Paul Krugman Crosses the Line

By Gerald Epstein

Cross-posted at our sister blog Triple Crisis

In his recent New York Times opinion column, “Sanders Over the Edge” (4/8/16), economist Paul Krugman offers his readers a basketful of misinformation on important economic matters about which he should – and probably does – know better. The column contains a large number of snipes and a great deal of innuendo against Bernie Sanders and his supporters, but here I focus on his claims about “Too Big To Fail” (TBTF) banks, their role – non-role, according to Krugman –  in the financial crisis, and Sanders’ understanding of the policy tools available to deal with them. Krugman’s claims about these issues are misleading, almost certainly wrong, and, in my view, call into question the credibility of his New York Times column as a source of economic information and analysis.

Krugman starts here:

“Bernie is becoming a Bernie Bro.”

I’ll leave it to others to dissect this one. Moving on:
“Let me illustrate the point … by talking about bank reform.

“The easy slogan here is ‘Break up the big banks.’ It’s obvious why this slogan is appealing from a political point of view: Wall Street supplies an excellent cast of villains. But were big banks really at the heart of the financial crisis, and would breaking them up protect us from future crises? Many analysts concluded years ago that the answers to both questions were no.”

As you can see by following Krugman’s link here, this is not, what Krugman suggests it is: it is not a link to an article quoting multiple analysts presenting strong arguments with evidence that large banks were not responsible for the crisis. It is a link to an opinion piece by Paul Krugman himself. Period.

And, moreover, in this linked piece, Krugman is far more circumspect and uncertain of the answers than is implied in his statement “that many analysts concluded years ago.” So, who are these “many analysts”? On what basis did they reach their conclusions?

Certainly, we can find some analysts who argue (“conclude” is a word that suggests an answer based on a comprehensive analysis of the facts) that the financial crisis was the result of government mismanagement, or was simply a textbook example of a bank run and not due to the actions of large financial institutions per se, or were the result of the decisions of a bunch of sub-prime mortgage providers – like Angelo Mozilo Countrywide Financial that operated more or less independently, and were outside of strict government regulation, that is they were in the “shadows.”

Krugman opts for this explanation: “Predatory lending was largely carried out by smaller, non-Wall Street institutions like Countrywide Financial.” But, you don’t have to have seen “The Big Short” to know that the sub-prime lenders like Countrywide Financial were just one set of  players along a powerful supply-chain that contained  multiple links. This chain was geared toward creating and selling structured, securitized financial products like collateralized debt obligation (CDOs) and CDO-squared’s, mostly produced, financed and sold by the largest (now former) investment banks, J.P. Morgan, Goldman Sachs, Lehman Brothers and commercial banks including Bank of America, Citibank. Contrary to Krugman, the U.S. government authorized Financial Crisis Inquiry Commission (FCIC) reports:

“We conclude dramatic failures of corporate governance and risk management at many systemically important financial institutions (italic added) were a key cause of this crisis .… They took on enormous exposures in acquiring and supporting subprime lenders and creating, packaging, repackaging, and selling trillions of dollars in mortgage-related securities, including synthetic financial products. Like Icarus, they never feared flying ever closer to the sun.” (pp. XVIII-XIX).”

The FCIC, thus, puts a central part of the blame squarely on the, so-called “systemically important financial institutions”, which Federal Reserve Bank President Neel Kashkari and former Goldman Sachs banker calls “Too Big to Fail Banks,” and which economist Bill Black, more appropriately calls “systemically dangerous banks.” I have read much of the academic literature on the financial causes of the great financial crisis and I think it is safe to argue that most experts agree with the FCIC and not Paul Krugman.

Paul Krugman, of course, is entitled to his views. But the point here is that it is highly misleading for Krugman to imply that the consensus among economists is quite the opposite of what it is in fact.

Who does Krugman blame in addition to the sub-prime lenders?

“… the crisis itself was centered not on big banks but on “shadow banks” like Lehman Brothers that weren’t necessarily that big.”

This again is highly misleading. First of all, Lehman Brothers was very big indeed. More important, this statement implies that there were “shadow banks” that were involved in the sub-prime debacle that were somehow distinct from the household name Wall Street banks like Citibank, Bank of America, Goldman Sachs, and J.P. Morgan, that Bernie Sanders, Elizabeth Warren and everyone else who talks about TBTF mean.

