Financial Crisis

A Couple of Krugman Kicks

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Raghuram Rajan takes long, detailed exception to a Paul (The Smartest Liberal on Earth™) Krugman (I understand he's won a famous prize) co-authored review of his book Fault Lines at the New York Times Freakonomics blog. Rajan particularly focuses on Krugman's (ever-shifting) denial that federal housing policy was important in precipitating the crisis: [UPDATE: This article, though it only came to my attention today, was from September. However, its points are still as timely as tomorrow's shitty economic news.]

In absolving Fannie and Freddie, Krugman has been consistent over time, though his explanations as to why Fannie and Freddie are not partially to blame have morphed as his errors have been pointed out.  First, he argued that Fannie and Freddie could not participate in sub-prime financing. Then he argued that their share of financing was falling in the years mortgage loan quality deteriorated the most.  Now he claims that if they indeed did it (and they did not), it was because of the profit motive and not to fulfill a social objective…..

Critics were quick to point out that Krugman had his facts wrong. As Charles Calomiris, a professor at Columbia University, and Peter Wallison, of the American Enterprise Institute (and member of the Financial Crisis Inquiry Commission), explained, "Here Krugman demonstrates confusion about the law (which did not prohibit subprime lending by the GSEs), misunderstands the regulatory regime under which they operated (which did not have the capacity to control their risk-taking), and mismeasures their actual subprime exposures (which he wrongly states were zero)."

So Krugman shifted his emphasis. In his blog critique of a Financial Times op-ed I wrote in June 2010, Krugman no longer argued that Fannie and Freddie could not buy sub-prime mortgages. Instead, he emphasized the slightly falling share of Fannie and Freddie's residential mortgage securitizations in the years 2004 to 2006 as the reason they were not responsible. Here again he presents a misleading picture. Not only did Fannie and Freddie purchase whole sub-prime loans that were not securitized (and are thus not counted in its share of securitizations), they also bought substantial amounts of private-label mortgage-backed securities issued by others. When these are taken into account, Fannie and Freddie's share of the sub-prime market financing did increase even in those years.

The Krug also doubts that monetary policy played a role, and Rahan hits him on that as well:

He argues that the Fed's very accommodative monetary policy over the period 2003 to 2005 was also not responsible for the crisis. Here Krugman is characteristically dismissive of alternative views. In his review, he says that there were good reasons for the Fed to keep rates low given the high unemployment rate. Although this may be a justification for the Fed's policy (as I argue in my book, it was precisely because the Fed was focused on a stubbornly high unemployment rate that it took its eye off the irrational exuberance building in housing markets and the financial sector), it in no way validates the claim that the policy did not contribute to the manic lending or housing bubble.

A second argument that Krugman makes is that Europe too had bubbles and the European Central Bank was less aggressive than the Federal Reserve, so monetary policy could not be responsible. It is true that the European Central Bank was less aggressive, but only slightly so: It brought its key refinancing rate down to only 2 percent, while the Fed brought the Fed Funds rate down to 1 percent. Clearly, both rates were low by historical standards. More important, what Krugman does not point out is that different Euro-area economies had differing inflation rates, so the real monetary policy rate was substantially different across the Euro area despite a common nominal policy rate. Countries that had strongly negative real policy rates — Ireland and Spain are primary exhibits — had a housing boom and bust, while countries like Germany with low inflation, and therefore higher real policy rates, did not. Indeed, a working paper by two ECB economists, Angela Maddaloniand José-Luis Peydró, indicates that the ultra-low rates enforced by both the ECB and the Fed at this time had a strong causal effect in relaxing banks' commercial, mortgage, and retail lending standards over this period.

What does Krugman blame for the bubble and bust? Foreign savers reinvesting their saved bucks in the U.S. and driving down longterm interest rates.

In other kicking-Krugman news, Steven Horwitz in The Freeman on Krugman's call: "Let's Have a War! We could all use the money!"

Spending trillions of dollars fighting a war can certainly bring idle capital and labor into employment, driving up GDP and lowering unemployment. But this does not mean we are any wealthier than before.

