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Published On: Fri, Feb 8th, 2013

Paul Krugman: The Real Friend of Fraud

One of Paul Krugman’s constant themes is that financial regulation, if done by people who properly have been schooled as Democrats, will guard against fraud, and he is at it again in his most recent column. The flip side of that point, of course, is that Republicans want fraud to happen because they are evil and beholden to Wild West Capitalism.

Before I deal with Krugman’s own enthusiastic support for outright financial fraud, let me address one point that he claims: Barney Frank had absolutely no influence regarding the collapse of Fannie and Freddie. Krugman writes:

How can the G.O.P. be so determined to make America safe for financial fraud, with the 2008 crisis still so fresh in our memory? In part it’s because Republicans are deep in denial about what actually happened to our financial system and economy. On the right, it’s now complete orthodoxy that do-gooder liberals, especially former Representative Barney Frank, somehow caused the financial disaster by forcing helpless bankers to lend to Those People.

In reality, this is a nonsense story that has been extensively refuted; I’ve always been struck in particular by the notion that a Congressional Democrat, holding office at a time when Republicans ruled the House with an iron first, somehow had the mystical power to distort our whole banking system. But it’s a story conservatives much prefer to the awkward reality that their faith in the perfection of free markets was proved false.

This is one of those True Krugman Moments when he claims that (1) Frank had absolutely no influence in Congress even though he was the Democrat’s Congressional point man on banking and financial matters; (2) the government never attempted to have large sums of money funneled to borrowers in the “sub-prime” category; and (3) the financial system that existed during the housing boom was pure free market without a hint of government intervention anywhere.

(Given Krugman’s belief that Democrats are pure of heart and never would engage in financial fraud, I am surprised that he does not go after Jon Corzine, who was responsible for more than a billion dollarsin very questionable losses for investors. Oh, I forgot. Corzine was a Democrat politician; he lost the money honestly trying to help his dear clients. And Bernie Madeoff also was a Democrat.)

As that famed right-wing publication, The Boston Globe, declared in a feature on Frank:

When US Representative Barney Frank spoke in a packed hearing room on Capitol Hill seven years ago, he did not imagine that his words would eventually haunt a reelection bid.

The issue that day in 2003 was whether mortgage backers Fannie Mae and Freddie Mac were fiscally strong. Frank declared with his trademark confidence that they were, accusing critics and regulators of exaggerating threats to Fannie’s and Freddie’s financial integrity. And, the Massachusetts Democrat maintained, “even if there were problems, the federal government doesn’t bail them out.’’

Now, it’s clear he was wrong on both points — and that his words have become a political liability as he fights a determined challenger to win a 16th term representing the Fourth Congressional District. Fannie and Freddie collapsed in 2008, forcing the federal government to buy $150 billion worth of stock in the enterprises and $1.36 trillion worth of mortgage-backed securities.

Now, I absolutely agree that Frank did not cause the meltdown nor did he cause the collapse of Fannie and Freddie, but even though his party did not hold a majority in the House of Representatives, nonetheless he did have influence and lots of it. (The influence comes out in the committee action, not the actual vote on the floor.) Furthermore, I do not recall any prominent Democrats during that period calling for lending restrictions on people with bad credit.

photo 401K 2012/2013 via Flickr

photo 401K 2012/2013 via Flickr

The blame for the meltdown is bipartisan, although Krugman will never admit to such. As for the Consumer Protection Bureau which he champions throughout the column, I do not believe that Washington and the Democrats are ready to jettison the very tenets of political liberalism and call for strict lending standards and to shut out people with bad credit from mortgage markets. That really would be a first!

Krugman’s enthusiastic support for massive fraud, however, comes in his enthusiastic calls for inflation and lots of it, and inflation is a fraudulent way to repudiate debt (although Krugman has written that such a method is perfectly moral). As I have pointed out before, Krugman has openly agitated for government financial measures such as the Fed purchasing worthless financial instruments in order to jack up their market prices (if a private firm does the same, it is called “manipulation,” which is against the law).

The difference is in the sheer numbers. While the meltdown featured head-scratching decisions by banks, nonetheless the actual losses due to the Corzine-Madeoff kind of fraud (where people actually set out to deceive others) were small compared to the over-the-cliff losses that came from lots of people jumping into the housing market because it was hot.

Krugman, like most Keynesians, believes that regulators have excellent foresight and know beforehand what lines of production will be profitable and which will not. (One remembers the Democrats pushing “industrial policy” in the 1980s, a brainchild of Bill Bradley and Gary Hart, both of whom believed that government agencies should target upcoming industries and then subsidize them. We see how well that works with “green energy.”)

As Murray Rothbard once put it, if regulators actually had the kind of knowledge Krugman believes they have, then they would be in the markets themselves making lots of money employing their great foresight instead of making paltry government salaries. Instead, we find that regulators mostly will try to block any innovation, since they never will get credit for market successes, but surely will be blamed for market failures.

When it comes to fraud, however, keep in mind that it was the players in the market that realized Madeoff was running a scam, not the regulators. In fact, the lack of insight by regulators actually permitted Madeoff to run his operation longer than it should have gone, as people tended to think that if the regulatory agencies were OK with the guy, then he must be on-the-level.

The kind of fraud I fear, however, is not the fraud of some people being scammed in the financial markets. The greater and more dangerous fraud is that which Krugman heartily endorses: government money printing and the destructive inflation that follows it. Krugman’s Inflation Fairy is as dishonest as Bernie Madeoff and much more dangerous.

Krugman in Wonderland 624


William L. Anderson is an author and an associate professor of economics at Frostburg State University in Maryland. He is also an adjunct scholar with the Mackinac Center for Public Policy as well as for the Ludwig von Mises Institute in Alabama.

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About the Author

- William L. Anderson is an author and an associate professor of economics at Frostburg State University in Maryland. He is also an adjunct scholar with the Mackinac Center for Public Policy as well as for the Ludwig von Mises Institute in Alabama.

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