Thursday, December 17, 2009

Bizarro Economics of Paul Krugman

Raymond L. Richman

In an op-ed in the NYT (12-14-09), entitled “Disaster and Denial,” Paul Krugman blames the current recession on “Wall Street.” He writes, “With the meltdown caused by a runaway financial system still fresh in our minds, and the mass unemployment that meltdown caused still very much in evidence — every single Republican and 27 Democrats voted against a quite modest effort to rein in Wall Street excesses.” This economic analysis is not worthy of a Nobel prize-winner in economics. Wall Street did not cause the excesses; it merely marketed them. He continues:

Talk to conservatives about the financial crisis and you enter an alternative, bizarro universe in which government bureaucrats, not greedy bankers, caused the meltdown. It’s a universe in which government-sponsored lending agencies triggered the crisis, even though private lenders actually made the vast majority of subprime loans. It’s a universe in which regulators coerced bankers into making loans to unqualified borrowers, even though only one of the top 25 subprime lenders was subject to the regulations in question.

We believe the conservatives are right by and large although the Republicans also have a lot to atone for.

Contrary to Prof. Krugman's assertion, the “meltdown” was not caused by a “runaway financial system”. It was caused by the millions of subprime and other inadequately secured mortgages that resulted from Administration and Congressional pressure on banks and other lenders to make mortgage loans to unqualified borrowers. Government created private enterprises, Fannie Mae and Freddie Mac, were pressured by the likes of Rep. Barney Frank, to provide a market for such loans.

Wall Street created securities that marketed such loans throughout the Western World. They were not helped by economists who as a whole found nothing to worry about. Economists who studied the effects of the Community Reinvestment Act were unable to find any problem with the low quality loans.

The pressure on the banks to make mortgage loans under the act reached a crescendo under Pres. Clinton and Pres. G.W. Bush. Neighborhood “activists”, many known to be Marxists, like the founders of ACORN, blackmailed the banks which paid them huge amounts. They even were paid to identify homebuyers and process their applications for mortgages.

Banks, other financial intermediaries, and mutual funds considered the government as guaranteeing a continued rise in housing values. When the real estate bubble caused by foolish government policies burst, the financial community in the Western World had to be rescued.

That Paul Krugman and Pres. Obama learned nothing from the foolish policies that led to the mortgage crisis, is proved by Pres. Obama’s bringing pressure on the banks this week to lend more money to “small businesses”. The next debacle probably is likely to be caused by government policies, policies in pursuit of suppressing a mythical “man-made” global warming.

Low interest rates were maintained as a result of the trade deficits in goods which reached over $800 billion in 2008 (equal to 8 million jobs!). Democratic economists like Paul Krugman and Republican economists were all free traders and opposed imposing trade barriers that were lawful under World Trade Organization rules. Prof. Krugman’s area of expertise is international trade theory and as we show in our book, Trading Away Our Future (2008), he did not believe countries in the third (and first and second!) world would pursue policies that perpetuated their trade surpluses by continuing their lending to us. Unfortunately, they did do so, what we call in our book, "dollar mercantilism," intentionally. China (consumer goods), Japan (autos), Germany (autos), OPEC (oil), invested their dollar trade surpluses in U.S. financial assets which had the effect of supporting the housing bubble.

As an economist with a Ph.D. from the University of Chicago, I am ashamed of the role economists have played in this recession which shows no sign of improvement. Private investment has been stagnating and even declining. We seem to be alone in recommending direct action to bring trade into balance while eliminating the corporate income tax to make investment in manufacturing attractive once again, as well as recommending drilling for oil and gas on public lands and offshore, inter alia. It is too bad that American economics has become so ideological that it threatens the very future of the U.S. as a great power.

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