Wealth increases when people are able to engage in exchanges they believe will be mutually beneficial. The production of new goods that consumers wish to purchase is the beginning of this process. When instead we borrow from future generations to spend on goods and services connected not to the desires of consumers, but rather to the desire of the politically powerful to rain death and destruction on other parts of the world, we are not allowing individuals the freedom to do the things they think will make themselves better off. And we are certainly not extending that freedom to those killed in the name of our economy-enhancing war….

Employing people to dig holes and fill them up again, or to build bombs that will blow up Iraqis, will certainly reduce unemployment and increase GDP, but it won't increase wealth. The problem of economics is the problem of coordinating producers and consumers. This coordination happens when we produce what consumers want using the least valuable resources possible. That is why it is wealth-enhancing to dig a canal using earth-movers with a few drivers rather than millions of people using spoons, even though the latter would generate more jobs.

Sending soldiers off to war is a waste of human and material resources, and is almost by definition wealth-destroying, no matter what it does to GDP or unemployment rates. The only way one can view economics amorally, as Krugman wishes to, is if one is only concerned with total GDP and not its composition. However, it is the composition of GDP, in the sense of how well what we've produced matches consumer wants, that ultimately matters for human well-being.

Fear preceded Krugman:

NEXT: Just Call Them "DEA"--It Doesn't Matter What the Initials Stand For

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  1. Is there anyone who writes for the NYT op-ed page who isn’t functionally incapable of merging facts with opinion?

    The WSJ certainly has its share of
    “challenged thinkers” but people like Mary O’Grady help to even things out (she had a great piece today as a matter of fact –A Cuban Fairy Tale From PBS). I’m just wondering which one is the sane one at the NYT.

    Maybe this is a rhetorical question.

  2. Even with Krugman’s “goal-posts-on-wheels”, he begs the question of how much distortion a market can bear before that distortion drives the market.
    Regardless of how much funny paper they both bought, Fannie and Freddie were and are government-backed loss-sinks; there is no established depth to either of those rat-holes, and retailers were welcome to toss whatever risk they could find down them under the presumption that the government would pound enough sand in there to establish bottoms.
    Guess what? There isn’t enough sand in the world to fill socialist rat-holes.

  3. One can shuffle this shit as much as possible and the bottom line is that sub-prime was primarily an unregulated Wall St led disaster.

    Merrill, Bear, and Lehman were not “forced” to buy the mortgage shit from fly-by-night mortgage originators and the GSE’s were limited by law to a cap of a $330,000 mortgage by existing conforming loan standards.

    Of course the investment banks fucked themselves over and the great Bush/Paulson rode in with a $700 billion rescue package (distributed broadly) and I am supposed to believe the GOP is “free market”?

    1. shrike|12.27.10 @ 9:33PM|#
      “One can shuffle this shit as much as possible and the bottom line is that sub-prime was primarily an unregulated Wall St led disaster…”

      One can lie as much as possible, and guess what? It’s still the lies of an ignoramus.
      Still waiting for the lying ignoramus’ “predictions” instead of the lying ignoramus’ claims of timing the market….
      Go away, asshole.

      1. You have no idea why the unregulated investment banks no longer exist, do you?

        Of course not – you are steeped in “it must be gub’mit failure” like any other ignorant partisan.

        1. shrike|12.27.10 @ 10:04PM|#
          “You have no idea why the unregulated investment banks no longer exist, do you?”

          You stupid shit! You both don’t know what “unregulated” means and you couldn’t find an “unregulated” bank if your supposed brain could figure out what it means.
          Go away, asshole.

          1. OK – dumbass. A deposit bank is highly regulated – see Wells Fargo for example.

            They take DEPOSITS that are FDIC insured.

            Investment banks don’t take federally insured deposits – like Lehman, Bear, Merrill did not. They may invest their funds in kangaroo shit if they like.

            But nevertheless they went whole hog all-in on sub-prime!

            Not only that – the SEC erased their capital standards to the minimum – called the Net Capital Rule.

            So when they failed they blew a hole in a couple trillion dollars in other folks debt – which helped made AIG liable for a couple hundred billion in insurance policies on CDS!

            And this was all on jumbo loans Freddie and Fannie couldn’t touch.

