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?

Bernie Slanders: How the Democratic Party Establishment Suffocates Progressive Change

By Thomas I. Palley, Independent Economist Washington, D.C.

Cross-posted at the author’s blog,  An earlier version of this appeared at Social Europe.

The Democratic Party establishment has recently found itself discomforted by Senator Bernie Sanders’ campaign to return the party to its modern roots of New Deal social democracy. The establishment’s response has included a complex coupling of elite media and elite economics opinion aimed at promoting an image of Sanders as an unelectable extremist with unrealistic economic policies.

The response provides a case study showing how the Party suffocates progressive change. Every progressive knows about the opposition and tactics of the Republican Party. Less understood are the opposition and tactics of the Democratic Party establishment. Speaking metaphorically, that establishment is a far lesser evil, but it may also be a far greater obstacle to progressive change.

The elite media’s response was captured in a snapshot report by Fairness and Accuracy In Reporting (FAIR) showing that the Washington Post ran 16 major negative stories on Sanders in 16 hours, prior to the Michigan primary. The headlines were particularly hostile, and since only 40 percent of the public reads past the headline, that is as important as the substance of the story.

Economic policy has been the fulcrum of Sanders’ campaign, and the response of elite opinion has been exemplified by Paul Krugman of The New York Times.

For years, Krugman has mockingly used the term “very serious people” to attack Republicans opposed to President Obama’s policies. Now, he unironically revokes the credentials of all who do not support Clinton  by declaring: “every serious progressive policy expert on either health care or financial reform who has weighed in on the primary seems to lean Hillary.”

Regarding Sanders’ opposition to neoliberal trade agreements, Krugman writes “In this, as in many other things, Sanders currently benefits from the luxury of irresponsibility: he’s never been anywhere close to the levers of power, so he could take principled-sounding but arguably feckless stances in a way that Clinton couldn’t and can’t.”

The slamming of Sanders has also been joined by a gang of past Democratic appointee Chairs of the Council of Economic Advisers. In an open letter co-addressed to Senator Sanders, Messrs. Kruger, Goolsbee, Romer and Tyson mauled a favorable empirical assessment of Sander’s economic program conducted by Professor Gerald Friedman.  Without any detailed independent assessment, they simply declared the assessment unsupported by the “economic evidence”.

Messrs. Kruger et al. were then joined by Justin Wolfers, via one of his regular New York Times opinion pieces. His accusation was the beneficial effects of fiscal stimulus would disappear once full employment was reached and the stimulus withdrawn.

Wolfers is co-editor of the prestigious Brookings Papers on Economic Activity. Ironically, a recent issue contained an article by elite Democratic economists Larry Summers and Brad DeLong invoking a similar mechanism as Professor Friedman. Summers and DeLong argued a large negative temporary demand shock can permanently lower output: Friedman simply reversed that and argued a large positive temporary stimulus can permanently raise output and growth.

There is legitimate room for intellectual difference. What is so stunning is the tone of the critique and the fact it sought to diminish an important policy (fiscal stimulus) just because Sanders was using it to his political advantage.

Given their elite professional standing and easy access to elite media, these attacks quickly ramified throughout the mainstream media, illustrating how the elite media – elite opinion nexus works.

The slamming of Sanders reflects an enduring status quo defense mechanism which usually begins with insinuations of extremism, then mixes in charges of lack of qualification and realism, and ends with assertions of un-electability. It is applied in both political and public intellectual life.

The extremism gambit explains the persistent linking of Sanders and Trump. Whereas Trump is an egotistical demagogue and businessman with a disreputable business history, Sanders is a thoughtful social democrat with a long history of public service through high electoral office.

The un-electability charge pivots off the extremism insinuation as follows. Americans will not elect extremists; Sanders is an extremist; ergo, Sanders is unelectable.

As with the extremism insinuation, the un-electability charge lacks foundation. Polls show Sanders beating all the potential Republican nominees, and beating Trump handily.

The third charge is lack of qualification. The reality is Sanders has a fifty year history of political involvement, worked his way through the political ranks serving people, was Mayor of Vermont’s largest city, then Vermont’s representative in Congress where he co-founded the Congressional Progressive Caucus, and after that became a Senator for Vermont. That seems to be exactly the career and CV a President should have.

Lastly, Sanders has been dismissed as selling unrealistic pipe dreams. Social Security would be a pipe dream if we did not already have it; so would Medicare and public education too. There is a lesson in that. Pipe dreams are the stuff of change.

Rather than an excess of pipe dreams, our current dismal condition is the product of fear of dreaming. The Democratic Party establishment persistently strives to downsize economic and political expectations. Senator Sanders aims to upsize them, which is why he has been viewed as such a threat.

November will be a time for Democratic voters to come together to stop whoever the Republicans nominate. In the meantime, there is a big lesson to be learned.

Today, the status quo defense mechanism has been used to tarnish Bernie Sanders: tomorrow it will, once again, be used to rule out progressive policy personnel and options.

Progressives must surface the obstruction posed by the Democratic Party establishment. Primaries are prime time to do that, which means there is good reason for Sanders’ campaign to continue.