Is Elizabeth Warren the "Keeper of the Secret"? Part I

One of the hallmarks of a politicized society is that people caught up in the mix tend to believe that there is a "keeper of the secret" just over the horizon -- if only we can get this person into office. Lest one think I exaggerate, remember that during the fall of 2008, Barack Obama rode into office on a wave of the worst kind of, frankly, idolatry, as children's choirs literally were singing "Obama's gonna save us" and worse.

(I hope that the Statlers and Walldorfs of this blog will admit that Obama DID run as a Messiah, and his campaign did little to dispel that notion that The Chosen One was going to fix everything. Hmmm. How well is THAT working out today?)

Paul Krugman today has a new "Keeper of the Secret," Elizabeth Warren. Yes, Elizabeth Warren is "gonna save us" if only she can do the job that Dodd-Frank (or, as I like to call it, "FrankenDodd") has declared she will do.

Before addressing some of the specifics of Krugman's column, let me point out that people (like Krugman) who believe that we can have successful centralized government planning of the economy also tend to believe that there is a Special Person, the "Keeper of the Secret" who actually can make socialism or Socialism Lite work without the whole apparatus crashing and burning. Obama was the latest Knight in the White House, and we are told that if only -- if only -- Bobby or Teddy or even John, Jr., Kennedy could have occupied 1600 Pennsylvania Avenue, that today we would be living in a socialist heaven.

Now to Elizabeth Warren and Krugman's latest screed about how the Mean and Evil Republicans are picking on Messiah Lite. First, and most important, the position of "director" of FrankenDodd's "consumer protection agency" is supposed to be appointed by the president but approved by...Congress. So, the same people who screamed bloody murder when George W. Bush appointed people to various positions in the government and did an end run around Congress now are screaming bloody murder because Congress doesn't bow down and worship the person Obama appointed in an end run around Congress.

Sorry, people, if you want to have a politicized society, then you have to understand that in politics, truth and fairness simply don't matter. Krugman embraced that principle long ago and now he is enraged when others do the same thing.

Do you remember when the New York Times and people of Krugman's political ilk were going after Charles W. Pickering, calling him a racist and a Klan sympathizer? Yes, this is the same Charles Pickering who testified in 1966 against Sam Bowers, who at the time had a legal license to murder anyone he saw fit (including Goodman, Schwerner and Chaney in 1964). Bowers had the support of Mississippi's political establishment during that time, so going against him literally meant Pickering's life was in danger.

Furthermore, the Mississippi chapter of the NAACP -- the African-Americans who best knew him -- supported his nomination to be a federal appeals court judge, but the people allied with Paul Krugman successfully filibustered his nomination. The great Left-Libertarian Nat Hentoff -- not someone who might be mistaken for a Klan supporter -- called the whole thing reprehensible and excoriated the NYT and Senate Democrats for their outright lies.

I include this because Krugman seems to be of the belief that only Republicans engage in character assassination for political purposes. In fact, Krugman is a willing participant in character assassination -- when it suits his political goals -- so when he claims that only the other side does it is not something I find credible.

In Part II of this post, I will deal with the specifics of Warren and her role in FrankenDodd. Granted, I am sure that Krugman would say that the only reason I am questioning his column is because I want the Banksters to get away with financial crimes and I want people to go bankrupt. After all, only evil people can disagree with Paul Krugman.

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.

Krugman on Fire for Faulty Finance

Keynesians are nothing if not versatile. Until ObamaCare was signed into law, Paul Krugman was a "healthcare" economist (which really is a person with a Ph.D. in economics who believes that government can work magic through coercion in doling out medical care).

However, at this time, Krugman now is foremost a "financial" economist, which means a person with a Ph.D. in economics who believes that government can run the nation's financial system with brilliance and efficiency. Yes, yes, I know that there is this problem with the government's accounting methods (although Krugman believes that government under Democrats, no matter how fraudulent its accounting methods, still is magic), but Krugman being a True Believer thinks that government regulators are omniscient (if they are "smart" and they "believe in government") and can get past the problems that would bedevil most mortals.