            You fucking idiot.

            1. shrike|12.27.10 @ 10:21PM|#
              “…Investment banks don’t take federally insured deposits – like Lehman, Bear, Merrill did not. They may invest their funds in kangaroo shit if they like….”

              So, brain-dead, that means they’re “unregulated”?
              Go away, ass sucking prick.

              1. Yes – except for obvious stuff like child labor laws and insider trading…

                Oh shit – you’re not trying that shit are you?

                1. shrike|12.27.10 @ 10:38PM|#
                  “Yes – except for obvious stuff like child labor laws and insider trading…
                  Oh shit – you’re not trying that shit are you?”

                  ROADS!
                  Wonderful that you confirm your ignorance.
                  Go away, asshole.

            2. BTW, still waiting for those “predictions”, ass-sucking lying prick.

        2. Shrek,

          I’ve worked in the financial industry, and I can tell you from first-hand experience that there’s no such thing as an unregulated bank in the united states.

          -jcr

          1. Also, the general libertarian line is that banks SHOULD be regulated – how can one prevent fractional reserve banking from taking place WITHOUT regulation and enforcement?

            shriek just likes to argue with the pretend libertarian in his head.

        3. And shrike is steeped in “there is NEVER gub’mint failure” like most any ignorant partisan.

    2. I am supposed to believe the GOP is “free market”?

      You shouldn’t believe that.

    3. “…and I am supposed to believe the GOP is “free market”?”

      Please use strawmen under adult supervision. Stupid adolescents can get burned.

    4. Is anyone else fully convinced that shrike is actually Pauly Krugnuts? This level of discourse is only possible from a Nobel laureate.

      1. Please tell me how government made Lehman fail?

        Or Merrill – or Bear?

        oh – I forgot – Barney Frank did it! At least Rush Limbaugh (King of the Rednecks) tells you dittleheads that.

        1. shrike|12.27.10 @ 10:45PM|#
          “Please tell me how government made Lehman fail?”

          I’m pretty sure there is a basement to shrike’s ignorance, as an IQ has yet to be measured in negative numbers.
          But that’s uncertain…..

        2. are you a member of the flat-earth society? your incapacity to face reality is amazing.

          1. shrike may not be Krugman in drag, but they both bury their heads in the sandbox when it comes to Freddie and Fannie.

    5. Merrill, Bear, and Lehman were not “forced” to buy the mortgage shit from fly-by-night mortgage originators

      corporate welfare queens like Merrill, Bear, and Lehman (you forgot AIG) are no more a product of the market then national public radio is.

      And I don’t even have to get into super-uber-government sponsored enterprises Freddy and Fanny to prove that.

      Bush/Paulson rode in with a $700 billion rescue package (distributed broadly) and I am supposed to believe the GOP is “free market”?

      Thank you for pointing out that Bush got TARP passed through a democrat controlled congress which Obama voted yes on. Us libertarians often forget that TARP is a a prime example of how bipartisanship works….

      oh wait we didn’t forget.

      Never mind everything you said was team blue hack bullshit. carry on.

    6. I’ll happily concede that Merril Lehman, Bear Stearns, etc. made their own bed.

      What makes it not a free market disaster is TARP, though. It is the fact that we didn’t let the free market work, but instead chose to fuck over future generations so that people wouldn’t have to revalue their 401(k) plans. As if the market value of your stock is a property right the government must protect.

      Oh, boo hoo, lots of people would have lots too much money! Boo hoo, those poor pension funds, they didn’t realize what mistakes tehy were making!

      Jesus, what on earth makes anyone think having the government guarentee that innocent voters don’t lose money on their investments is a good idea? How on fucking earth is that supposed to even work?

      Reality check people, if the FUCKING REALITY is that your investment values are inflated there is nothing on earth that the government can do about it that doesn’t involve fucking over a dozen other people to save you.

      Bailing out the banks just so that “main street” doesn’t have to feel the pain is just a round about way of fucking over everyone who lives one block off of mainstreet.

      1. How on fucking earth is that supposed to even work?

        With Violence.

