Krugman apparently believes that his standard response of more stimulus applies regardless of the reasons we are in the economic downturn. Yet it is precisely because I think the policy response to the last crisis contributed to getting us into this one that it is worthwhile examining how we got into this mess, and to resist the unreflective policies Krugman advocates.
We put Fault Lines: How Hidden Fractures Still Threaten the World Economy on our Kindle reading list, but have not yet read the book. I’ve been very impressed with every one of prof. Raghuram Rajan articles I’ve read in the past two years (please do listen to the Cato event on the book release).
I just can’t read Paul Krugman any more. So I wasn’t aware how far off the rails he has gone defending his narrative the causes of the financial crisis (none of “us Democrats” were guilty). Prof. Rajan recently released a well-argued and documented rebuttle to the shifting Krugman narrative, concluding with this:
Finally, if he denies a role for government housing policies or for monetary policy, or even warped banker incentives, then to what does Krugman attribute the crisis? His answer is: over-saving foreigners. Put simply, trade surplus countries like Germany and China had to reinvest their financial surpluses in the United States, pushing down long-term interest rates in the process, and igniting a housing bubble that eventually burst and led to the financial panic. But this is only a partial explanation, as I argue in my book. The United States did not have to run a large trade deficit and absorb the capital inflows—the claim that it had to sounds very much like that of the overindulgent and overindebted rake who blames his creditors for being willing to finance him. The United States’ policies encouraged over-consumption and over-borrowing, and unless we understand where these policies came from, we have no hope of addressing the causes of this crisis. Unfortunately, these are the policies Krugman wants to push again. This is precisely why we have to understand the history of how we got here, and why Krugman wants nothing to do with that enterprise.
Let us try and understand what happened in order to avoid repeating it. There is also a matter of detail suggesting why we cannot only blame the foreigners. The housing bubble, as Monika Piazzesi and Martin Schneider of Stanford University have argued, was focused in the lower income segments of the market, unlike in the typical U.S. housing boom. Why did foreign money gravitate to the low-income segment of the housing market? Why did past episodes when the United States ran large current account deficits not result in similar housing booms and busts? Could the explanation lie in U.S. policies?
My book suggests that many—bankers, regulators, governments, households, and economists, among others—share the blame for the crisis. Because there are so many, the blame game is not useful. Let us try and understand what happened in order to avoid repeating it. I detail the hard choices we face in the book. While it is important to alleviate the miserable conditions of the long-term unemployed today, we also need to offer them incentives and a pathway to building the skills required by the jobs being created. Simplistic mantras like “more stimulus” are the surest way to detract us from policies that generate sustainable growth.
Finally, a note on method. Perhaps Krugman believes that by labeling other economists as politically extreme, he can undercut their credibility. In criticizing my argument that politicians pushed easy housing credit in the years leading up to the crisis, he writes, “Although Rajan is careful not to name names and attributes the blame to generic “politicians,” it is clear that Democrats are largely to blame in his worldview.” Yet if he read the book carefully, he would have seen that I do name names, arguing that both President Clinton with his “Affordable Housing Mandate” (see Fault Lines, page 35) as well as President Bush with his attempt to foster an “Ownership Society” (see Fault Lines, page 37) pushed very hard to expand housing credit to the less well-off. Indeed, I do not fault the intent of that policy, only the unintended consequences of its execution. My criticism is bipartisan throughout the book, including on the fiscal policies followed by successive administrations. Errors of this kind by an economist of Krugman’s stature are disappointing.
One of prof. Rajan’s references is the 2008 Wallison, Calomiris paper “The Last Trillion-Dollar Commitment – The Destruction of Fannie Mae and Freddie Mac“, subtitled “The government takeover of Fannie and Freddie was necessary because of their massive losses on more than $1 trillion of subprime and Alt-A investments.” Here are some of the particulars:
(…) Affordable housing loans and subprime loans are not synonymous. Affordable housing loans can be traditional prime loans with adequate down payments, fixed rates, and an established and adequate borrower credit history. In trying to increase their commitment to affordable housing, however, the GSEs abandoned these standards. In 1995, HUD, the cabinet-level agency responsible for issuing regulations on the GSEs’ affordable housing obligations, had ruled that the GSEs could get affordable housing credit for purchasing subprime loans. Unfortunately, the agency failed to require that these loans conform to good lending practices, and OFHEO did not have the staff or the authority to monitor their purchases. The assistant HUD secretary at the time, William Apgar, later told the Washington Post that “[i]t was a mistake. In hindsight, I would have done it differently.” Allen Fishbein, his adviser, noted that Fannie and Freddie “chose not to put the brakes on this dangerous lending when they should have.” Far from it. In 1998, Fannie Mae announced a 97 percent loan-to-value mortgage, and, in 2001, it offered a program that involved mortgages with no down payment at all. As a result, in 2004, when Fannie and Freddie began to increase significantly their commitment to affordable housing loans, they found it easy to stimulate production in the private sector by letting it be known in the market that they would gladly accept loans that would otherwise be considered subprime.