If these banks were not at the center of the crisis, then why, according the Congressional Oversight Panel , did the massive and “non-shadowy” Citibank get a tax payer bail-out in the amount of  $476.2 billion in cash and guarantees. Why did similarly placed Bank of America get $336.1 billion? “Little Lehman” didn’t bring these behemoths down. Their central role, and those of other TBTF banks – in financing, buying and selling toxic mortgage products put them – and the economy – into free-fall.

Paul Krugman didn’t inform his readers that important economists who study shadow banking do not exclude these massive banks from key aspects of this shadow banking system. Far from it: these TBTF banks are increasingly seen by experts to be at the center of this global shadow finance eco-system.

Krugman similarly misinforms his readers in discussing Bernie Sanders’ command over the details of the Dodd-Frank law and what it has to say about dealing with too-big-to-fail-banks. In a widely reported – and misreported – interview with the Daily News, Sanders was asked how he would break up the big banks. Krugman was only slightly more polite than Vanity Fair magazine which proclaimed that the interview proved that “Sanders Doesn’t Know Diddly Squat About Wall Street”. Krugman referred to the “recent interview of Mr. Sanders by The Daily News, in which he repeatedly seemed unable to respond when pressed to go beyond his usual slogans.”

To sort this out, let’s look at the relevant part of the transcript:

Daily News: Okay. Well, let’s assume that you’re correct on that point. How do you go about doing it?” (That is: break up the big banks.)

Sanders: How you go about doing it is having legislation passed, or giving the authority to the secretary of treasury to determine, under Dodd-Frank, that these banks are a danger to the economy over the problem of too-big-to-fail.

Daily News: But do you think that the Fed, now, has that authority?

Sanders: Well, I don’t know if the Fed has it. But I think the administration can have it.

Daily News: How? How does a President turn to JPMorgan Chase, or have the Treasury turn to any of those banks and say, “Now you must do X, Y and Z?”

Sanders: Well, you do have authority under the Dodd-Frank legislation to do that, make that determination.

Daily News: You do, just by Federal Reserve fiat, you do?

Sanders: Yeah. Well, I believe you do.”

The relevant facts are these: Under Section 121 of the Dodd-Frank Act the  Board of the Governors of the Federal Reserve has the authority, subject to a 2/3 vote of the Financial Stability Oversight Council (FSOC) to take a range of actions, including (as a last resort) to “require the company to sell or otherwise transfer assets of off-balance-sheet-items to unaffiliated entities”, that is, to shrink the size of the bank in question. Note that the Chair of the FSOC is the Secretary of the Treasury. So, Sanders is correct that the Federal Reserve and the Secretary of the Treasury are the key players here. To be sure, Sanders’ last statement above, that Federal Reserve could break up the banks just by fiat – whatever that means – is not true under section 121.

Still, the Federal Reserve has more tools under its control through Dodd-Frank. For example, under section 619 (one of the key sections outlining the so-called Volcker Rule that tries to ban proprietary trading), states that for these financial institutions “no transaction, class of transaction, or activity may be deemed a permitted activity……(iv) would pose a threat to the financial stability of the United States.” The Federal Reserve would have significant power to issue regulations in this situation.

More generally, the goal of Dodd-Frank, as stated in Section 112 in describing the mission of the newly created Financial Stability Oversight Council (FSOC) is “eliminating expectations on the part of shareholders, creditors, and counterparties of such companies that the Government will shield them from losses in the event of failure.” That is, end too big to fail.

In the end, Dodd-Frank does provide tools and responsibilities to the Fed and to the Secretary of the Treasury, along with other financial regulators, that can be used to break up the banks. Sanders’ answer was inelegant, to be sure, but, in reality, his answer reflects the fact that the law is on unchartered territory and in places is vague and would certainly be contested by the banks. So Bernie’s first answer is also the cleanest. “How you go about doing it is having legislation passed …”

In short, Sanders’ answers are way beyond “his usual slogans” as Krugman claims.

Is it possible that Krugman doesn’t understand these points. Seems very unlikely. I cannot begin to imagine his motives, but that is not the main issue here.

