Krugman: Government programs had nothing to do with the housing bubble

I must say that when Paul Krugman gets on a subject, he sticks with it, and the latest chapter in his "it's all the fault of free markets" mantra comes in today's column in which he deals with the report of Financial Crisis Inquiry Commission. Not surprisingly, he sticks to his other mantra -- Republicans always are the cause of all problems and ills and Democrats have all the answers -- in this screed.

Unfortunately, the one thing he does not do is to deal with the actual problem, but to Krugman, solutions to the current crisis are problems, while in his view, we "solve" this problem by, well, creating more problems.

He begins (predictably):

When the financial crisis struck, many people — myself included — considered it a teachable moment. Above all, we expected the crisis to remind everyone why banks need to be effectively regulated.

How naïve we were. We should have realized that the modern Republican Party is utterly dedicated to the Reaganite slogan that government is always the problem, never the solution. And, therefore, we should have realized that party loyalists, confronted with facts that don’t fit the slogan, would adjust the facts.

As one who has read Krugman for a long time, I definitely believe that the last statement describes him quite well. So, here we go with Krugman's "facts" about the bubble:

It’s not as if the story of the crisis is particularly obscure. First, there was a widely spread housing bubble, not just in the United States, but in Ireland, Spain, and other countries as well. This bubble was inflated by irresponsible lending, made possible both by bank deregulation and the failure to extend regulation to “shadow banks,” which weren’t covered by traditional regulation but nonetheless engaged in banking activities and created bank-type risks.

Then the bubble burst, with hugely disruptive consequences. It turned out that Wall Street had created a web of interconnection nobody understood, so that the failure of Lehman Brothers, a medium-size investment bank, could threaten to take down the whole world financial system.

Now, it is true that, in George W. Bush's words, "Wall Street got drunk," but as Peter Schiff noted in a speech at the Mises Institute in 2009, there is this little issue of who was supplying the liquor -- the Federal Reserve System. As I have noted before, the government has a number of programs to extend home ownership well beyond its logical bounds and there was pressure from authorities for banks to throw away the underwriting standards for mortgages. That this would build up into a bubble is no surprise.

There also is the matter of Lehman Brothers. I'm sorry, but the notion that the reason we had this crisis is because the government let Lehman fail is a bit much. Wall Street as a whole was overleveraged, but unlike Krugman, who wrongly says that it was because banks and the "shadow banks" were operating in a market totally unregulated by government, it seems to me that the famed "Greenspan Put" that also was part of Fed policy under Ben Bernanke created huge moral hazards that encouraged this drunken spree.

In Krugman's Keynesian world, markets don't respond to price signals, as prices have meaning only in the aggregate as part of an index. Things like relative prices and profits are meaningless, which is why Krugman can claim that the heavily-subsidized industry of "alternative energy" can lead us out of this depression. (Krugman does not seem to believe that free market profits have anything to do with the valuation of the factors of production, and why should they, given that in the Keynesian view, factors are homogeneous, economically speaking.)

Krugman's defense of Fannie and Freddie is pretty hilarious:

In the world according to the G.O.P. commissioners, it’s all the fault of government do-gooders, who used various levers — especially Fannie Mae and Freddie Mac, the government-sponsored loan-guarantee agencies — to promote loans to low-income borrowers. Wall Street — I mean, the private sector — erred only to the extent that it got suckered into going along with this government-created bubble.

It’s hard to overstate how wrongheaded all of this is. For one thing, as I’ve already noted, the housing bubble was international — and Fannie and Freddie weren’t guaranteeing mortgages in Latvia. Nor were they guaranteeing loans in commercial real estate, which also experienced a huge bubble.

Beyond that, the timing shows that private players weren’t suckered into a government-created bubble. It was the other way around. During the peak years of housing inflation, Fannie and Freddie were pushed to the sidelines; they only got into dubious lending late in the game, as they tried to regain market share.

In this view, Freddie and Fannie were the victims of those rapacious capitalists. There was no subprime market; the Fed had nothing to do with this, and government came in on the tail end of things.

This is NOT a defense of Wall Street or the Republicans. I will say outright that one cannot have both a deregulated financial system AND something like the "Greenspan Put." It is not possible because the kinds of moral hazards that such policies create are such that we should not be surprised when we see a meltdown of this magnitude.

I don't think the banks were "suckered" by the government; they were in bed with the people who were supposed to be regulating them. Unlike Krugman, however, I don't think that this lack of oversight was due to free market ideology, as I know no free-market economist who believes that markets and moral hazard can exist simultaneously without creating real problems.

No, people were getting rich and not having to work very hard at it. As in a bubble atmosphere, even if everyone knows there is a bubble, the trick is to jump off before the whole thing peaks and then pops.

Because Krugman is stuck in his ideological and political ghetto, he really offers nothing but inflation as a "solution." He claims to understand the effects of financial bubbles, but his ideology, partisanship, and Keynesian thinking blinds him to the cause of bubbles. And if he cannot understand the cause of the problem, he hardly is qualified to recommend solutions.