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!

0115cover--very-large

 

New Issue!  Our Jan/Feb 2015 issue is (finally) out–or at least it is ready to be sent to the printers tomorrow. (E-subscribers will get their pdf by email tomorrow also.)  We posted John Miller’s “Up Against the Wall Street Journal” column today: Another Gift for Corporations–Lower Tax Rates, timely because of Obama’s discussion of tax reform in the State of the Union (more on the SOTU when I get a chance to post some links that have been accumulating on my desk).  There is lots else to enjoy in this issue.  Here is our p. 2 editors’ note:

Why Must It Be So? 

Almost by definition, those who are battling the wealthy and powerful are normally going to be on the defensive. Being the wealthy and powerful is like holding the high ground in a battle. It makes it easier to repel any challenges. And it means that you must have won battles in the past, or you wouldn’t still have the high ground.

Seeking to understand and explain why society is how it is—what we try to do at Dollars & Sense—means confronting, over and over, why the other side is winning, how they occupy the high ground. But it’s a task that can give rise not only to despair, but also to hope: Ask “why is the world how it is?” and you’re liable to end up asking “well, why isn’t it different?”
In this issue, Deborah M. Figart and Thomas Barr look at the growing world of check-cashing outlets (CCOs). With a mostly low-income clientele not well-served by regular banks, check-cashing is an industry rife with the possibility of predatory practices and extortionate fees. So why isn’t that always the case? Figart explains that the story varies a great deal from one state to another, and that the difference is effective (and effectively enforced) regulation.

Gertrude Schaffner Goldberg takes a look back at the mass upsurge of the Great Depression era—the labor struggles that created large industrial unions and the lesser-known movements of the unemployed—and why we haven’t seen anything on a comparable scale during our Great Recession. She argues that the underlying conditions of the present era, while not as severe as the 1930s, were enough to create a much larger upsurge than actually happened. The missing ingredients have been even modestly supportive government policies and cohesive, ideologically committed groups of organizers.

Robin Broad shows us an example to emulate—the 1964 “Tokyo No,” in which 19 lower-income countries opposed a World Bank proposal to create a tribunal where investors could sue governments, sidestepping national courts. While the tribunal system still went through, this is no mere nostalgia for past defiance. The issue of “investor-stage dispute settlement” is ever more pressing, as such institutions have grown in power, and is provoking renewed defiance today.

Economist Jayati Ghosh points to the obstacles standing in the way of economic development and labor solidarity, and yet offers an optimistic and ambitious vision of the world that could be: where “your life chances are not fundamentally different because of accidents of birth. So if you are born as a girl of a minority ethnic group in a rural area of a poor region, you would still have access to minimum conditions of life and opportunities for developing your capabilities that are not too different from a boy born in a well-off household of a dominant social group in an affluent society.”

So, how do we get there from here? We do not have mass movements in the United States today at the scale of the 1930s. To give but one example, in 1934 and again in 1937, the percentage of all employed workers involved in a work stoppage was over 7%, a figure exceeded for only three years in the next half century. There are, however, nascent movements impacting U.S. political life in important ways. The Occupy Movement sounded a battle cry over the growing abyss of income and wealth inequality—giving us a new lexicon of the “1%” and the “99%.” Movements like Our Walmart and the Fight for 15 are showing that workers in low-wage industries like fast food and retail will not take low pay and abusive working conditions lying down. The Black Lives Matter movement is fighting back against the racist and repressive face of the state. (We should note, too, hopeful developments on the world scene: Leftist parties like SYRIZA in Greece and Podemos (We Can) in Spain, for example, are on the rise, offering alternatives not only to business neoliberalism and right-wing populism, but also to center-left parties that have done the dirty work of austerity.)
The movements of today are, perhaps, less akin to those of the Depression era than to those that persisted between the Red Scare and the Great Crash—that, even under assault by employers and the state, laid the groundwork for mass risings of the next decade. The challenge, now, is to build these movements, as Goldberg describes, into mass movements of millions, and to imbue them, as Ghosh proposes, with the vision of a new society that only they can make.

Links on SOTU, Black Lives Matter, the economics profession, the Van Hollen plan, and other stuff soon!

–Chris Sturr