In his Friday, April 16, column, Krugman repeats his usual tricks of rewriting history and then claiming that all that is needed to "save" the financial system is to bring back the financial cartels that dominated U.S. finance from the New Deal until the early 1980s. Of course, that means his methods are utterly predictable: claim that Republicans want financial failure and then blame Ronald Reagan for everything. In other words, truth really does not matter.

Before going further, let me emphasize that I have no faith in whatever Republicans are promoting in Congress. When they were in power, they used Wall Street like their own private piggy bank, and it blew up in their faces. Nonetheless, while I don't trust them in power, I do find that at least some of the rhetoric they are using now actually has some truth in it.

In likening Sen. Mitch McConnell's arguments against provisions in the Democrats' plan to calling for the abolishing of fire departments, Krugman writes:

In his speech, Mr. McConnell seemed to be saying that in the future, the U.S. government should just let banks fail. We “must put an end to taxpayer funded bailouts for Wall Street banks.” What’s wrong with that?

The answer is that letting banks fail — as opposed to seizing and restructuring them — is a bad idea for the same reason that it’s a bad idea to stand aside while an urban office building burns. In both cases, the damage has a tendency to spread. In 1930, U.S. officials stood aside as banks failed; the result was the Great Depression. In 2008, they stood aside as Lehman Brothers imploded; within days, credit markets had frozen and we were staring into the economic abyss.

So it’s crucial to avoid disorderly bank collapses, just as it’s crucial to avoid out-of-control urban fires.

There he goes again, parroting the Wall Street line that "we let Lehman fail and then look what happened after that." I hate to say it, folks, but had the Bush administration "saved" Lehman, we still would have had a huge mess. It was not the failure of Lehman per se that created the temporary Big Freeze on Wall Street, but rather the hard fact that the entire financial industry was infected by the toxic mortgage securities that had become the basis for a lot of financial pyramid schemes.

Likewise, had the Hoover administration and the Federal Reserve System "saved" the banks by flooding them with newly-printed money, as Krugman insists should have been the case, the economy still would have imploded. The problem was not lack of action by the federal government, but rather that the financial system that was undergirded by the Fed was inherently unstable. Furthermore, the new regulation initiatives pushed by Krugman and the Democrats really does not address the larger problem that comes when banks are permitted to engage in something akin to Bernie Madoff's Ponzi fraud.

(In this wonderful speech in which he addresses a number of issues Krugman has raised, Peter Schiff says, tongue-in-cheek, that given Madoff's financial practices, he should have been made Secretary of the Treasury.)

Instead, Krugman envisions a regulatory scheme that is a repeat of what existed before 1980, but now brings the brokerage houses and investment banks into the mix:

Since the 1930s, we’ve had a standard procedure for dealing with failing banks: the Federal Deposit Insurance Corporation has the right to seize a bank that’s on the brink, protecting its depositors while cleaning out the stockholders. In the crisis of 2008, however, it became clear that this procedure wasn’t up to dealing with complex modern financial institutions like Lehman or Citigroup.

So proposed reform legislation gives regulators “resolution authority,” which basically means giving them the ability to deal with the likes of Lehman in much the same way that the F.D.I.C. deals with conventional banks. Who could object to that?

Well, I would object to it for the very reason that I believe that what we would have would be just a larger cartel, but a cartel that would behave exactly the way that cartels behave: cut back production, fund projects that are politically, not economically viable, and make sure there is no financial innovation in the system. Furthermore, the scheme Krugman is pushing does nothing to eliminate the moral hazard in the system, and he knows it. His solution? Let the regulators decide what should be financed, as they always make the right decisions (if they are Democrats, are "smart" and "believe in government.")

Of course, there is the obligatory slap at Reagan, claiming that it was he who gave us financial deregulation when, in fact, the major initiatives began when Jimmy Carter was president and the Democrats enjoyed larger majorities in Congress than they have now. That is the hyper-partisan Krugman at work, but it is falsification of the historical record, and deliberate falsification at that.