    7. Actually, shriek, the shit that isn’t going to get shuffled away is the fact that, far from “not sufficiently overseeing” the subprime market, the regulators actively encouraged its growth. Given that, increasing the power and influence of regulators is only going to empower them to encourage the next “market failure”.

  4. You can’t leave out Robert Wenzel who slaps Krugman around daily.

    The only people I know that still take Pauly seriously are people who use the NYTs are their only source of info (people that don’t care enough to be informed but want other people to think they are).

  5. “(I understand he’s won a famous prize)”

    Looks like Obama isn’t the only one who won an undeserved Emmy (that’s the one for world class acting, isn’t it?)

  6. My favorite Krugman piece is the one where he predicted the Internet would have roughly the same effect on the economy as the fax machine.

  7. Goddamn Shrike, can you stop being a dumbass for even one day to redeem your miserable twisted cunt of a soul?

    Not only was Freddie, Fannie, and the Fed involved in Opportunity Societopia, so was the FDIC:

    http://online.wsj.com/article/…..whats_news

    It turns out that the U.S. government itself was one of the lenders giving out high-interest, subprime mortgages, some of them predatory, according to government documents filed in federal court.

    The unusual situation, which is still bedeviling bank regulators, stems from the 2001 seizure by federal officials of Superior Bank FSB, then a national subprime lender based in Hinsdale, Ill. Rather than immediately shuttering or selling Superior, as it normally does with failed banks, the Federal Deposit Insurance Corp. continued to run the bank’s subprime-mortgage business for months as it looked for a buyer. With FDIC people supervising day-to-day operations, Superior funded more than 6,700 new subprime loans worth more than $550 million, according to federal mortgage data.

    The FDIC then sold a big chunk of the loans to another bank. That loan pool was afflicted by the same problems for which regulators have faulted the industry: lending to unqualified borrowers, inflated appraisals and poor verification of borrowers’ incomes, according to a written report from a government-hired expert. The report said that many of the loans never should have been made in the first place.

    Hundreds of borrowers who took out Superior subprime loans on the FDIC’s watch — some with initial interest rates higher than 12% — have lost their homes to foreclosure, data on the loans indicate…

    The Superior situation could be costly for the FDIC. Texas-based Beal Bank SSB, which bought a portfolio of Superior loans, about half of them originated under the FDIC, is suing the agency in U.S. District Court in Washington. The suit claims many of the loans were made improperly and are plagued with problems.

    An internal FDIC legal assessment, obtained by Beal Bank and filed in court last month, acknowledged “numerous appraisal deficiencies” in the portfolio and a “small number of loans that appear to be fraudulent from inception.” Calling the FDIC’s legal position poor, the undated 26-page assessment suggested that the agency’s liability could be as much as $70 million. Another FDIC official, in a deposition, estimated that the cost of settling the case could be less than one-third that amount.

    In a recent court filing, the FDIC estimated that about 1,500 of the 5,315 loans it sold to Beal either have defaulted or are nonperforming. The FDIC already has bought back another 247 of the mortgages, most of them for violations of federal anti-predatory-lending laws intended to protect borrowers from unreasonably high fees or deceptive practices. Beal Bank has said in court filings that 73 of the repurchased loans were originated while the FDIC was running Superior…

    Meanwhile, a separate portfolio of Superior subprime loans that the FDIC sold to Bank of America Corp. — which the bank in turn sold to investors — also has been troubled. As of April, investors had suffered “realized losses” — which generally occur after foreclosures — on 511 of the 3,964 loans in that pool, according to data provided to investors…

    FDIC Chairman Sheila Bair has been unusually forthright in putting part of the blame for the mortgage mess on regulators, who she has said should have acted earlier

    1. “Goddamn Shrike, can you stop…to redeem your miserable twisted cunt of a soul?”

      no, she’s a dedicated flat-earther. she won’t change.

  8. What does Krugman blame for the bubble and bust? Foreign savers reinvesting their saved bucks in the U.S. and driving down longterm interest rates.

    Actually this is incorrect. He blamed the housing bubble (correctly i might add) as a regional problem caused by the zoned zone.

