Sunday, April 4, 2010

Krugman: Bailouts are Inevitable

Paul Krugman lays out what I think is an interesting question in this post on his NYT blog: Is it inevitable that the financial system will be bailed out in a crisis? Krugman answers with a firm, yes. In his view, if the system is not tightly-regulated, then sooner or later investors will run off the cliff.

Thus, he reasons, it is better to have tight regulation and avoid failure altogether:
In a crisis, the financial system will be bailed out. That’s just a fact of life. So what we have to do is regulate the system to reduce the chances of crisis and the taxpayer costs when the bailout occurs.(emphasis Krugman's)
Here is the problem with his argument, as I see it. Regulation effectively creates a government-protected and enforced cartel. The financial system that ruled until the early 1980s was in danger of running aground because inflation was leading depositors to take their money from banks and put it elsewhere.

Furthermore, people can be glad there was an "elsewhere" in the financial system. Think where we would be economically had there not been investment bankers and others outside the banking cartel to help finance some of the most important high-tech ventures in our history.

Krugman's "solution" is to make everyone part of the cartel. And don't kid yourselves; what he is demanding is the formation of a financial cartel, and all of the evils that go with it. What Krugman refuses to admit is that the Federal Reserve System and government policies to push people into home ownership are what touched off this mess, and had the government not bailed out a number of the players, Wall Street would have had to pick up the pieces honestly, instead of what we see today.

Had bank regulations stayed the way that Krugman says they should have stayed, all of us would be much poorer today. It was not the fact that people were given more opportunities to engage in finance that touched off this meltdown. In the end, it was the Usual Suspects in Washington.

2 comments:

crisismaven said...

Hi, a kindred spirit. How Krugman got this Memorial Prize (named after Nobel who ever since gyrates like a dynamo in his grave) for international trade no one can fathom. First, he rants about the allegedly unfair advantage for China due to alleged currency under-valuation but can't explain how they buy their importsat equally inflated prices and still allegedly grow, and then he wants exactly those people installed as regulators who can't see a bubble nor can imagine who caused it but drive their country right into sovereign default. as they say in Ireland: "they can't find their [what was the other word for donkey?] with their hands".

hsenpfeffer said...

These dubious investments are the problem along with the excessive compensation for the so called investors. The country started off the cliff in the 1980's when these so called investors were using inherited money and leverage to buy up productive firms and part them out like common auto thieves. Moving money from one pocket to another does not create value. Gambling on likelihood of loan default does not create value. Trading on spread of currency prices does not create value. Inflating real estate prices does not create value. Finance, insurance and real estate are not industries. They skim off from productive workers. The current financial crisis is due to resources being plunged into these non productive sectors of the economy and away from useful purposes. And if you were incapable of seeing the current financial crisis coming, like most economists, you should walk away, hang up your shingle and do something useful with your life. This has been the biggest disruption of a generation, was totally man made and predictable. Economics which cannot even foresee something like that is no more than voodoo.