Paul Krugman and Zombie Financial History
William L. Anderson
by William L. Anderson: Malum
Prohibitum: The Evil Legal Language of Progressivism
liked to say that economists often tended to specialize in the area
where their knowledge was the worst, and given Paul Krugman's butchery
of the historical record, I'd say Rothbard had a good point. Regular
readers of Krugman's columns and blog posts and other public statements
would believe, for example, that World War II ended the Great Depression,
that Jimmy Carter and Ted Kennedy (who were major forces in deregulation
during the 1970s) were conservative Republicans, and that the only
thing better than war to bring prosperity would be the nationwide
preparation to fight an invasion of imaginary space aliens.
whenever Krugman goes on a partisan political screed, truth is left
behind, and his
recent column is no exception. While I have no problem with
his criticizing Republicans, nonetheless I actually would want for
him to get his criticisms correct, especially his points that the
Republican Party is dedicated to laissez-faire economics
and actually cutting the size and scope of government.
he decides to make essentially this set of claims:
- The financial
meltdown was purely the fault of private enterprise except for
one governmental error: it did not regulate enough;
- The GSEs,
Freddie and Fannie, had absolutely nothing to do with the meltdown.
the big question: How did we get into the mess we’re in?
crisis of 2008 and its painful aftermath, which we’re still dealing
with, were a huge slap in the face for free-market fundamentalists.
Circa 2005, the usual suspects – conservative publications, analysts
at right-wing think tanks like the American Enterprise Institute
and the Cato Institute, and so on – insisted that deregulated
financial markets were doing just fine, and dismissed warnings
about a housing bubble as liberal whining. Then the nonexistent
bubble burst, and the financial system proved dangerously fragile;
only huge government bailouts prevented a total collapse.
learning from this experience, however, many on the right have
chosen to rewrite history. Back then, they thought things were
great, and their only complaint was that the government was getting
in the way of even more mortgage
lending; now they claim that government policies, somehow
dictated by liberals even though the G.O.P. controlled both Congress
and the White House, were promoting excessive borrowing and causing
all the problems.
of this revisionist history has been refuted in detail. No, the
government didn’t force banks to lend to Those People; no, Fannie
Mae and Freddie Mac didn’t cause the housing bubble (they were
doing relatively little lending during the peak bubble years);
no, government-sponsored lenders weren’t responsible for the surge
in risky mortgages (private mortgage issuers accounted for the
vast majority of the riskiest loans).
But the zombie
keeps shambling on – and here’s Mr. Rubio Tuesday night: "This
idea – that our problems were caused by a government that was
too small – it’s just not true. In fact, a major cause of our
recent downturn was a housing crisis created by reckless government
policies." Yep, it’s the full zombie.
The only accusation
he left out was that Republicans were responsible for keeping the
space aliens away from us, thus nullifying our chances for economic
recovery. But, let us take a look at the record, given that Krugman
has made some very important claims.
that he is quietly making the larger claim: price signals mean nothing
to entrepreneurs; only government regulators and agents can understand
the economy and what actually is happening, and that only government,
through spending, regulation, and outright ownership and control
of the factors of production, can bring about prosperity.
So, let us
talk about the government's role in this whole thing. First, he
leaves out an important player, the Federal Reserve System, and
the fact that neither Alan Greenspan nor Ben Bernanke would admit
to the creation of the housing bubble and both continued with their
policies of pushing down interest rates and directing funds into
the housing market through their statements and actions.
ignores the simple fact that government is the single largest player
in the mortgage business through its policies of encouraging and
funding home ownership. To claim that the only influence government
had through the housing bubble was not regulating enough is yet
another Krugman howler, and his claims that Freddie and Fannie were
not lending during the "peak bubble years" and that government agencies
did not encourage loans to "sub-prime" borrowers is the typical
Krugman rewriting of history.
I'll get to
Freddie and Fannie in a moment, but the notion that the banks simply
came up with the idea of lending to sub-prime borrowers on their
own really does defy history. Yes, it is true that the vast majority
of sub-prime loans DID come from the banks, and that their attempts
to securitize these loans in order to mitigate the risks were a
disaster. I have no problem with this accusation against the Wall
Street firms, but there is one thing that Krugman leaves out: the
infamous Greenspan-Bernanke "Put."