    I do not give Krugs to much credit though. even a stopped clock bla bla bla…

  9. So Krugman shifted his emphasis. In his blog critique of a Financial Times op-ed I wrote in June 2010, Krugman no longer argued that Fannie and Freddie could not buy sub-prime mortgages. Instead, he emphasized the slightly falling share of Fannie and Freddie’s residential mortgage securitizations in the years 2004 to 2006 as the reason they were not responsible. Here again he presents a misleading picture. Not only did Fannie and Freddie purchase whole sub-prime loans that were not securitized (and are thus not counted in its share of securitizations), they also bought substantial amounts of private-label mortgage-backed securities issued by others. When these are taken into account, Fannie and Freddie’s share of the sub-prime market financing did increase even in those years.

    The best part of this is at least Krugs would understand how his whole argument is destroyed by these facts…yet shrike goes on like an automoton sceaming his ignorance about markets.

    Here is a hint Shrike. If the federal government spent 6 trillion dollars on Coca-cola stock every investment firm and bank would follow.

    Nothing really magical here. the government said garbage mortgages were valuable…then they proved it by dumping trillions into them. the market followed the government and when the government manufactured market fell off a cliff the private investors followed.

    Now you can say it was greed…but you forgot to add it was extremely stupid to invest in what the government tells you to.

    of course any libertarian could have told you that at any time along the way.

    Investing in a government manufactured market is a really really bad idea.

    1. If the federal government spent 6 trillion dollars on Coca-cola stock every investment firm and bank would follow.

      Ding! Ding! Ding! We have a winner!

  10. That Steven Horowitz excerpt is so incredibly ass kickingly awesome, it should be framed and sent to every member of congress and mainstream journalist.

  11. The interesting thing about this, to me, is that Krugman really did deserve his Nobel. He has a really world-beating brain at his disposal.

    But the Prize was bad for him. To get the prize he had to make good arguments, and back them up. Now that he has won the prize he can be lazy- he is speaking from the pulpit. He is an authority, so he can indulge his prejudices.

    People like authority, I guess. Ideally we would assess all arguments blindly- we wouldn’t care where they came from. But we are not like that- Krugman’s Nobel means that people will listen to him no matter how stupid what he says is.

    1. Krugman really did deserve his Nobel…

      Meh. He did some interesting work on trade theory. Nobel-worthy is highly debatable. It isn’t really like his work opened up a whole new line of thinking or research. It was sort of a stand-alone theory. A good one. A valuable one. But, not exactly paradigm-shifting.

      1. What paradigm-shifting stuff do we see in economics in any given decade? It’s not physics. Krugman’s work was important.

        I suppose we could reserve the Prize for real breakthroughs, but if we did that we would have handed out only a couple of Prizes since the establishment of the prize. Von Neumann and his co-author (Morgenstern?) deserved one. Who after that?

  12. I also have to point that not only is New York all right if you like saxophones… saxophones are kind of awesome.

  13. On the topic something I find feckin hilarious is the UK Labour Party 2005 election campaign poster.

    It shows a man and a wife standing next to their house with the slogan.
    “Economic stability or Higher Tory Interest rates”

    Classic stuff!

  14. As always, the unrefutable libertarian save-all maxim rears its pretty little head:

    “If it appears the market completely FUBAR’d something, it absolutely must be the fault of the nearest government program. Q.E.D.”

    Have fun in your fantasy world, guys.

    1. Not unreasonable though, from a pragmatic perspective. If people are free to choose whether or not to stick their hands in a fire, they’ll eventually learn not to do it (from the example of others, in many cases). If the government decides that everyone should put their hands in the fire, well, tough shit for everyone.

      1. Add Chad to the pile of fools who think Fannie/Freddie had nothing to do with the housing collapse.

    2. As usual, Chad is entirely unable to refute the article.

    3. My ignorance is invincible! So long as I get nothing right, I remain strong!

    4. This is Spoof Chad!

      Next time, more shrill and much longer. Throw in a few logical fallacies.

      1. He’s been slacking on the “externalities”, as well… maybe Chad is sick?

        We can only hope.