Now, Krugman is correct. We can have financial cartels and they will be relatively stable -- at least for a while -- but because the man has absolutely no knowledge of regulation (except he believes in it, provided regulators are Democrats, are "smart" and "believe in government") and apparently knows nothing about the huge volume of academic and popular literature on what really happens in regulatory schemes, he gets it wrong in the end.

The banking cartel whose passing he laments did not come to an end because Ronald Reagan dreamed of free markets. It ended because that cartel could not and would not finance a number of new entrepreneurial initiatives that have marked our economy for the last 30 years. Much of what has driven modern life, from telecommunications to computers to discount retailing came about because these initiatives were financed outside the banking cartel. The pressure to "let the banks compete" came not from Reagan but from the bankers themselves, along with Democrats like Alfred Kahn, who saw the real limitations that the New Deal-era regulations were imposing upon the economy.

Unfortunately, Krugman wants us to forget that in 1980 -- before Reagan even received the Republican nomination for president -- the economy was suffering from high unemployment AND double-digit inflation. Banks were losing capital because of the regulatory restrictions, and we had government-created and enforced cartels in railroads, trucking, finance and telecommunications. It was the Democrats that saw the problems this regime was creating and worked to do something about them.

As always happens in the political realm, the deregulation initiatives turned into schemes to help finance politicians, and whenever an industry, like high-tech, did not give enough political contributions, Congress encouraged anti-trust authorities to move in and make threats, as what happened in the Microsoft prosecutions of the late 1990s. Krugman really does not recognize that situation, nor do I believe that he is capable of understanding it, as his hyper-partisan ideology and his Keynesianism prevent him from absorbing an education in simple economics.

Thus, Krugman's "solution" is just to create an even larger cartel by bringing in the politically-connected brokerage houses and investment banks, but that just is setting up the economy for another crisis, just like what we had in 1980. Krugman, however, does not worry about that problem. Like the economist stranded on a desert island who decided to "assume" a feast was spread before him, Krugman simply "assumes" that government-created cartels will solve all of our economic problems. History tells us something different, but that does not matter. Krugman "assumes" a different history than what really happened.

Well, Paul, What Did You Expect With the Bailouts?

Poor Paul Krugman. Here we had the government stepping in to "fix" the mess in the financial markets, and this is a government that is run by his fellow Progressives. Yet, Krugman sees doom. Hmmm.

In "The Secret of the Banks' Success" on his blog, Krugman writes:

Back in early 2009 I was skeptical about the ability of major banks to recapitalize themselves out of profits. I was wrong, it turns out. Here’s why: Financial-industry profits have soared, probably because banks that can borrow money cheaply — because they have an implicit guarantee from the feds — are more or less guaranteed money machines unless they do something stupid; and gross stupidity has been placed temporarily on hold.

This has been good for the TARP, which won’t lose much money.

Beyond that, however, I find this ominous. We got into this mess because we had an over-financialized economy, with finance making a share of profits out of all proportion to its actual economic contribution. And now it’s baaaack.

If Krugman were to talk to the Austrian Economists -- a group he holds in total contempt -- he might find that the better road would have been for there to be no TARP at all.

The very best thing that could have happened to Wall Street, which was exposed by the free market for being over-leveraged and its executives overpaid, would have been to let some people besides Lehman go out of business. As Peter Schiff asked in a great speech last year, "Why do we need Goldman Sachs?" Indeed, why do we need a lot of the very players with the Ivy League pedigrees who brought down our economy, yet made a bundle in the process?

Instead, we now have the same people even more politically entrenched than before, who understand that beyond all else, as long as they give political contributions and agree to appear at a D.C. show trial or two, they have free reign for as long as they want. It's a great deal for them, but lousy for everyone else.

Krugman seems to understand that point instinctively, but because he apparently does not believe in the established "Capture Theory" of Regulation, he is not going to understand why the regulatory regime that he wants exists only in his imagination.

Sorry, Ben, You Did It Again

In this blog post, Paul Krugman quotes a Ben Bernanke speech of 2002 and then comes up with, frankly, a bizarre conclusion.

