

Paul Krugman: Partying Like It’s 1929 - tomh
http://www.nytimes.com/2008/03/21/opinion/21krugman.html?ei=5124&en=d4be1d2ea1520dfe&ex=1363752000&partner=permalink&exprod=permalink&pagewanted=print

======
yummyfajitas
Paul Krugman is very confusing. It's almost like he is trying to fool people
who don't understand the difference between _savings and loan_ banks and
_investment_ banks ("shadow" banks, in his lingo).

The problem in 1930 was that depositors at savings and loan banks all wanted
their money back simultaneously. Many people (read: main street) got screwed,
leading to the creation of the FDIC. I.e., "the bank doesn't have your money.
Sorry."

The problem today is that savings and loan banks gave out a bunch of loans to
low quality borrowers. They then sold these loans to investment banks while
misleading them about the quality (and the IB's just figured it out).
"Conventional" banks (the ones PK seems to think are so great) screwed the
"shadow" banks (those scary unregulated ones), and now investors are trying to
avoid risky investments until things clear up.

Both are scary in a "trouble on wall street [financial word] [financial word]
bad for the economy [financial word] [financial word]" sense. But beyond that,
the situation is rather different.

~~~
giardini
Hogwash.

The problems lie squarely with the investment banks and firms who (1) failed
to perform due diligence in their en mass purchases of morgages and (2) who
sorted those mortgages into hi-, medium-, and low-risk "tranches" and then
sold each tranch to other firms as Collateralized Mortgage Options (CMOs). The
fault also lies with the bond rating firms who gave incorrect ratings to the
CMOs so created.

To add to this morass, some investment firms bought up multiple hi-risk CMOs,
then combined and re-tranched them into second-tier hi-, medium-, and low-risk
tranches! They then somehow got high ratings for these second-tier CMOs from
the bond rating firms!

Sure, savings and loans were giving out loans w/o checking properly, but had
the investment firms been performing proper due diligence, the savings and
loans would not have been able to sell them and the problem would not have
occurred.

And since the concentration of leverage occured at the investment bank/firm
level and only due to their creation of CMOs and meta-CMOs, they bear the
responsibility for this snafu.

Unfortunately, all this makes no difference. The taxpayer will bail out the
rich investment banks, the dollar will continue to weaken, our capital will be
used up to protect large investment firms and less capital will be available
for productive uses by small and large firms.

Wall Street wins and Main Street loses once again.

~~~
yummyfajitas
I agree completely about bailouts, they are ridiculous. Bear should be allowed
to fail. That will teach the IB's to do a better job next time.

But I disagree with you that IB's didn't do their due diligence. Measuring the
quality of individual mortgages isn't their job. The IB's job here is to build
securities out of individual mortgages, given accurate knowledge of the
mortgages from the ratings agencies and local banks.

It's a lot like trading commodities. A market maker in commodities doesn't
need to know what a grade A cow looks like or how a cattle auction works. His
job is to trust the cow raters to do their job while he packages sets of cows
into financial futures. If a rancher is colluding with a cattle appraiser to
pretend that 1000 mad cows are Grade A beef, it's not the fault of commodities
traders (although commodities traders will be hurt).

The flaw with the mortgage market was not happening on the IB's end. The
individual mortgages were not of the quality the local banks promised for
various reasons you've outlined. They were then packaged into securities which
were suitable only for higher quality loans. Those securities are failing now,
and the market has become a lemon market (which killed liquidity) and caused
all sorts of other problems.

Investment banks: "Given loans of known quality, we can package them into
bond-like securities."

Local banks: "Pray, Mr. Investment Banker. If you put into the package loans
of the wrong quality, will the right security come out?"

(With apologies to charles babbage)

~~~
giardini
The investment banks didn't have to evaluate all mortgages: they should have
been _sampling_ those mortgages and evaluating the firms that supplied them
with mortgages however. The wise firm that did would have anticipated problems
well in advance.

And it was the IBs' responsibility when they retranched high-risk CMO's into
2nd-tier CMOs and then got those CMOs certified by the bond firms as good as
gold. That was criminal, in fact, and charges should be filed against the IBs
and the bond rating firms as appropriate.

------
ctkrohn
I'm tired of reading articles like this. If you're going to blame the current
crisis on a lack of regulation, please tell me what SPECIFIC regulations you
would implement, and explain how they would have helped us avoid the situation
we're in.

~~~
Prrometheus
I personally can't stand Paul Krugman. I know he's done good work in academia,
but his op-eds push a liberal agenda regardless of the evidence in favor of
it.

In this case, how would the federal regulators know how to price risk better
than the owners of financial businesses? Krugman doesn't say. He posits that
they have some magic knowledge by virtue of being government agents.

The truth is, there was a unprecedented bubble in real estate values and real
estate related debt. No one knew how to price them correctly. For a regulator
to attempt to do so would be like a regulator setting the right price for
Yahoo in 1999.

Neither does Krugman mention past failed financial regulation. Canada had only
a handful of bank failures in the 1930's, compared with thousands in the US.
The reason was that banks in the United States were kept small by anti-branch
banking laws designed to keep any one bank from having too much power. The
larger banks of Canada survived, not so the banks of the US.

What assurance do we have that the current regulators will get it right? Many
people in public life seem to be drawing bad lessons from the current crisis
so far. I'm inclined to think that they won't get it right.

~~~
mmmurf
Consider the current regulation that exists over the housing market:

\- Mortgage interest deduction: In other words, you don't get a tax break for
buying a house, you get it for being in debt b/c you bought a house. Hmm..
what incentive does this create?

\- One time capital gains tax exemption for the sale of a home: This
encourages people to sell their home and then buy a more expensive home, even
if a less expensive one would have sufficed.

\- The implicit federal bailout of Fannie and Freddie: These companies
underwrite a lot of the more risky mortgages and as long as there is an
expectation that the government will bail them out, nobody looks too closely
at their soundness.

These are the regulations that got us into trouble in the first place.

Now is the time for less regulation, not more!

------
astine
'Safe banking' is a contradiction in terms. Every time you place money in
another organization, their is an amount of risk involved. It only seems like
it shouldn't be risky because the Fed guarantees so many banks and loans. This
gives the banks more leeway to make risky loans and artificially shifts wealth
around in the economy hurting the lower classes.

Fortunately, it also means that there is more to go around for startups.

~~~
tim2
What? Why is it impossible for the risk to be negligable?

------
mmmurf
I have to say that these comments (the first 5 at least) are so refreshing.
It's great that there are people out there who see through Krugman's
propaganda.

------
davidw
BTW, if people are interested in economics, there's now a subreddit for it:

<http://reddit.com/r/Economics/>

Of course it gets some of the same wingnuts that the rest of reddit gets, but
there are a few bright guys there.

------
bobbin
More propaganda about the great depression.
[here]([http://www.freedomainradio.com/Traffic_Jams/great_depression...](http://www.freedomainradio.com/Traffic_Jams/great_depression.mp3))
is a lengthy podcast about the great depression and its causes.