  15. Since you brought up The Crash, I shall now whore my blog:

    The Cause of the 2008 Mortgage Crash

  16. I read Krugman today. He was sorta linked from Tierney in the comments and I’m feeling very lazy. The topic of his piece is that the recent surge in commodity prices is being brought on not as a hedge against a debased currency or a hallmark of inflation, but because China and India are getting rich.

    Yeah, an unprecedented surge in q4 oil prices wasn’t caused by any combination of inflation, speculation using cheap dollars available from QE2, or (less likely) the Obama Administration’s de facto ban on offshore drilling post-BP fuckup. It’s ‘cuz China, that’s why.

    I’m sitting here watching my Bakken holdings surge almost 2000% since summer ’09, and my business is largely immune from the $5 a gallon gas we’ll likely get next summer, but is this idiot always that much of an assclown apologist? And if so, why hasn’t anyone strung him up by his toenails?

    There was one little bit in the column where Krugman argued that a 4-year flattening in U.S. oil production proves Peak Oil, not mentioning that one of said years, 2008, was a period when the price of oil dropped from $145 a barrel to $35 in a couple of weeks… likely hindering investment in production at least for the short term.

    /2,000 rigs in North Dakota next year.

  17. Just to throw in some anecdotal commentary, when I supported the subprime operations of a now-defunct bank in the early Aughts, I recall having multiple conversations about whether Fannie and Freddie would be bailed out in a crisis. The answer was inevitably yes. And I heard that from regulators (off the record and in their personal opinions), too.

    If an investment with a decent return has a risk floor (or, in this case, a wrongly perceived floor), then investors will often select such investments.

    That’s not all of the problem, as there were many other factors–private and regulatory–that contributed to the collapse, but it didn’t help. Nor did the simultaneous attempts to restrict risked-based pricing in subprime with the push to get everyone a house.

  18. From the article:

    Interestingly, before the housing market collapsed, HUD proudly accepted its role in pushing low-income lending through the various levers that Krugman now denies were used. For instance, in 2000 when it announced that it was increasing Fannie and Freddie’s affordable housing goals, it concluded:

    Lower-income and minority families have made major gains in access to the mortgage market in the 1990s. A variety of reasons have accounted for these gains, including improved housing affordability, enhanced enforcement of the Community Reinvestment Act, more flexible mortgage underwriting, and stepped-up enforcement of the Fair Housing Act. But most industry observers believe that one factor behind these gains has been the improved performance of Fannie Mae and Freddie Mac under HUD’s affordable lending goals. HUD’s recent increases in the goals for 2001-03 will encourage the GSEs to further step up their support for affordable lending.”

  19. krugman related. pretty funny. sfw.

    http://www.youtube.com/watch?v…..re=related

  20. HEY! KRUGMAN!

    I got yer economics right HERE!

  21. There are no clean hands with respect to the financial crisis, but especially on Wall Street. To the extent that regulators are to blame, it is in large part because the didn’t regulate enough. One of the essential causes of the crisis was human irrationality–short-term profits blinding investors to risk. If the crisis proved anything, it was that there is no such thing as an invisible hand. Of course there have been countless crises before that proved that, but cultists aren’t too keen on facts that contradict their worldview. Government shares blame, but it does not shoulder all of it, and as I said a lot of the blame is in its unwillingness or inability to regulate the financial sector.

    1. If the crisis proved anything, it was that there is no such thing as an invisible hand.

      Actually, it reaffirmed just the opposite. You can’t repeal the laws of economics, which is why all your pie-in-the-sky central planning dreams got smacked down.

      1. In TonyWorld, there is NEVER enough regulation.

  22. There is no denying — at least by the intellectually honest — that Fannie Mae and the US Congress were the chief promoters of subprime, Alt-A, no doc, NINJA, nothing down, negative amortization, and other junk mortgages.

    For years, Fannie Mae heaped high praise upon the most egregious subprime lender of them all, Countrywide, and held it out as an example for the financial industry to emulate.

    Check out http://content.knowledgeplex.o…..ywide.pdf.

    Many firms were suckered into the scam. Probably most believed their own bullshit.

    For an overview of the financial crisis by a Top-10 banker who didn’t need a bailout, see http://www.youtube.com/watch?v=aSxA-vtjRx0.

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