Excellent post by Paul Krugman

Here is one bit:

This is actually a very broad problem with all accounts of the crisis that try to exonerate the private sector and place the blame on the government and/or the Fed: none of the proposed evil deeds of policy makers were remotely large enough to cause problems of this magnitude unless markets vastly overreacted. That is, you have to start by assuming wildly dysfunctional financial markets before you can blame the government for the crisis; and if markets are that dysfunctional, who needs the government to create a mess?

Here is another:

*I find myself thinking of the old comedy routine in which a doctor tells his patient, “You’re a very sick man; the least shock could kill you” – whereupon the patient lets out a strangled cry and drops dead.


Regulated financial institutions (whose key advantage is the access to LOLR facilities) were responsible for the overreaction of the financial markets. Financial institutions are the brains of the economy, there is no wonder they overreacted, as they were (and are) on various drugs supplied by government.

"Put it this way: if our financial system is so high-strung, so manic-depressive, that low rates for a few years can inflate a monstrous bubble, while a few discouraging words from high officials can send them into a tailspin*, this doesn’t make the case that policy must walk on eggshells, forgoing any attempt to fight prolonged unemployment. Instead, it makes the case for much, much stronger financial regulation."

So Krugmans first response is simply to argue for government intervention, of any kind, before actually trying to understand why markets are so manic depressive. What forces are acting on markets that wont act on government officials? Krugman's failure to answer (or even ask) this question completely reveals him for the government propagandist that he is.

Can't multiple entities be at fault? There seems such a desire to blame one set of actors over another. It does seem to me that there is plenty blame to go around. It seems to me that faced with a crisis most people have a knee-jerk reaction to find their own personal bête noire to be responsible when in reality major financial/economic events are complex phenomena that have numerous causes that cannot be conveniently parked at one actors door. I would think the crisis in the result of lots of trends and events: imbalances for savings and trade, passive regulation, new financial instruments that were not well understood, government policies to encourage home ownership, risk-sharing financial instruments that dispersed risk throughout the system, etc etc. In short, I tend to think that everything conspired to create the conditions for a bubble and a panic and, as is the way of things, people eventually woke up to this and "all fall down".

"none of the proposed evil deeds of policy makers were remotely large enough to cause problems of this magnitude"

Huh?? de facto ownership of about 60% of the (primary and secondary) mortgage market isn't big enough to cause a housing bubble and subsequent crash? Wait, make that de facto ownership of about 60% of the mortgage market plus control over risk-taking of the other 40% (with mandates for a certain percentage of low-interest loans). Wait, make that: de facto ownership of about 60% of the mortgage market plus control over risk-taking of the other 40% plus control over the money supply flooding into the mortgage market.

Wait, make that: de facto ownership of about 60% of the mortgage market plus control over risk-taking of the other 40% plus control over the money supply flooding into the mortgage market, plus control over affordability of mortgages through the tax code, making them at least 30% cheaper than other consumer goods for many millions of Americans through tax writeoffs.

Wait, make that: de facto ownership of about 60% of the mortgage market plus control over risk-taking of the other 40% plus control over the money supply flooding into the mortgage market, plus control over affordability of mortgages through the tax code plus indirect control over risk taking at banks via deposit insurance, "too big to fail" bailouts, subsidies and various regulations.

Wait ...

Never mind. Krugman can believe whatever he wants.


Your argument is fascinating as well. I look forward to your defense of gun control. After all, if we're blaming the Fed for giving banks the tools to engineer financial collapse, shouldn't we blame gun vendors for giving criminals the tools to conduct shootings?

At some point, bankers have to take individual responsibility for their actions, and stop blaming everyone else for their mess. In other words, they're saying "don't blame us, we only did it because the Fed didn't stop us. So it is clearly their fault."

Not sure why the post struck Tyler as particularly noteworthy; seems like typical Krugman fair to me. A 40-50% deviation from the proper target rate couldn't possibly have contributed to our financial mess, nay it is all those crazy greedy bankers (which I do think was a contributing factor, but not sufficient enough to explain all of it).

Maybe I've been reading too many GMU econ blogs, but the condescending quote by itself is vapid in light of the admission that "markets fail, use markets."

E. Barandiaran
There is a similar Talmudic saying, "It is not the mouse that is the thief but rather the hole." Sorry for the threadjack.

Accounting rules...for one.

What Krugman's logic seems to basically be saying is that the cops don't affect behavior because they aren't always right beside you looking over your shoulder.

It is not even obvious that there was an over-reaction. Everything was entirely rational on an individual basis, in the midst of government forced marriages and counterparty ambiguity. The market failure could be that there was no market for the toxic assets in fire sale mode. My new thinking point is that there wasn't enough money supply for the asset redistribution on the way down and the inflation was disappeared into the asset prices on the way up. We had inflation, but no money supply growth that could have greased the asset sales under stress and reduced panic.

