Monday, October 19, 2009

Babies with Candy

In his latest NYTimes column, Nobel Laureate, Paul Krugman is in (recycled) whining mode. Highlights:

...Goldman Sachs is making record profits... banks that are actually in the business of lending, as opposed to trading, are still in trouble...

while the wheeler-dealer side of the financial industry, a k a trading operations, is highly profitable again, the part of banking that really matters — lending, which fuels investment and job creation — is not...

In the first phase of the crisis, Main Street was punished for Wall Street’s misdeeds; now broad economic distress, especially persistent high unemployment, is leading to big losses on mortgage loans and credit cards.

And here’s the thing: The continuing weakness of many banks is helping to perpetuate that economic distress. Banks remain reluctant to lend, and tight credit, especially for small businesses, stands in the way of the strong recovery we need...

we desperately need to pass effective financial reform. For if we don't, bankers will soon be taking even bigger risks than they did in the run-up to this crisis... When bankers gamble with other people's money, it's heads they win, tails the rest of us lose.

The truth of the matter is more complicated than Krugman would like you to think. This deep into the credit crisis, even Nobel winning, NYTimes column writing, Princeton professors ought to understand the manner in which bank lending is tied to fixed income security markets (where the bulk of Goldman's reported profits came from).

Main Street, was not, as Krugman pretends, an innocent victim of Wall Street's misdeeds. Main Street, hand in hand with Wall Street, borrowed far more money than it was able to pay back, leading up to the crash.

To spur any recovery, of course, businesses require funding. Krugman's apparent view that this best comes from a return to not-entirely-responsible lending seems perverse. More obviously sensible would be tax cuts and reduced regulatory burdens.

Finally, the notion that financial reform will decrease risk taking is something other than evidence-based. Consider a recent Journal column detailing the Government's hand in almost 2/3s of all bad mortgages.

Krugman is right, of course, to be concerned about the agency costs embedded in our financial system. But legislators and regulators, as much as bankers, play games with other people's money. Was Krugman more honestly concerned he would be more in favor (de-)regulatory policies that gave people more control over their own money.

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