Here is a quote from Bernanke's speech (and the quote, historically speaking, is wrong):

It was in large part to improve the management of banking panics that the Federal Reserve was created in 1913. However, as Friedman and Schwartz discuss in some detail, in the early 1930s the Federal Reserve did not serve that function. The problem within the Fed was largely doctrinal: Fed officials appeared to subscribe to Treasury Secretary Andrew Mellon’s infamous ‘liquidationist’ thesis, that weeding out “weak” banks was a harsh but necessary prerequisite to the recovery of the banking system. Moreover, most of the failing banks were small banks (as opposed to what we would now call money-center banks) and not members of the Federal Reserve System. Thus the Fed saw no particular need to try to stem the panics.

Krugman then declares:

The point is that breaking up the big players, then saying that it’s OK to let banks fail because no one player is crucial to the system is not a solution.

Uh, this is a non sequitur (a favorite argumentation tool that Krugman uses time and again), and really is head-scratching. One of the arguments for breaking up large banks has been that if they are "too big to fail," then they need bailing out, which causes lots of problems.

However, Krugman goes on, even if we break up the banks and then make them "not to big to fail," nonetheless, we should bail out those banks, too. This does not compute, people. If we are supposed to bail out banks no matter how big they are, then the original doctrine of breaking up banks is unnecessary. (Actually, I don't subscribe to the "too big to fail" doctrine, but since Krugman does, I figured I would challenge him on his own ground.)

Throughout the speech, Bernanke acts as though the only player in this whole affair was the Federal Reserve System, as though President Herbert Hoover's massive interventions did not happen. (My guess is that Bernanke, like Krugman, believes that Krugman actually followed Andrew Mellon's "liquidation" advice and did nothing. That is not true, no matter how many times these guys claim it is.)

However, Bernanke saves the best for last. In his speech, he closes with this:

For practical central bankers, among which I now count myself, Friedman and Schwartz's analysis leaves many lessons. What I take from their work is the idea that monetary forces, particularly if unleashed in a destabilizing direction, can be extremely powerful. The best thing that central bankers can do for the world is to avoid such crises by providing the economy with, in Milton Friedman's words, a "stable monetary background"--for example as reflected in low and stable inflation.

Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression. You're right, we did it. We're very sorry. But thanks to you, we won't do it again.

Bernanke is right, and even more right than he realizes. Indeed, the Fed's actions of holding down interest rates and fueling not only the stock market bubble of a decade ago, but also the disastrous housing bubble truly does demonstrate that "destabilizing" actions by central banks can bring financial calamity, and we are living that right now.

However, this is not what Bernanke means. No, he means that the Fed did not "inflate" enough from 1929 to 1933, and he would not make that "mistake" again. And he has not, and the calamity grows worse.

Unfortunately, the Austrian paradigm, while explaining this downturn perfectly, is not popular among the "elite" economists, who really want to believe that if they crank up the printing presses and borrow money until the cows come home, they can beat this downturn via government spending. That "solution" never has worked, and it never will work. Bernanke has done it again, just as his predecessors 80 years ago had done. And, just like his Fed forebears, he never will understand the damage he has done and will continue to do.

What Constitutes "Financial Reform"?

In a recent column, Paul Krugman raises a very important issue, and while he goes through his usual partisan attacks, nonetheless I think this is something that should be up for discussion. What actually constitutes legitimate "financial reform"? Indeed, what does?

First, everyone is in agreement that Wall Street, not to mention financial houses across the globe, are in big trouble. Why? The fundamental reason is that they throw trillions of dollars into investments that ultimately could not give the anticipated returns and, in fact, many of those investments completely went bust.

Second, I think most people are in agreement that we cannot go back to business as usual, or the arrangement that gave us the actions by bankers and others in the financial world that brought about the meltdown and subsequent depression. Thus, the question is not if we should have reform, but rather what kind of reform should it be.

That being said, one can be sure that Krugman and the Austrians (including me) are going to be on opposite sides of the issue. Krugman wishes to bring back what Austrians refer to as banking cartel that was established during the New Deal. Beyond that, we also are in major disagreement about the role of the Federal Reserve System in financial reform. (OK, I'll be honest. We Austrians want the Fed to have no role at all because we don't want the Fed to be in existence.) Krugman writes the following:

Many opponents of the House version of banking reform present their position as one of principle. House Republicans, offering their alternative proposal, claimed that they would end banking excesses by introducing “market discipline” — basically, by promising not to rescue banks in the future.