I don't know anybody who gave even a glancing look at the financial condition of their bank before they decided where to deposit their savings.
Almost everyone I know considers it the cornerstone of prudent financial planning to park practically all of their wealth in one single property and to initiate that investment with 80% leverage.
Either of these behaviors would seem patently absurd to anyone living in a society not poisoned by a dysfunctional & powerful regulatory framework.
I've heard enough from the GMU folks to understand how we can all be insane without realizing it, but it still amazes me the extent to which people accept the status quo as a given, and then blame the consequences on "the market". The market is, after all, a product of a regulatory framework. How in the world do we knock some sense into people whose reaction to every problem is "We need more rules." And, how does Tyler call that post "excellent" without forgetting a whole bunch of important things?

I look forward to Krugman's defense of the Mohammed cartoonist, whose drawing set off worldwide riots, and someone trying to kill him with an ax.

"none of the proposed evil deeds of the cartoonist were remotely large enough to cause problems of this magnitude unless Muslims vastly overreacted. That is, you have to start by assuming wildly dysfunctional financial religious people before you can blame the cartoonist for the crisis; and if Muslims are that dysfunctional, who needs the cartoonist to create a mess?"

WTF? This might be the stupidest comment I've ever seen on this site. What's truly remarkable about this is that Jim "mocks" Krugman's argument by re-stating it in a form that Jim surely agrees with! But in Jim's fevered imagination, liberals like Paul Krugman hate freedom of expression and love Muslims who riot, so zing!

Did markets vastly overreact or did they have real reason to fear political polls that showed that the United States political structure was about to make a sharp left turn?

Were the rules of the game changing quickly, new rules that were anti-business. Was it rational to want to shift in response to political change?

It was rational for people to speculate in housing markets when interest rates were extremely low and housing prices were increasing. People became payment buyers without concern for the total price of housing units.

Is there something different about housing markets? Are they less liquid and more subject to changes on the margin?

For example, in most markets housing stock does not turn over that quickly. (I think it is seven years.) So in a market with a housing shortage, relative to demand, a few buyers can force up the prices on the margin. As long as the majority of owners withhold their units from the market the buyers on the margin can inflate the value of the entire housing stock. (Not to mention that owners can tap the paper profits on their home with a home equity loan i.e. they sell they borrow against the gain on their house without selling their house.

So perhaps evil deeds on the part of government can create all kinds of havoc in markets were small marginal changes can create large paper changes in value.

@Barbar: As usual, these defenses of government invention rely on flights of fancy. (I can keep this up, you know.)

I fail to follow your objection. The entire purpose of the CRA was to force banks to make loans in "underserved" areas. (that is, to Democrat constituencies) Perhaps you were confused by my referring to those who received loans under the program "privileged", since they were poor. But what else does one call someone who receives favored treatment at the expense of others?

Having made these bad loans, the banks needed a way out, and thus the BS securities. Their goal was to minimize their loss, but they were able to turn a profit because the buyers of the lower quintiles were blind to systemic risk. Having made money on the operation, the logical thing for the banks was to expand the operation.

Since the government required the banks to make these bad loans in the first place, their regulators were poorly positioned to cry "foul" on the trading of these securities. To do so would have been to admit that their original program was punitive. Furthermore, the later runs may well have been better deals than the originals, as the underlying loans were often made to people with actual credit histories. Again, it would have been difficult to condemn the later transactions without implicating the earlier ones.

The CRA is what drove the creation of these deals. Government failure to expose the bubble earlier is what made the collapse as bad as it is. And their pathetic attempts to reinflate it risk a repeat.

Leave it to the aptly-named Right Wing-nut to raise the CRA canard. Subprime was driven largely by institutions that are not covered by the CRA. My sister used to work at one that collapsed.

To the person who asked how much money was really lost, my sister and the shareholders in her company lost a LOT.

To my eye, Krugman and also DeLong tend to caricatures, and reductionist arguments. The "markets are better" point of view is always caricatured as an extreme "markets are perfect" argument, for example. I really have no respect for Krugman. He has abandoned all pretense of intellectual rigor.

I've said this before, I've been thinking about this topic for nearly a decade. Both Krugman and DeLong have essentially said that it is a waste of time for professional economists. That may be and thus it's not surprising that they don't have a handle on the issue.

Barbar, I'd say investors bought them because they had money that they had to do something with. They didn't think they were risky, and they weren't unless allowed to become a systemic monster and held with incredible leverage which was required to make a meaningful profit under low interest rates.

Barkley Rosser,
AIG FP in London was an unregulated entity that produced drugs - AAA capital insurance. This insurance was purchased by regulated institutions.

I find Krugman's argument to be pretty weak. Has he never heard of a catalyst? One of the risks of government action is that when government does something, it tends to put a stamp of approval on it for everyone else. Did the presence of Fannie and Freddie in the housing market signal that mortgage derivatives were okay, and even the preferred way to handle mortgage debt?

It seems to me that with a change in initial assumptions, you could make the opposite point from Krugman's - The fact that a relatively small level of government action in the securities market could lead to such a large, destabilizing bubble is proof that government action is dangerous, and government should remove its involvement in markets even further.

Now, I'm not saying that this is the correct interpretation. I'm saying that Krugman's comment is just as unsupported and speculative.

Thanks for your sharing.
Simple style and great versatility make Coach Handbag ideal work-and-play bags.Today you can get all the Coach purses at lower price in our store.All the Coach Outlet will actually fix the eyes of passers-by.

Comments for this post are closed