What it brings into question is Paul Krugman’s credibility as a New York Times commentator on these issue. Krugman’s credibility does not stem from his political analysis. Krugman is not a Political Scientist. Krugman’s “brand” is that he is a “brilliant, Nobel Prize winning economist.” In fact, much of his early research was brilliant; and, to be sure, Krugman did win the Nobel Prize. BUT, the misleading discussion of economics contained in his piece, “Sanders Over the Edge” does raise this question in my mind: Is Paul Krugman still qualified to write an economics opinion column for the New York Times?

New Issue!

0715cover--for-blogOur July/August issue is out!  We have posted two articles:  our cover feature, an interview with Gerald Epstein of UMass-Amherst:  From Boring Banking to Roaring Banking; and John Miller’s “Up Against the Wall Street Journal” column, Trans-Pacific Partnership: Corporate Power Unbound.

Here is the issue’s p. 2 editorial note:

Are You Pulling My Leg?

Hearing some of the justifications offered for dominant economic policies and institutions today, readers of Dollars & Sense may wonder, “Do they really believe this? They must pulling my leg!”

Harvard economics professor Gregory Mankiw, writing in a recent New York Times “Economic View” article, for example, declares the case for “free trade” a “no brainer” among economists. Mankiw engages in the usual sleight of hand: slipping seamlessly from the benefits of international trade, to the desirability of “free trade” policies (deregulating international trade), to support for contemporary “free trade” agreements (which are primarily focused on deregulating international investment and finance, not trade in goods). We might agree that this is a “no brainer,” but not in the sense Mankiw means. The argument is convincing as long as you don’t actually think about it.

In this issue of Dollars & Sense, we have several examples of similar justifications.

Economists Anita Dancs and Helen Scharber take a look at the criticisms of the “local food” movement coming from mainstream economists. Here, the economists’ main case for a “10,000 mile diet” (as one recent book put it) is actually quite similar to the one for “free trade”—based on what Dancs and Scharber call the “CASTE paradigm.” Comparative Advantage, economies of Scale, and Trade, the mainstream economists claim, lead to greater Efficiency. While Dancs and Scharber don’t think that “locavores” have got it quite right, they emphasize that the existing food system is hardly the result of markets untouched by government intervention (subsidized water, anyone?) and that, in any case, unfettered markets would not lead to socially efficient or equitable results.

Gerald Epstein takes us into the world of high finance, and the transition from regulated “boring” banking (from the New Deal to the Reagan Revolution) to the terrifying “roaring” banking of the post-deregulation era. Again, economists claimed that financial deregulation and innovation (like new-fangled securities) were going to deliver vast benefits—fueling new productive investment, making it easier for people to save for retirement, helping families and businesses manage risk, and so on. (More than a few of the economists who made such arguments had undisclosed ties to the big financial firms themselves.) How did that work out for us?

In the “Economy in Numbers,” Raul Zelada Aprili and Gerald Friedman look at the consequences of so-called “Washington Consensus” economic policies (or “neoliberalism”) in Latin America. Mainstream economists and the politicians they advised took advantage of the Latin American debt crisis of the 1980s to discredit the government “import substitution industrialization” policies of the 1950s-1970s—and to push for a profound “free market” restructuring of the region’s economies. In fact, economic growth was significantly faster during the import substitution era than during the heyday of neoliberalism—and has accelerated in the last decade, as governments across the region have turned away from neoliberal policies.

The thing that we need to keep in mind is that, though “neoliberalism” may sound like a belief system—the word does end in “ism,” after all—it is really more than that. It describes a set of economic policies or institutions. The ideology of neoliberalism, the unflinching belief in “free markets” everywhere and for everything, lays atop the interests of global capital. Claims that financial deregulation would benefit us all—and the imperviousness of finance to significant reform in the wake of a disastrous crisis—reflect the political power of what Epstein calls the “bankers’ club.” The CASTE paradigm, likewise, is not just a set of fallacious arguments, but a defense of the existing distribution of power in the food system and in society more generally.

That’s what we need to realize. They’re not really pulling our leg. More like twisting our arm.

Also: Rob Larson explains how “Money Yells.” Part 1, in this issue, focuses on the political economy of the internet, and recent battles over “net neutrality.” Kristian Williams explores the race and class underpinnings of policing. And Steven Pressman reviews a defense of Social Security, just as we’re about to celebrate the program’s 80th anniversary.