Krugman and Canadian Bacon

Paul Krugman seems to have this thing about Canada. Even after a number of Canadians at a meeting told him that they did not like their country's medical system, Krugman pretended they never existed and continues to claim that any negative stories about Canadian medicine are "lies" (his word).

His latest Canadian love affair is with the banking system of our neighbor of the North, and he does have some good points. First, there have been no bank failures in Canada and the system has not come crashing down, as it has done here. (I also point out that Canada did not have any bank failures during the Great Depression at a time when half of U.S. banks went under.)

Second, he notes that both Canada and the USA had low interest rates during that period, yet Canada did not suffer from the same housing bubble that ate the U.S. economy, and he claims to have discovered the Canadian secret: regulation. He writes:

...Canada’s experience does seem to support the views of people like Elizabeth Warren, the head of the Congressional panel overseeing the bank bailout, who place much of the blame for the crisis on failure to protect consumers from deceptive lending. Canada has an independent Financial Consumer Agency, and it has sharply restricted subprime-type lending.

Above all, Canada’s experience seems to support those who say that the way to keep banking safe is to keep it boring — that is, to limit the extent to which banks can take on risk. The United States used to have a boring banking system, but Reagan-era deregulation made things dangerously interesting. Canada, by contrast, has maintained a happy tedium.

More specifically, Canada has been much stricter about limiting banks’ leverage, the extent to which they can rely on borrowed funds. It has also limited the process of securitization, in which banks package and resell claims on their loans outstanding — a process that was supposed to help banks reduce their risk by spreading it, but has turned out in practice to be a way for banks to make ever-bigger wagers with other people’s money.

There he goes again. First, and most important, financial "deregulation" was not the brainchild of Ronald Reagan, no matter how many times he repeats that lie. As I have pointed out before, the first wave of financial "deregulation" came during the administration of that Right-Wing Republican, Jimmy Carter. Granted, like the episode with the Canadians complaining about their medical system, Krugman ignores little facts that might get in the way of his narrative.

(He hardly is alone here. For example, during the infamous Duke Lacrosse Non-Rape Case, as more and more evidence appeared debunking the prosecutor's narrative, members of the Duke faculty, administration, and the editorial board of the New York Times -- one of Krugman's employers -- dug in their heels and resorted to even wilder claims in order to preserve the Big Lie.)

Now, I will agree with Krugman that U.S. financial institutions took huge risks in the subprime mortgage market, and, furthermore, they were reckless with their leverage. However, Krugman always resorts to his magic bullet as the cure: regulation and the establishment of a government consumer "protection" agency. In other words, like his employer in the Duke Lacrosse Non-Rape Case, he does not like to be confused with facts.

First, and most important, American banks are regulated. That's correct, regulatory agencies did not disappear during the Reagan administration in a frenzy of free-market madness. Second, he omits the moral hazard and the infamous "Greenspan-Bernanke Put" which let the financial institutions know that the government always had their backs, not matter how deep the hole they dug for themselves.

Third, it seems that the Canadian government has been receiving "bailout" money from its government, an item that the Nobel Laureate (and many of the rest of us) missed. In other words, the Canadian banks might not be the towering citadels of finance that Krugman wants us to believe is the case.

Fourth, Krugman leaves out an important law (and accompanying set of regulations) that pushed home ownership rates in the so-called subprime market: The Community Reinvestment Act of 1977. Under this law, banks were supposed to loosen mortgage underwriting standards to let borrowers with low credit ratings buy houses, and in 1994, the Clinton administration (Yes, another Right-Wing Republican presidency, you know) began to push banks to do even more subprime lending.

When the Bush administration came into office, it added another wrinkle to this push to lower underwriting mortgage standards by pushing the "Ownership Society." This program was based upon the belief that home ownership would bring many other desirable social results. Somehow, I don't think that foreclosures were among those intended results.

The results, as we see in the graph below depicting home ownership rates, were significant regarding overall U.S. home ownership:



Not surprisingly, we see that home ownership rates spiked significantly after 1994 and continued upward at a steep rate until the whole scheme fell apart a couple of years ago. In other words, it was not just low interest rates, but rather low interest rates plus government policies meant to push unqualified people into home ownership. We know the rest of the story.

Now, the idea that a consumer protection agency along with more regulation would have kept U.S. institutions out of the subprime market is a real howler. First, the expansion of the subprime was government policy, done partly in the name of "consumer protection." Second, the regulators themselves were the ones that were pushing banks to make these loans, so to say that regulators disappeared is not true.

I agree that so-called deregulation plus moral hazard has turned into a "heads I win, tails you lose" situation for Wall Street, but that hardly is a free-market situation, no matter how many times Krugman claims it is. Instead, we have seen the development of a politically-based corporatism in which politically-favored institutions are given a near-free ride -- and everyone else pays for it.

Krugman persists in this belief that under the correct guidance, government regulators (in an administration run by Progressive Democrats) can act as omniscient referees. Sorry, Paul. That view holds as much promise as the prospect of Canadian Bacon being served at a Passover meal.