Economists have not had a good war. In the battle over how to understand and respond to the recent financial crisis and recession, few have emerged covered in glory and medals. Indeed, some economists and economic ideas have been tarred as the proximate causes of the waves of financial destruction that swept the Western world and elsewhere.
As is often the case, some of the sharpest shots have been unfriendly fire from within the profession. The most prolific – and prominent – sniper is surely Paul Krugman, an eminent Princeton University economist who for years has been shooting from his perch as a regular columnist in the New York Times and an occasional contributor to the paper’s weekend magazine.
Professor Krugman is brilliant, and there are few students or instructors of economics who have not read carefully his work on trade theory, to pick one area in which his influence has been significant. Even his polemics are well done. His much-circulated essay on the state of macroeconomics1 is a useful overview of the divides within the economics business – even if it did suffer from his tendency to employ straw-man caricatures of financial economists, his choice bêtes noires, who are all described as idiots savants whose naive trust in economic models to assign prices to financial assets was obviously silly.
But since taking on the role of public intellectual in the past decade, Krugman has allowed his passionate distaste for everything connected to George W. Bush to distort his writing and perhaps to undermine his credibility.
One example, a recent New York Times column,2 begins by attacking Republicans for expressing doubt about the value of a public health insurance option, in other words a government-run health insurance component similar to what prevails in Canada. The Republicans are, I submit, undertaking a legitimate debate over health care funding and insurance (a debate mostly absent in Canada, I feel compelled to point out). Krugman quickly shifts to an attack on growing income inequality in the United States since 1980:
Moreover, most of whatever gains ordinary Americans achieved came during the Clinton years. President George W. Bush, who had the distinction of being the first Reaganite president to also have a fully Republican Congress, also had the distinction of presiding over the first administration since Herbert Hoover in which the typical family failed to see any significant income gains.
And then there’s the small matter of the worst recession since the 1930s.
There’s a lot to be said about the financial disaster of the last two years, but the short version is simple: politicians in the thrall of Reaganite ideology dismantled the New Deal regulations that had prevented banking crises for half a century, believing that financial markets could take care of themselves. The effect was to make the financial system vulnerable to a 1930s-style crisis – and the crisis came.
Here we have one more sharp poke at George W. Bush, embodiment of a “Reaganite” ideology that supposedly bears the blame for all that has gone awry in America – from income inequality to the current recession. On this telling, a misguided trust in markets lay at the root of the United States’s recent financial and economic debacle. What is intriguing about this passage is how political animus has led to selective historical omissions.
So some background. The primary “New Deal regulations that had prevented banking crises for half a century” are embodied in the Glass-Steagall Act of 1933. In the 1990s, a series of mergers put the companies that had become Citigroup, a bancassurance conglomerate, offside of Glass-Steagall owing to the combined firm’s wide-ranging financial activities. A congressional initiative – led, yes, by Republicans – sought to bring the legislation to where the market had already moved. (The ordering and timing was different, but much of the same happened in Canada in the last two decades, enabling chartered banks to buy brokerage houses and engage in a range of other activities.)
The key U.S. reform legislation was passed in 1999, which I remark because the President of the day was of course neither George W. Bush nor Ronald Reagan, but Bill Clinton. President Clinton, in his second term, faced a Republican congressional majority. The House of Representatives and the Senate had clashed over the contents of the reform bill, but Congress agreed on changes that gave financial regulatory reform an overwhelming bipartisan majority. There would be some deregulation, but it would be coupled with consumer-oriented measures intended to give a broader mandate for the Consumer Reinvestment Act. Under this legislation, banks could do more lending than before, primarily mortgage lending in lower-income neighbourhoods, specifically to racial minority borrowers.
And there is the rub. Readers of my last essay in these pages3 may recall that I gave some of the history of the dramatic expansion of government-insured mortgage lending in the United States, which more than any other single factor lay at the root of the financial debacle we have just witnessed. Arguably well-intentioned members of Congress, who saw political favour in directing more credit into disadvantaged neighbourhoods, entered an unholy alliance with neoconservatives, also arguably well-intentioned, who also encouraged home ownership for people who perhaps ought not to buy a house because they could not afford to do so. The initiative drove up the U.S. home ownership rate, notably at the low end of the real estate market.
The alliance that underpinned these changes benefited numerous lenders and securitizers, who became very rich by bundling together doubtful and good mortgages and selling them on to government-controlled mortgage underwriters and insurers who were encouraged, or required, by Congress and the White House to take on enormous risks on behalf of taxpayers. The key state agencies, Fannie Mae and Freddie Mac, now insure or hold on their own books $5.5 trillion in mortgages.
In turn, investment banks in the United States, plus organizations like state-controlled German banks, traded and invested heavily in the securitized mortgages that backed the lending I just described. Investment banks such as Bear Stearns and Lehman Brothers, as well as the large mortgage lenders, many of them government-backed, came under the gun as the lending market they had facilitated unravelled over the course of 2007 and 2008. These investment banks and financial institutions found themselves in trouble because they had imagined they fully understood the risks in the government-sponsored mortgage securities markets they had helped create. They didn’t.
And that brings me back to Professor Krugman. The history I have just summarized is hardly obscure, but neither is it well understood. This history is required to parse the “Reaganite” and George W. Bush roles in the financial meltdown and recession. Krugman, in his political animus, does not provide it. Thereby, he ceases to be a “public intellectual” and becomes more of a partisan ideologue.
Consider this Web addendum to his summer 2008 defence of Fannie Mae and Freddie Mac, the state-sponsored mortgage lenders:
What you need to know here is that the right — the WSJ editorial page, Heritage, etc. — hates, hates, hates Fannie and Freddie. Why? Because they don’t want quasi-public entities competing with Angelo Mozilo.4
Angelo Mozilo was head of Countrywide Financial, the largest of the aggressive private mortgage lenders. No honest assessment would conclude that Fannie and Freddie were Countrywide’s competitors; they were mutual enablers. The people who ran these institutions did business with each other and became rich doing so, and they lobbied and funded the legislators who oversaw their activities. A misunderstanding of this underlying political economy seems to have led Krugman down a garden path.
Academics’ getting excited and motivated by politics is nothing new. Yet there is always a cost, and that is the trouble when partisan animus overshadows thoughtful policy discourse. An early victim can be the truth.
1 New York Times Magazine, September 6, 2009.
2 New York Times, August 23, 2009.
3 “Buying Trust with Trillions,” Inroads, Winter/Spring 2009, pp. 10–13.
4 Paul Krugman, “Ideology and the GSEs,” July 14, 2008, retrieved November 7, 2009, from http://krugman.blogs.nytimes.com/2008/07/14/ideology-and-the-gses/