When the financial
deregulation occurred both during the Carter-Reagan years and at
the end of the Clinton administration, the government did not
get rid of the moral hazard that essentially guaranteed reckless
behavior. Both Greenspan and Bernanke time and again promised to
"create liquidity" if the banks got into trouble, and when the markets
had the trillions of the Fed standing behind them, it is no wonder
that they ran off the rails. Moral hazard has a way of encouraging
the very actions that lenders and the entities supporting them should
not be taking.
entail both profits and losses, and when the government essentially
lets the banks keep their profits but then promises to socialize
the losses, why are we shocked, SHOCKED when the banks do the things
they did? What Krugman refuses to do is to acknowledge that the
players in private enterprise really will respond to the prospect
of losses when they engage in risky behavior. Instead, he
simply ignores the fact that the banks knew the Fed and the taxpayers
were covering their behinds and so they could be free to engage
in behavior that anyone with half a brain knew could produce very
I'll make another
point about the crisis: the Austrians were on it long before the
Keynesians and the rest of American economists jumped on the bubble
bandwagon. Mark Thornton in
a "new era" in housing are everywhere. Housing construction is
taking place at record rates. New records for real estate prices
are being set across the country, especially on the east and west
coasts. Booming home prices and record low interest rates are
allowing homeowners to refinance their mortgages, "extract equity"
to increase their spending, and lower their monthly payment! As
one loan officer explained to me: "It's almost too good to be
it is too good to be true. What the prophets of the new housing
paradigm don't discuss is that real estate markets have experienced
similar cycles in the past and that periods described as new paradigms
are often followed by periods of distress in real estate markets,
including foreclosure sales, bankruptcy and bank failures.
while the Austrians may be laissez-faire in their economic
viewpoints, they hardly are fans of the banks and they certainly
did not believe that the Fed and the housing bubble constituted
a new era of prosperity. (For that matter, I warned the property
tax appeals board in Allegany County, Maryland, in the spring of
2006 that the current housing situation was a bubble and that it
would crash, and that government officials should not make future
budget predictions off what we were presently seeing. They told
me flat out that I was wrong.)
out the Fed's "Put" and the other quiet assurances from Congress
and the Bush administration that the government had the backsides
of the banks, Krugman ignores an important reason as to why the
banks ignored price signals and engaged in reckless behavior. While
I am sure that Krugman was taught early in in graduate school about
moral hazard, his leaving out that important point more to his intellectual
dishonesty than it does his lack of economic knowledge.
Were the GSEs
actually non-players in this whole affair, as claimed by Krugman?
First, if that were so, then neither entity would have gone bankrupt
in 2007, since they did not have risky loans on their books. While
it is true that neither GSE was responsible for the vast creation
of the subprime loans and their subsequent securitization, but that
did not mean they were minor players in the system at the time.
de Rugy writes:
Freddie contributed to the housing crisis by making it easier
for more people to take out loans for houses they could not afford.
Beginning in 2000, Fannie and Freddie took on loans with low FICO
scores, loans with low down payments, and loans with little or
government’s role in the housing market goes back at least to
1938, but that role changed fundamentally in the 1990s when the
government made a push to increase homeownership in the United
States. At that time, the federal government pursued several policies
that were meant to encourage banks to lend money to lower income
earners and to give incentives to low income earners to buy houses.
The result, as we now know, was a gigantic amount of subprime
mortgages at a time when house prices were starting to go down.
In other words,
the encouragement to create sub-prime housing loans came from federal
policies, something that Krugman ignores. (Krugman apparently wants
us to believe that the banks would suddenly create a bunch of bad
loans on their own, and with the full knowledge that if they lost
money, the government would not be there to force taxpayers to underwrite
these bad loans.) Freddie and Fannie did play a role in creating
these sub-prime securities, even if Krugman and the NYT want
to ignore that fact.
It gets better.
