurance giant. Since 2009 he has been chairman of JP Morgan Chase International.

His nomination to a third term as head of Israel’s central bank seemed assured, starting in October, until Chinese authorities let it be known that he had been arrested and held for 24 hours for shoplifting a garment bag in the Hong Kong airport in 2006. Frenkel countered that he thought a colleague had paid for the item before he left the shop that day. But he had failed to mention the incident to the committee that vetted him for the job.  He withdrew his candidacy last month.

So what will the Russians think if Lawrence Summers is nominated to head the Federal Reserve Board?  They may be reminded of Bertolt Brecht’s line from The Threepenny Opera, “What is robbing a bank compared with founding a bank?”

The incident in Summers’s career in government most likely to derail his candidacy has to this point been largely ignored.  As a rising star in the Clinton Treasury Department in the mid-1990s, Summers was at the epicenter of a case of corruption in which the US government’s reputation for probity was seriously damaged abroad – in Russia in particular. That he occupied the spot just above the earthquake doesn’t mean he wasn’t involved. For nearly twenty years he has managed to keep his role in the affair out of the public eye – not so much a cover-up as an enduring whitewash.

What happened is this. In May 1997, a US advisory mission to the Yeltsin government of Russia, administered by Harvard University, was abruptly shut down after an investigation by the US Agency for International Development.  Allegations had surfaced that project director Andrei Shleifer, a Harvard University professor, his wife, bond trader Nancy Zimmerman, his deputy, Jonathan Hay, and Hay’s girlfriend (now wife) Elizabeth Hebert, had not only violated their contract with the US government by trading in Russian securities; they had enlisted their Russian counterparts in an attempt to muscle in on the Russian mutual fund business, then thought to be the key to the coming privatization of state-owned enterprises. As Carla Anne Robbins and Steve Liesman wrote in The Wall Street Journal a few months later, “What made the allegations especially surprising was that the Harvard men had been assigned to promote, among other things, Western ideals of fair play.”  .

Even more surprising, though unmentioned at the time, was that Shleifer’s best friend, former Harvard University professor Summers, had general oversight of US aid to Russia in the aftermath of the Cold War as Deputy Treasury Secretary. Summers had known the young émigré since 1980, when the Harvard College sophomore signed on as Summers’s research assistant. (Shleifer had grown up in the former Soviet Unions; he was fifteen when his parents obtained permission to leave.)  Summers recommended Shleifer to the Massachusetts Institute of Technology for graduate work, and lobbied for his return to Harvard from the University of Chicago in 1992, in time to direct the project, which the Clinton administration commissioned soon after the 1992 election. The two economists and their families often vacationed together, including the summer of 1996.

The incident was widely ventilated in the Russian press, reinforcing the skepticism of US intentions, but it quickly faded from view in the United States. Shleifer returned to his teaching job at Harvard, and, behind the scenes, was influential in construing the Russian financial crisis in 1998, after which Time magazine called Fed chairman Alan Greenspan, Treasury Secretary Rubin and his deputy Summers “The Committee to Save the World.”  Harvard quit the advisory business and disbanded its Institute for International Development. Summers succeeded his mentor, Robert Rubin, as Treasury Secretary.  In the closing months of the Clinton administration, the Justice Department sued Harvard, Shleifer, Hay and Zimmerman, seeking treble damages from the university for the mission gone awry.

Meanwhile, Summers tried out for the Harvard presidency, staying with the Shleifer family while interviewing. Once hired, Summers urged faculty dean Jeremy Knowles to retain his friend. The university elected to fight the government’s complaint.  Summers brought Rubin onto the (then) seven-member corporation that is the university’s governing body. And, testifying under oath, Summers, now the president of Harvard, dismissed the adverse consequences of his friends’ frisky financial behavior: “I had enough knowledge of Russian mores and Russian practices and Russian views from the conversations that I had with Chubais and Vasiliev [senior Russian officials] to be confident that the set of issues contained the allegations were not issues that were consequential for them; and indeed that they would have, in part, valued advisers more extensively if they were more involved in actual private-sector activities.”

Four years later Harvard, Shelifer and Hay all lost their case, both in the jury trial that established that the contract existed, and in a federal judge’s finding that they had indeed breached it, failing to deliver disinterested advice, though the university avoided the threefold return of the $34 million value of the contract that the government had sought. Zimmerman settled her complaint. Summers’s disavowal of any knowledge of the matter contributed to his forced resignation, particularly after a thorough account of the affair appeared in Institutional Investor. (See this widely-read Huffington Post piece by Harvard professor Harry Lewis for details.)

Shleifer eventually was stripped of his endowed chair but retained his professorship, and faculty dean Knowles sealed the Committee on Professional Conduct thorough and painstaking report. When Summers returned to Washington, this time to the White House, as President Obama’s top economic adviser, he prominently mentioned Zimmerman, by then a billionaire hedge fund proprietor, as among his kitchen cabinet of advisers.

The striking thing is the extent to which Summers has been sheltered over the years in the telling of the story.  He has, of course, benefited from an enormous reservoir of good will from the beginning of his career.  He is technical economics’ foremost princeling: both parents were economists and had distinguished careers of their own, while Paul Samuelson was his father’s brother, and Kenneth Arrow is his mother’s brother. By now he is the proprietor of an enormous favor bank as well.   Journalists’ books about Russia in the 1990s neglect to mention the Harvard scandal.  So do accounts by diplomats and development professionals. Newspapers haven’t followed the story.  Economist bloggers such as Paul Krugman, Gregory Mankiw, J. Bradford DeLong and Tyler Cowen have given it a good leaving alone.  (Let’s see who among them links this weekly.) And last month, moments before MIT professor James Poterba, president of the National Bureau of Economic Research, gave Summers a glowing introduction to a ballroom that contained dozens of European and not a few Russian economists, a smiling Shleifer glided across the front of the hall.

The Frenkel story demonstrates that it is harder than ever to stay out of the limelight once the stage is truly global. The story of Harvard’s Russia scandal may not be well-known in the United States or Great Britain, but its ironies are familiar to well-informed citizens in the former Soviet Union.  Some part of the saga could have gone through Vladimir Putin’s mind in the course of his Dublin meetings with Barack Obama last month; its implications (does he know?  does he know and not care?) may have contributed to the Russian president’s thinly-veiled contempt. It is like Jacob Frenkel and the vetting committee.  You have to wonder why Summers has put the president in this position.

3 responses to “An Airport Store, Compared to the Founding of a Mutual Fund”

  1. David:
    It still seems to me that the major part of the story is Shleifer stabbing his mentor in the back with his doings. Summers fault seems to be his defense of his friend not his actual actions.

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