Monday, March 14, 2011

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.


AP Lerner said...

Oh Prof. Anderson, even when you sort of get it right, you get it it oh so wrong. First, please stop repeating this nonsense Krugman supported TARP. Krugman supported Swedish style nationalization. You may not see the difference, but it's significant. Is it too much to ask you to get your facts straight.

And as you sit on in comfy seat in Frostburg with your publicly funded job sponging off the capitalists like myself, it's obvious you do not have the slightest idea how close the system was to failing. Companies like AT&T were days from failing. I know this because I actually put capital to work. You don't know this because it's painfully obvious you gave net set foot on a trading desk. The system needed to be fixed, not the banks. If you don't know the difference, please resign from Frostburg.

Bob Roddis said...

If the "system" was close to failing, it was because it was a "system" of diluted funny money based upon surreptitious theft which made economic calculation impossible and which made everyone think they were richer than they actually were.

The "collapse" would have simply been the result of nature taking its course and alerting everyone of their prior state of delusion. The collapse should have been allowed to proceed.

Bob Roddis said...

The reason for a collapse would have been that there wasn't enough stuff around owned by the debtors to satisfy their unpayable debts. Stuff had to be seized from taxpayers to do this. This is why neither APLerner, Wray nor Mosler will ever explain where the stuff is supposed to come from to satisfy the unpayable government debt. They can't explain it.

Anonymous said...

AP Lerner, failure is more important than success in business.

As an allocator of capital, you would know that your failure is even society's gains, because you provided an iota of information to other capitalists who understood how to allocate capital better.

In the long run, 90% of businesses fail, and yet quality of services provided by businesses keep going up.

Businesses do not need to be saved, they should gladly be allowed to fall into pieces, so that when we put them back together, we have something much better than we started.

Schumpeter called it creative destruction.

Mike Cheel said...

Nothing wrong with the banks...

Ike said...

From Professor Krugman:

...the biggest obstacle to recovery isn’t the financial condition of major banks, which were bailed out once and are now profiting from the widespread perception that they’ll be bailed out again if anything goes wrong.

This sounds like an admission that TARP was indeed a Moral Hazard.

Am I wrong?

Anonymous said...

@AP Lerner: Oh, come on. When you can't demonstrate a basic understanding of the ideas you claim to argue against, we humor you, and get a laugh at your ignorance. Then you pull off this lame ad hominem? Just because you flunked econ and took up accounting as a backup plan doesn't mean you have to spew vitriol at those who can understand opportunity cost and examine the economy as more than a series of balance sheets.

I think I see the problem, though. If people followed the Ausriam school, you'd be quite out of a job, with nothing to stop you from turning into the leech you're destined to be. I believe the Japanese word for it is "hikkikomori".

Bob Roddis said...

In trying to decipher the web of mystery and doubletalk that is MMT, neither Mosler nor Mitchell address either 1) Where the stuff comes from to satisfy the unpayable debt; nor 2) How the price, investment and capital structure is not fatally distorted by all of their asset, wealth and purchasing power shiftings which result from their keystroke account clickings:

Bob Rdddis said...

Since AP will invariable play it coy with his comments, we must read the original MMT sources. The nub of our difference is the claim that micro logic does not apply at the macro level, per Bill Mitchell:

"The general reasoning failure that occurs when one tries to apply logic that might operate at a micro level to the macro level is called the fallacy of composition. In fact, it is what led to the establishment of macroeconomics as a separate discipline. Prior to the Great Depression, macroeconomics was thought of as an aggregation of microeconomics. The neo-classical economists (who are the precursors to the modern neo-liberals) didn’t understand the fallacy of composition trap and advocated spending cuts and wage cuts at the height of the Depression."

Wrong. The same logic and economic laws apply under a funny money regime except that the system of surreptitious theft it fosters is too complicated for the average voter to follow.

Bob Roddis said...

“Three difficulties with Neo-Chartalism” by Eladio Febrero, Universidad de Castilla-La Mancha, page 7:

“The state controls the value of money--
Neo-Chartalists argue that the state has the ability to provide state-money with a certain AMOUNT OF VALUE of value (Wray, 2003, p. 104). Here, the term value stands for purchasing power.”

Further, the Neo-Chartalist program is an "ELR program" (acronym for the government as ‘employer of the last resort’: Wray, 1998, chapter 6). The author, Febrero, seems to believe in such a program despite his minor critiques of MMT.

These people get away with this nonsense by believing in the refuted historical theory that laissez faire and sound money lead to depression and by purposefully ignoring Austrian Theory and historical analysis in every respect.

Bob Roddis said...