But that’s a fantasy. For one thing, governments always, when push comes to shove, end up rescuing key financial institutions in a crisis. And more broadly, relying on the magic of the market to keep banks safe has always been a path to disaster. Even Adam Smith knew that: he may have been the father of free-market economics, but he argued that bank regulation was as necessary as fire codes on urban buildings, and called for a ban on high-risk, high-interest lending, the 18th-century version of subprime. And the lesson has been confirmed again and again, from the Panic of 1873 to Iceland today.

The question is this: Why is this proposal a "fantasy"? I suspect Krugman would answer that in nearly every banking crisis, it always has been government to the rescue. For that matter, Murray Rothbard, who cut his teeth on banking crises by writing THE authoritative book of the Panic of 1819 (from his doctoral dissertation at Columbia University), pretty much has said the same thing.

Thus, Krugman would argue that when it comes to finance, we always must operate within a Second Best atmosphere, that the "best" form of regulation is not available because governments never fail to rescue the banks after they begin to fail systematically. OK, but that now brings us to the second problem: If we are agreed that government intervention is inevitable (and Austrians are not convinced that it is or has to be this way), then what is the best way to do it?

Krugman has argued for a return to what essentially was a banking and finance cartel that existed from the New Deal all the way until the early 1980s. He claims that Ronald Reagan was the culprit, bringing in "free-market ideology" in which banks somehow were totally deregulated and that banking regulators fell prey to the same myopic ideology that bewitched the politicians.

Here is the problem. We are looking at two different philosophies of regulation. The one that Krugman espouses is this: Regulators (who truly believe in the Greatness of Government) hover over the system, dispensing wise advice, stopping banks from making loans for idiot investments, and generally directing the system toward creating a wonderful economy.

This is what Progressivism always was about. Progressivists believed that "good government" would hire the "best and brightest" as regulators and decision-makers, and they would guide all of us with their expertise. The belief was (and, apparently, still is) that the experts knew all of the answers in how to successfully run an economy.

One does not even need to have read F.A. Hayek's "The Use of Knowledge in Society" to enlist one's b.s. detectors. Rothbard once noted that if these regulators were so brilliant and far-seeing -- indeed, much more far-seeing than most entrepreneurs -- then they obviously would have the requisite skills for taking part in the markets, making lots of money. Furthermore, under the kind of regulatory system that Krugman and others favor, people who have no vested interest in the success or failure of a set of investments nonetheless would be the ones making the decision of whether or not it should be allowed.

This should ring alarm bells on its face, for there is no way that such a system is sustainable. Ultimately, as we know, the system tends to be "captured" by the participants, and specifically the politically-connected producers. Furthermore, what ultimately happens is that the government essentially forms a cartel for producers. Whether in transportation, production of electrical power, or finance, government regulatory bodies have stifled innovation, forbade the entry of new firms into a regulated industry (at the behest of established firms), and held back economic growth.

For all of Krugman's reminiscing about the good old days of finance, it is easy to forget that the moves to "deregulate" the system did not come about because of ideology, as I outline in an academic paper I recently sent to a journal. Instead, the movement came because the system with its regulations on interest rates could not attract new money because inflation was outstripping interest gains, and people were putting funds into alternative investments, such as money market accounts, which not only were liquid but also were paying upwards of 8 percent or more. Banks simply could not compete.

Another problem was that banks were not prepared to deal with the new generation of technology and investments. For example, Ted Turner could not finance his proposed Cable News Network operation with conventional bank financing (banks were not interested in this far-flung idea that had, they believed, no chance of success). Instead he turned to Michael Milken of Drexel Burnham Lambert. Milken underwrote the operation by issuing low-rated, high-return bonds (what detractors called "junk bonds").

Because Milken was not part of the banking-finance cartel, ultimately his detractors were able to join forces with Rudy Giuliani and the New York Times (which is eternally fighting capitalism), and destroy Milken and his company. Perhaps the greatest financial mind of our generation was lost because of this.