Far from being an almost non-existent player in the crisis, we find
GSEs actually did have large housing portfolios during this
Mae and Freddie Mac are considered government-sponsored enterprises
(GSEs). Although both were, before the crisis, privately financed,
the general sentiment was that in the event of a crisis in the
mortgage market, the federal government would step in and back
the GSEs. In other words, the government implicitly guaranteed
Fannie and Freddie's securitized loans. This allowed them to borrow
at interest rates below those of the financial markets and to
hold much lower capital requirements than commercial and investment
banks. The aggregate value of this subsidy has been estimated
to range "somewhere between $119 billion and $164 billion, of
which shareholders receive respectively between $50 and $97 billion.
Astonishingly, the subsidy was almost equal to the market value
of these two GSEs."
As a result,
by the time the housing crisis began to unfold, Fannie and Freddie
had become the dominating force in the secondary mortgage market,
providing 75 percent of financing for new mortgages through securitization
at the end of 2007. At the end of 2010, they still held about
50 percent of securitized, first-lien home loans.
Russ Roberts also investigated and found that Freddie and Fannie
were more like silent partners in the crisis, contra Krugman:
Freddie bought 25.2% of the record $272.81 billion in subprime
MBS [mortgage-backed securities] sold in the first half of 2006,
according to Inside Mortgage Finance Publications, a Bethesda,
MD-based publisher that covers the home loan industry.
Fannie and Freddie purchased 35.3% of all subprime MBS, the publication
estimated. The year before, the two purchased almost 44% of all
subprime MBS sold.
We are not
speaking of insignificant numbers. Furthermore, as de Rugy points
out, Congress and the administration were not exactly non-players
in setting the table for a housing crisis:
lawmakers in both parties enacted policies directed at increasing
home ownership rates, resulting in lower mortgage underwriting
standards for Fannie and Freddie. Roberts notes that from 2000
on, Fannie and Freddie bought loans with low FICO scores, loans
with very low down payments, and loans with little or no documentation.
Contrary to Paul Krugman’s assertions, Fannie and Freddie did
not "fade away" or "pull back sharply" between
2004 and 2006.
As the following
chart from Roberts’ study shows, during that same time Government
Sponsored Enterprises (GSEs) bought near-record numbers of mortgages,
including an ever-growing number of mortgages with low down payments.
as the chart below shows, while private players bought many more
subprime loans than Freddie and Fannie, GSEs purchased hundreds
of billions of dollars worth of subprime mortgage-backed securities
(MBS) from private issuers, holding these securities as investments.
(The charts are shown in the Roberts article.)
would have us believe is that the government, along with its Frankenstein
financial creatures of Fannie, Freddie, and the Community Redevelopment
Act, only wanted banks to make sound mortgages with the usual minimum
of 20 percent down, good credit scores, and the like. That clearly
is nonsense. As Thomas
DiLorenzo notes, the only way that banks on their own would
have made such risky loans was the fact that federal policies demanded
they do so.
One does not
need to hold the banks to be innocent bystanders to recognize the
role of government policy in the financial crisis. Furthermore,
while I have no problem with financial deregulation, I DO have a
problem with financial deregulation that is backed by moral hazard.
Deregulation was supposed to free financial entities to diversify
their loan portfolios and to be able to provide liquid capital to
entrepreneurs and businesses that had promising and new ventures.
financial deregulation did make possible the revolution in computers
and telecommunications, and had we kept the regulatory system Krugman
endorses in place, there would be no Apple Computers, cellphone
networks, improved transportation, and IBM would still be the industry
leader in the dominant mainframe computer business. Since Keynesians
know nothing about entrepreneurship and even less about finance,
Krugman probably is incapable of understanding how economies grow,
still being stuck in the "aggregate demand" intellectual ghetto.
deregulation only could have worked in the long run had the government
made banks and financial houses responsible for their losses. By
increasing the various government-led financial backstops as deregulation
occurred, Congress almost guaranteed more reckless behavior, and
no one should be surprised at what happened.
these tidbits of truth are left out in Paul Krugman's own zombie
version of economic history. That this rewriting of history comes
on the editorial pages of the New York Times should shock
no one. After all, the "Newspaper of Record" has been fabricating
the "record" for a long time.
L. Anderson, Ph.D. [send him
mail], teaches economics at Frostburg State University in Maryland,
and is an adjunct scholar of the Ludwig
von Mises Institute. He
also is a consultant with American Economic Services. Visit
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