Paul Krugman: The Real Friend of Fraud

One of Paul Krugman's constant themes is that financial regulation, if done by people who properly have been schooled as Democrats, will guard against fraud, and he is at it again in his most recent column. The flip side of that point, of course, is that Republicans want fraud to happen because they are evil and beholden to Wild West Capitalism.

Before I deal with Krugman's own enthusiastic support for outright financial fraud, let me address one point that he claims: Barney Frank had absolutely no influence regarding the collapse of Fannie and Freddie. Krugman writes:

How can the G.O.P. be so determined to make America safe for financial fraud, with the 2008 crisis still so fresh in our memory? In part it’s because Republicans are deep in denial about what actually happened to our financial system and economy. On the right, it’s now complete orthodoxy that do-gooder liberals, especially former Representative Barney Frank, somehow caused the financial disaster by forcing helpless bankers to lend to Those People.

In reality, this is a nonsense story that has been extensively refuted; I’ve always been struck in particular by the notion that a Congressional Democrat, holding office at a time when Republicans ruled the House with an iron first, somehow had the mystical power to distort our whole banking system. But it’s a story conservatives much prefer to the awkward reality that their faith in the perfection of free markets was proved false.

This is one of those True Krugman Moments when he claims that (1) Frank had absolutely no influence in Congress even though he was the Democrat's Congressional point man on banking and financial matters; (2) the government never attempted to have large sums of money funneled to borrowers in the "sub-prime" category; and (3) the financial system that existed during the housing boom was pure free market without a hint of government intervention anywhere.

(Given Krugman's belief that Democrats are pure of heart and never would engage in financial fraud, I am surprised that he does not go after Jon Corzine, who was responsible for more than a billion dollars in very questionable losses for investors. Oh, I forgot. Corzine was a Democrat politician; he lost the money honestly trying to help his dear clients. And Bernie Madeoff also was a Democrat.)

As that famed right-wing publication, The Boston Globe, declared in a feature on Frank:

When US Representative Barney Frank spoke in a packed hearing room on Capitol Hill seven years ago, he did not imagine that his words would eventually haunt a reelection bid.

The issue that day in 2003 was whether mortgage backers Fannie Mae and Freddie Mac were fiscally strong. Frank declared with his trademark confidence that they were, accusing critics and regulators of exaggerating threats to Fannie’s and Freddie’s financial integrity. And, the Massachusetts Democrat maintained, “even if there were problems, the federal government doesn’t bail them out.’’

Now, it’s clear he was wrong on both points — and that his words have become a political liability as he fights a determined challenger to win a 16th term representing the Fourth Congressional District. Fannie and Freddie collapsed in 2008, forcing the federal government to buy $150 billion worth of stock in the enterprises and $1.36 trillion worth of mortgage-backed securities.

Now, I absolutely agree that Frank did not cause the meltdown nor did he cause the collapse of Fannie and Freddie, but even though his party did not hold a majority in the House of Representatives, nonetheless he did have influence and lots of it. (The influence comes out in the committee action, not the actual vote on the floor.) Furthermore, I do not recall any prominent Democrats during that period calling for lending restrictions on people with bad credit.

The blame for the meltdown is bipartisan, although Krugman will never admit to such. As for the Consumer Protection Bureau which he champions throughout the column, I do not believe that Washington and the Democrats are ready to jettison the very tenets of political liberalism and call for strict lending standards and to shut out people with bad credit from mortgage markets. That really would be a first!

Krugman's enthusiastic support for massive fraud, however, comes in his enthusiastic calls for inflation and lots of it, and inflation is a fraudulent way to repudiate debt (although Krugman has written that such a method is perfectly moral). As I have pointed out before, Krugman has openly agitated for government financial measures such as the Fed purchasing worthless financial instruments in order to jack up their market prices (if a private firm does the same, it is called "manipulation," which is against the law).

The difference is in the sheer numbers. While the meltdown featured head-scratching decisions by banks, nonetheless the actual losses due to the Corzine-Madeoff kind of fraud (where people actually set out to deceive others) were small compared to the over-the-cliff losses that came from lots of people jumping into the housing market because it was hot.