The above post should have read:

"Neo-Chartalists argue that the state has the ability to provide state-money with a certain AMOUNT OF VALUE".

The second "of value" was a typo.

Mike Cheel said...

@Bob I believe the "value" the states provides is the end of a gun? Use this as currency or else.

Will said...

I think one subtlety worth noting is that (in this instance) all Krugman is asking for is the government enforce its fraud laws- not create new regulations.

Libertarians should take contract fraud very seriously, and a mortgage is certainly a contract.

Bob Roddis said...

Krugman is right when he says that "the rich are different from you and me: when they break the law, it’s the prosecutors who find themselves on trial."

The operational reality of this claim is the phony narrative holding that the logic, economics and morality of macro is different than that of micro.

Tel said...

Krugman in 2008 said of TARP:

Not a good plan. But sufficiently not-awful, I think, to be above the line; and hopefully the whole thing can be fixed next year.

... and he also said ...

It passes my test of no equity, no deal; that, plus the danger of financial panic if it doesn’t go through, makes it worth passing, though celebration is not in order.

But the important difference is that Krugman was sure that the banks could not be allowed to fail, while libertarians were arguing that the first step should have been bankruptcy and then the second step should have been negotiating how to reassemble what's left. With the banks sitting in bankruptcy you wouldn't have heard anyone saying "a contract cannot be broken" and demanding bonus payments.

As others have pointed out, there are existing FDIC provisions for shutting down an insolvent bank in an orderly manner. Those laws could have been used instead of TARP.

The hidden factor is that the US government underwrites a large proportion of the sunken mortgages sitting on the banks books, so in a way the TARP was about government bailing itself out (with all the contradiction that such an act implies).

Of course, that's all history now... what matters is whether the rule of law will be reinstated and whether the banks will be investigated for those cases where evidence does point to fraud. At least if individual bank employees know they are at risk, it will do something to discourage the moral hazard.

Although I support freedom, I certainly don't support the freedom to perpetrate fraud. The object of libertarianism is to come up with a minimal set of laws that allow us to maximize out remaining freedoms -- and laws against fraud are necessary for commerce and free exchange of goods.

William L. Anderson said...

Krugman's comments at the time of the bailout reflect his belief that the Wise, Ideological Left Regulators would take over and Govern Wisely. He really does seem to believe that all it takes to be a good regulator is to have the right ideology.

Guess what? Moral hazard and Capture Theory rule? And the results are tragic.

Tel said...

Speaking of governments bailing themselves out, this is nice history of bank guarantees in the USA:

He makes the point that for the past 80 years or so, the US has been kicking the can on down the road, as both the risks and the bailouts got larger to the point that the entire system now hangs on an open-ended taxpayer liability. In a nutshell: the system must either change or collapse, because the taxpayers can only prop it up for so long.

Mike Cheel said...


"Libertarians should take contract fraud very seriously, and a mortgage is certainly a contract."

Indeed this is one of the fundamental premises of Libertarianism and one of the only things government is good for (enforcing contracts that is). Securing the rights of the individual is the main purpose of government and so enforcing contracts that are agreed upon by both parties is part of that.

William L. Anderson said...

I don't know any libertarians that have defended the fraudulent practices of the banks, unless one can say that the Obama administration is libertarian. The Wall Street Journal editorial page has shilled for the banks, but that page is run by neoconservatives who have never disliked a U.S. military intervention abroad.

My point has been that while Krugman might have thought that the bailout would strengthen the forces for Good And Proper Regulation, it seems that it actually strengthened the hold of the banks that were in the worst shape. This goes beyond just creating and sustaining moral hazards. It also punishes those firms that did not drink the Financial Kool-Aide and would have made it through the crisis in good shape.

Krugman was hoping for a return to the old system that existed before DIDMCA was passed in 1980. (I think we call that "turning back the clock," something liberals always accuse conservatives of wanting to do.) Krugman wants us to believe that the system was running almost perfectly and it was Ronald Reagan and the conservative, free-market ideologues that forced the changes in regulatory structure.

Funny how he confuses Ronald Reagan with Jimmy Carter, and confuses a heavily-Democratic Congress with Republicans.

Mike Cheel said...


I wasn't suggesting that libertarians in any way support fraud. Only that they support enforcing contracts. If there is fraud involved then of course the fraudulent party should be held accountable for its actions.

ekeyra said...

Hold people accountable for their actions? Now thats just crazy talk.

Mike Cheel said...


"Hold people accountable for their actions? Now thats just crazy talk."

Apparently it is if you work on capital hill. Or perhaps Paul Krugman?