Gee, think the bailout might have had something to do with this?

Paul Krugman is angry, and to a certain extent, I don't blame him. Yes, the Banksters are screwing their customers and the abuses seem to be protected by congressional Republicans and the other Usual Suspects.

To be honest, Krugman's column is worth reading and what I am going to say in this post will make no sense unless you do read it. Krugman outlines examples in which some of the big banks have, in essence, defrauded homeowners, engaged in bait-and-switch tactics, and taken money under false pretenses, and look to get away with it.

I share that outrage, but the difference is that Krugman and I have conflicting opinions about why this situation has come about in the first place. Krugman sees free-market capitalism as the culprit, and cannot understand why the government isn't "fixing" the problem, while I see crony capitalism and the bailout of 2008 as being the heart of the issue.

In other words, Krugman believes that more intervention is the solution, while I believe that intervention has been the problem and that Krugman's "solutions" only will make matters worse.

When Henry Paulsen in September 2008 demanded that Congress pass a bailout, Krugman agreed with him that such an action was necessary to "save the system." My sense at the time was that if the "system" could screw up this badly, perhaps it should not have been saved at all.

Now, Krugman also believed (and still does) that post-bailout, the financial structure should have been reconfigured into something akin to the regulated banking cartel that existed before 1980. (Yes, it was a government-created and protected cartel.) And for all of Krugman's insistence that the cartel worked just fine, and that deregulation came about purely because Ronald Reagan became president and "conservative ideology" forced a change in the system, he really needs to read his history, unless he wants to convince me that Michael Milken, a liberal Democrat, really was a closet Reaganite.

The larger problem is that Krugman seems to be one of the few True Believers in the economics profession that government regulation of an industry can and should be done in a pure "public interest" fashion, and as long as people of the Proper Ideology are running the system, the Wise and Omniscient Regulators will govern wisely. I hate to tell the Great One that "Capture Theory" is alive and well and has a much better explanatory record than does "Public Interest Theory" that Krugman espouses.

Last Saturday, I heard a speech by former congressman and budget director in the Reagan administration, David Stockman, who spoke on the bailout and the aftermath. Stockman told the audience that the notion that unless Congress bailed out the Banks That Drank The Kool-Aide the "system would collapse" was nonsense, more propaganda from Paulsen and the Goldman-Sachs crowd.

As Stockman noted, while there was real danger that perhaps Bank of America and Goldman-Sachs might not be able to make their payrolls, the idea that ordinary American companies would not be able to do the same was nonsense. Here is where someone like Stockman really collides with Krugman.

Remember that Krugman also is one of the True Believers that the failure of the government to bail out Lehman Brothers touched off the "crisis," that Lehman was so interconnected to the entire system that everything was at risk because of its financial collapse. I believed then and believe now that such sentiments were nonsense, and Stockman's speech certainly does not undermine that belief.

However, I would like to point out a different set of connections, which is that the bailout actually strengthened the "bad banks" at the expense of the good ones. Many forget that a capitalist system is one of profits AND losses. Losses are important because they send important signals to entrepreneurs to move resources in a different direction.

Krugman was thinking that the bailout might make the banks more subservient to the state, and then someone like Elizabeth Warren could move in and Govern With Great Wisdom and all will be at peace again. That is nonsense.

What happened with the bailout? A number of banks, aided and abetted by the Federal Reserve System and government policies to put people into home ownership, helped drive themselves and the housing market into the ground. At that time, the Bush administration should have allowed the losses to take their course, and while the short-term fallout would have been bad, in the end it would not have been worse than the slow death of the system that we now are experiencing.

The bailouts did not turn Bank of America and others into whimpering, obedient puppies. Instead, the bailouts created even bigger monsters, something that Krugman in all of his rage simply refuses to see.

Yeah, it was Lehman all along!

One of the prevailing myths that seems to keep going like the Energizer Bunny is that the financial meltdown occurred because the Bush administration let Lehman Brothers fail. Yes, this was a major event, the biggest bankruptcy in U.S. History, yet the economy did not go down because Lehman failed, no matter what Paul Krugman might say. And he says:

I’m puzzled: shouldn’t the papers this morning be full of retrospectives about The Event That Ended The Economy As We Knew It? (Not to mention the event that guaranteed an Obama election win.)

Or have the financial media decided to go along with the prevailing public view that none of this happened until after Obama was inaugurated?

While this is a short post on Krugman's part, nonetheless it is full of the usual fallacies he likes to promote. First, and most important, the economy did not go down because Lehman failed; Lehman failed because it had been a major player in promoting an unsustainable boom, and during the boom, it profited well, and when that toga party came to an end, so did Lehman's profitability.

Second, a rescue of Lehman by stuffing its assets full of funny money from the Federal Reserve System would not have changed the fundamental picture a whit. Wall Street was in trouble because its balance sheets were unbalanced, not because the Fed had failed to create enough new dollars. Lehman had bet the house on the housing market and lost.

Furthermore, had the Fed and the Bush administration let the banks and financial houses that were unsound go under, yes, the original economic downturn would have been steeper than it was. However, there were healthy financial houses and there were a lot of healthy assets in the economy, and they would be leading us in a recovery right now.

Instead, the government, first under Bush and then under Obama, decided to paper over the holes in the asset framework with Monopoly Money as though there had not been a massive amount of malinvestment occurring. As we have seen, we now have no recovery and the future is grim.

So, Happy Lehman Day to all of us. It would have been happy had Henry Paulson not demanded that taxpayers and the Fed bail out his good friends.