I can say forthrightly that no great financial minds come out of the kind of regulated system that Krugman and others are demanding. However, I will concede this important point: throughout history, whenever the banks have fallen into trouble, the government has responded by trying to prop up these failing institutions, and the Federal Reserve System has been the mode of choice in the last three recessions. Furthermore, by promising not only help from the Fed but the expansion of deposit insurance has raised the moral hazard problems and made it inevitable that not only will the banks and financial houses take unnecessary risks, but that they are more likely to engage in what Austrians call malinvestment, that is, investing in unsustainable lines of production.

In my view, the only real financial reform would be to cut the banks and financial houses loose from central banking and from government deposit insurance. They would have to bear the costs of errors and would not be able to rob the taxpayers when the markets have declared their investments null and void. Unfortunately, even though this cold shower would not be politically acceptable, it is the only kind of reform that actually would work.

Krugman can quote Adam Smith all he wants, but somehow, I don't think that Ben Bernanke makes for a very good "invisible hand." We can argue about reform all we want, but in the end, the standard "reform" is not reform at all, but just the establishment of another financial cartel.

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.

Turning on Geithner and Bernanke?

It seems that the architects of Obama's economic policies are facing the wrath of the Democrats and the pundits, and Paul Krugman is trying to be first in line to come up with a catchy term: Geithnerdammerung. (A play on Wagner's Gotterdammerung, or "Twilight of the Gods." Kind of appropriate.)

Yet, as I have read Krugman's columns over the last year, his criticism of Obama, Geithner, and Bernanke has not been over their policies of printing vast sums of money or driving our government into unpayable debt. No, he is upset because they have not tried to turn our economy into something akin to Venezuela or Bolivia.

I mean, what's there for a Keynesian not to like in a situation in which the state effectively shuts out entrepreneurs and raises the barriers for private firms that are not looking for handouts? When the original "TARP" was debated in September 2008, many of us objected not on ideological grounds (although certainly libertarians aren't going to support this kind of thing), but also on longer-term economic issues.

In a recent interview with the New Yorker, financial economist Eugene Fama forcefully made the point to let the bad financial institutions fail. He was not speaking as an ideologue; he was speaking as someone who understands finance and human nature. Asked about the claims by Bernanke and Henry Paulson that not bailing out the banks would have brought the entire financial system crashing down, Fama's reply is instructive:

Maybe it would have—for a week or two. But it pretty much stopped for a week or two anyway. The credit markets stopped for more than a week or two. But I think that was really a function of increased uncertainty about the future.

He goes on:

...there is just a high degree of risk aversion on the part of people currently in government. They don’t want to be blamed for bad outcomes, so they are willing to do bad things to avoid them. I think Bernanke has been the best of the performers.

Having had a lot of graduate economics classes taught by people who hold to Fama's way of thinking, I understand the points in the interview in a way that the average reader does not. (He makes a number of surprising comments regarding asset bubbles and the like, and the average reader or even average economist is going to be doing some head-scratching.)

Now, what does this have to do with Krugman? In the beginning, Krugman was for the bailouts because to him, economic assets are all the same. It does not matter if the banks balance their books using newly-printed money or if they do it by actually engaging in real-live profitable behavior. That's the nature of Keynesian "economics." It is "economics as though economics doesn't matter."

So, Krugman's objection was not in the government's running up debt, the Fed inflating (saving us from the faux threat of "deflation") and buying billions of dollars of assets with funny money, or even the government's nationalizing the mortgage system. (Yeah, no moral hazard there.)

Instead, he objects because the Obamaites have not gone whole hog and done what Juan Peron did in Argentina and Hugo Chavez has done in Venezuela: seize the banks and other businesses and turn them into state-run enterprises. That such moves led to chaos in those countries and destroyed their economies does not compute with the Keynesians.

(I would challenge readers to look at what Peron did and see if it differs in substance from what Krugman has demanded be done here. To a Keynesian, there is no difference at all in assets, whether they are held by government or by private owners, except that the government always can do things better and cheaper because they don't have to bear the costs of profits.)