Krugman, like most Keynesians, believes that regulators have excellent foresight and know beforehand what lines of production will be profitable and which will not. (One remembers the Democrats pushing "industrial policy" in the 1980s, a brainchild of Bill Bradley and Gary Hart, both of whom believed that government agencies should target upcoming industries and then subsidize them. We see how well that works with "green energy.")

As Murray Rothbard once put it, if regulators actually had the kind of knowledge Krugman believes they have, then they would be in the markets themselves making lots of money employing their great foresight instead of making paltry government salaries. Instead, we find that regulators mostly will try to block any innovation, since they never will get credit for market successes, but surely will be blamed for market failures.

When it comes to fraud, however, keep in mind that it was the players in the market that realized Madeoff was running a scam, not the regulators. In fact, the lack of insight by regulators actually permitted Madeoff to run his operation longer than it should have gone, as people tended to think that if the regulatory agencies were OK with the guy, then he must be on-the-level.

The kind of fraud I fear, however, is not the fraud of some people being scammed in the financial markets. The greater and more dangerous fraud is that which Krugman heartily endorses: government money printing and the destructive inflation that follows it. Krugman's Inflation Fairy is as dishonest as Bernie Madeoff and much more dangerous.

Rage Against the Fraud

When I was teaching in secondary school 30 years ago, I explained to my students how the Fed engages in open market operations and how the Fed expands and contracts what we call the monetary base. I had not been pushing gold, silver, or any other commodity, but one of my students was puzzled.

"What backs the money?" he asked. "Debt," I replied. He and the other students looked at me with astonishment, as they understood instinctively that debt had "value" of dubious worth, and that such a system meant the government could expand the monetary base into oblivion. At that moment, they understood that the USA had essentially a fraudulent monetary system. And, yes, they showed anger, lots of it.

Paul Krugman would have thought them to be a bunch of crazies. Money, after all, is nothing more than a tool that aids a "social system" and that governments can and should manipulate its supply and its value over time in order to help achieve certain social "goals." Anyone who thinks differently, according to Krugman, is certifiably crazy, a nut job.

While he does not explicitly endorse the newest rabbit-from-the-hat scheme in his most recent column, nonetheless he says that it might be necessary because "crazies" in Congress (some Republicans) believe that we cannot continue to borrow money forever and want President Obama to put a lid on spending scheme. Now, I am the first to say that many of these Republicans are delusional but for a different reason than what Krugman claims.

Most Republicans are "hawks" when it comes to U.S. military adventures overseas, and that has been painfully apparent in the discussion over the nomination of Chuck Hagel for U.S. Secretary of Defense. While a U.S. Senator, the Nebraska Republican spoke out against the vast expansion of military spending and the wars in Iraq, Afghanistan, and elsewhere. He also denounced the beating of war drums against Iran, something that has incensed many conservatives who apparently are itching to bomb Tehran and expand U.S. Middle East wars.

I cannot denounce the rightist mindset on war enough. The same people who once decried Soviet military spending now are blind to the fact that even though the USA spends more on its military budget than the rest of the governments of the world combined, that isn't enough, and that any cutback, no matter how small, means that "we are not safe."

Yes, I think it is good that the Republicans at least are talking about entitlements, although I wish they would also deal with the agricultural subsidies and all of the other corporate welfare that has their fingerprints all over it. Since the Democrats have "discovered" that a lot of military spending also comes in the form of welfare, they definitely have become less vocal in their historical opposition (at least following the Vietnam War) to Pentagon spending.

In other words, I don't look at the Republicans as the "good guys" seeking to be financially responsible when, in fact, they are a major part of the problem. However, Krugman denounces the Republicans not for their hypocritical stance on military spending, but rather because they are even asking the hard questions on whether or not we can continue this "borrow-from-Peter-to-pay-Paul" finance scheme. As Krugman sees it, the irresponsibility is not in those that seek to spend and borrow as through the future does not exist, but in those that say we have to stop this madness.

So, what does he do? He endorses what essentially is a money-printing scheme to get around the hard choices and hard discussion. Are we borrowing 40 cents for every dollar the federal government spends? No problem. Just strike a coin with an announced "value," and that will take care of everything. Continue the financial shell games as though one day the economy magically will turn around, get "traction," and then prosperity will return.

