Both the liberal orthodoxy, as represented by Paul Krugman, and the conservative orthodoxy still completely fail to understand the financial crisis. That is why they have not even begun to successfully address it:
In the real world, recent events were a devastating refutation of the free-market orthodoxy that has ruled American politics these past three decades. Above all, the long crusade against financial regulation, the successful effort to unravel the prudential rules established after the Great Depression on the grounds that they were unnecessary, ended up demonstrating — at immense cost to the nation — that those rules were necessary, after all.
But down the rabbit hole, none of that happened. We didn’t find ourselves in a crisis because of runaway private lenders like Countrywide Financial. We didn’t find ourselves in a crisis because Wall Street pretended that slicing, dicing and rearranging bad loans could somehow create AAA assets — and private rating agencies played along. We didn’t find ourselves in a crisis because “shadow banks” like Lehman Brothers exploited gaps in financial regulation to create bank-type threats to the financial system without being subject to bank-type limits on risk-taking.
No, in the universe of the Republican Party we found ourselves in a crisis because Representative Barney Frank forced helpless bankers to lend money to the undeserving poor.
O.K., I’m exaggerating a bit — but not much. Mr. Frank’s name did come up repeatedly as a villain in the crisis, and not just in the context of the Dodd-Frank financial reform bill, which Republicans want to repeal. You have to marvel at his alleged influence given the fact that he’s a Democrat and the vast bulk of the bad loans now afflicting our economy were made while George W. Bush was president and Republicans controlled the House with an iron grip. But he’s their preferred villain all the same.
The demonization of Mr. Frank aside, it’s now obviously orthodoxy on the Republican side that government caused the whole problem. So what you need to know is that this orthodoxy has hardened even as the supposed evidence for government as a major villain in the crisis has been discredited. The fact is that government rules didn’t force banks to make bad loans, and that government-sponsored lenders, while they behaved badly in many ways, accounted for few of the truly high-risk loans that fueled the housing bubble.
First, Krugman is totally and completely wrong about “the free-market orthodoxy that has ruled American politics these past three decades”. The last I noticed, the US financial system was still a government-mandated monopoly in the grand tradition of the East India and Hudson Bay companies. To claim that a nation which requires the reporting of all cash transactions over a certain amount to the government and where even cutting hair requires special permits is a “free market” is totally absurd.
But one cannot reasonably claim that the government is the primary villain in the financial crisis either. The government did put pressure on the banks to make bad loans, but the fact is that although they are certainly a serious probem, it is not the problematic banks loans are actually the major problem. Consider the following facts. The two total amount of money presently loaned out by all the commercial banks in the USA is $6.8 trillion dollars, down from a peak of $7.3 trillion in 2008. The total amount of debt presently owed by the financial sector is $13.8 trillion, down from $17.1 trillion in 2008.
This is the Wall Street Casino to which I have referred. It is sometimes referred to as the “investment” side of banks, which is nothing more than them borrowing money and gambling it in the form of derivatives on the different currency and equity markets. This is no more productive or capitalist than Grandma’s bingo night or Uncle Joe’s day at the horse track, it is simply gambling on a larger scale.
So, it should be readily apparent that anyone who is still attempting to frame the problem in terms of bank loans and not bank debts simply does not even begin to comprehend either the nature or the scope of the crisis.
There are serious economic problems, to be sure, but the core of the financial crisis would be better described as Bingo Night Finance than Rabbit Hole Economics.