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  • We Didn't Know Krugman's Nobel was for Fiction

    New York Times columnist Paul Krugman has truly outdone himself this time. He has managed to identify a single piece of legislation passed by President Ronald Reagan in 1982 that single handily brought down the entire world economy a mere 25 years plus later. AEI’s Peter Wallison sets the record straight:

    The Garn-St. Germain Act was an effort to save the S&L industry from the consequences of government regulation. During the inflation of the late 1970s (note to Krugman: thanks in part to the policies of Ronald Reagan’s political opponents) interest rates rose above the 5.25 percent cap federal regulations placed on what S&Ls could pay for deposits. As a result, deposits poured out of S&Ls into investments that paid higher market-based rates. This was the genesis of money market mutual funds, which were able to offer shareholders higher rates on their money than banks and S&Ls, with virtually equivalent safety. The loss of deposits threatened the survival of S&Ls. The first step authorized by Congress was the Depository Institutions Deregulation Monetary Control Act of 1980 (another note to Krugman: this was a Democratic Congress, before Reagan took office), which authorized the cap on deposit interest rates be lifted gradually, and this was accomplished over the next three years by the Depository Institutions Deregulation Committee, consisting of the major bank and S&L regulators, chaired by the secretary of the treasury.

    However, unlike banks, S&Ls were still restricted by law from making loans other than for housing, and thus they had no short-term investments that would allow them to earn profits even if they could now attract funds by paying market rates. The Garn-St. Germain Act was meant to correct this by freeing S&Ls to use a portion of their deposits to make non-housing loans. But it came too late. The mismatch between what S&L’s could earn on the mortgages they already held in 1982, and the rates that they now had to pay for their deposits, resulted in huge losses for the industry, and its eventual collapse in the late 1980s. The lessons that most economists and economic historians derived from the S&L debacle were that it is a mistaken policy to place a regulatory cap on interest rates, and an even more mistaken policy to limit the ability of depository institutions to diversify their assets. The lesson that Krugman learned is that regulation of rates and investments is always good, even if it drives a whole industry into bankruptcy.

    There were certainly abuses when the S&Ls tried to use their new powers, but the fundamental reasons for losses in the S&L industry were the combination of a cap on deposit rates and the restrictions on permissible investments.

    Even if this were not true, however, Krugman misses some important facts. After the S&L industry collapsed, Fannie and Freddie grew to take their place. Despite efforts by the Bush administration and the Republicans in Congress to rein them in through toughened regulation, Congress would not act to restrict their growth or risk-taking. Now the two companies are insolvent, under the control of the federal government, and held or guaranteed $1.6 trillion in subprime and Alt-A loans—popularly known as “toxic assets”—when they were taken over. Not apparently a student of the subject, Krugman contended in his columns before they were taken over that they didn’t hold any subprime loans. It’s doubtful that his column will report, in the future, what is likely to be the fact that Fannie and Freddie will cost U.S. taxpayers at least $400 billion, dwarfing the losses of the S&L industry.

    Finally, Krugman appears to have forgotten that in 1991—after the S&L collapse—President Bush proposed and Congress adopted the Federal Deposit Insurance Corporation Improvement Act, a very strict regulatory law that gave bank and S&L regulators broad new authority to prevent the excessive risk-taking that occurred in the S&L industry and among commercial banks. So for those (like Krugman) who believe in the efficacy of government regulation, whatever lingering effects might have come from the deregulatory Garn-St. Germain Act were cancelled out by the tough new regulatory law nine years later. Despite that act, however, it is important to note that we now have the greatest bank crisis since the Great Depression. This is a clear demonstration that tough regulation—although it is necessary when institutions are backed by the federal government—is no panacea.

    Posted in Economics [slideshow_deploy]

    9 Responses to We Didn't Know Krugman's Nobel was for Fiction

    1. Frank Norton, CA says:

      Thank you. I was about to email Dr. Krugman with some of the facts that you put together. I also noted that Congress makes law not the President. Why do the Democrats not seem to know that ?

    2. Larry, in the Republ says:

      It's ALL part of the "new", progressive party policy,as explained by main stream media. They just dressed up the forces of "Change" in new color. Chased the same rainbow they did starting in 1976 with Jimmy Carter, but this time with a "damn the torpedoes",(or constitutional law) full steam ahead mindset! On THIS trip over the rainbow though, the stakes are WAY higher. Now the Government is putting our tax coffers on the hook and slingin' 'em into an ocean of DEBT!! I personally think they've done slung the bait off the hook and it's just floatin' around as slush and pet project fodder! The subsequent feeding frenzy has gone on now since January of this year- and doesn't seem to have a reprise in sight. Obviously Mr. Krugman paid no attention to Fannie Mae and Freddie Mac, in the ditches, on "his" trip down the yellow brick road. He should click his heels three times and wish for Barney Franks, to cover his backside, just like the covering up he did during the Bush Administration! Mr. Krugman should also stay away from those mushrooms found at the feet of Fred and Fannie:)they make you stupid:)!

    3. Barb -mn says:

      Fannie, Freddie, ACORN. Paid for by the tax payers of American GOVERNMENT FRAUD.

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    5. Steve, Ohio says:

      Well, at least you only "title" him as a NYT columnist. Often, I see him listed as a economist. This guy is little more than a Joke and only because he is acually living. For anyone read his column, books or listen to anything he says, is silly. He has never been right about anything, let alone trying to find a way to pin this mess on conservatives.

      We all know where the problems began. Their names are Barney Frank, Chris Dodd, Maxine Waters, etc. Until we get some conservatives with the backbone to go afer these people, we will always sit on the sidelines while they destroy our country and all of our great businesses.

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    7. LP says:

      There is plenty of blame to go around for the current financial crisis. However, I find it interesting that although Carroll sets the record straight with some important facts that Krugman left out, Republicans are still unwilling to admit their role in this!!

    8. Pingback: A Nobel Prize for Stupidity? « Trying Liberty

    9. Whicket Williams Kin says:

      Who will lead the charge for accountability? Barney Frank Must be held accountable at some point. We have to start somewhere, and this is "low hanging fruit"

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