I'm on a list serve with a number of Austrians, and one person, a writer and editor, had this to say, and I believe his words are spot on:

The really amazing thing to me in all this is how EVERY commenter I'm seeing, savvy political or supposedly serious economist, acts as if the actual real physical economy where real goods and services are produced seemingly doesn't play into this at all---this debate seems to me to be revealing an apparent actual lack of understanding that money is not the same thing as wealth.

The only way it doesn't reveal that is if -- and this is what i'm trying to be sure I understand -- the trillion dollar coin solution is NOT economically significant if we are already in a world of fiat money. That is, a sort of, "Well, if you accept fiat money at all, this coin nonsense is just as good a means to make money from nothing as any other."

Keynesians would denounce this person as being a rube, an ignoramus, someone who does not "understand economics." Yet, the opposite is true. He is not the one who is delusional. People who pretend that we can spend as though we are much wealthier than we really are truly are the people who are deluded.

Moral Obligation Fraud

One of the hallmarks of Keynesian "economics" is the view that one does not differentiate between a real and a paper asset. Paper currency is just as valuable as, say, gold coins and a heck of a lot better, since one can more easily reproduce paper money. Likewise, Keynesians are quick to jump on the "print-money" bandwagon as a quick fix for dealing with a real economic crisis, including the demand that governments essentially defraud its citizens.

Paul Krugman has done this whole thing one better as he calls for the Obama administration to engage in financial fraud under the guise of "moral obligation bonds." Yes, this is the same Paul Krugman who in the past has called for criminal investigations for Wall Street executives (except for Jon Corzine, who was a Democrat politician, so it doesn't matter how badly he defrauded his clients), but the amount of financial fraud in Krugman's proposal would dwarf anything that the most dishonest people in the financial markets had done. Indeed, Bernie Madeoff has slain his thousands and Krugman his tens of thousands.

Before I explain why I believe Krugman is demanding financial fraud, let us examine his own words. He writes:

Don’t like the platinum coin option? Here’s a functionally equivalent alternative: have the Treasury sell pieces of paper labeled “moral obligation coupons”, which declare the intention of the government to redeem these coupons at face value in one year.

It should be clearly stated on the coupons that the government has no, repeat no, legal obligation to pay anything at all; you see, they’re not debt, and therefore don’t count against the debt limit. But that shouldn’t keep them from having substantial market value. Consider, for example, the fact that the government has no legal responsibility for guaranteeing the debt of Fannie and Freddie; nonetheless, it is widely believed that there is an implicit guarantee (because there is!), and this is very much reflected in the price of that debt.

One must admit that this is rich, calling a bond upon which the government legally could default a "moral obligation" security. (And don't forget that the government, even if it paid back this loan, would essentially default via the "magic" of inflation.) This from a person who in past columns has marveled that governments in the past actually took financial obligations and financial treaties seriously.

But it gets even better, as Krugman writes:

And maybe the coupons wouldn’t have to be sold on the open market; why not just have the Fed buy them? Bear in mind that the Fed doesn’t always buy safe assets; it’s buying a lot of mortgage-backed securities (from Fannie and Freddie; see above), and during the worst of the financial crisis it bought lots of commercial paper. So why not slightly speculative pieces of paper sold by the Treasury?

 In other words, the Fed can pretend that what essentially are political securities has real value. That is financial fraud, period. People have gone to prison for much less. And lest one think I have misread Krugman, he gives us this gem:

If there is a legal problem even with selling these coupons, there are still alternatives, such as paying suppliers with these coupons and then having the Fed buy them. The mechanics really don’t matter; as long as we’re in a liquidity trap, printing money, printing conventional debt securities, or printing funny money with no legal standing that nonetheless lets the government pay its bills are all equivalent.

 So, instead of facing the hard reality that the government cannot spend at current levels given the ability of the U.S. economy to produce enough tax revenues, Krugman claims that we can fix our problems by having Treasury and the Fed pull more rabbits from their proverbial hats. Call it what you wish, but this is fraud by every legal and moral definition. It also is the hallmark of Keynesian "economics."