[Gfranc]

This thread is old...but I do want to finish by saying that I think we agree on a few points. The main issue I still have is that Krugman believes that Keynesian models can be applied in our political system. Sure, they should work just as you portray, but they don't. And they never will. Keynesian models are simply to prone to corruption. I said he was an idiot though, not a fool.

Of course the fed is bailing out the banks...they always will, they are the banks! This is a very, very dangerous road. We've made a real mess out of something that really is simple. I can't say it better than this. http://unqualified-reservations.blogspot.com/2011/10/profess...

[trevelyan]

Gfranc,

You aren't clear enough on the difference between fiscal and monetary policy for your comments on corruption to make any sense. If you think US banking policy is corrupt that has nothing to do with Krugman or Keynesian models. Quite the opposite since Krugman has been arguing very publicly AGAINST the sorts of policies you seem to find instinctively distasteful: he does not think the bailout is solving the underlying economic problems with the banks and writes practically every week about WHY. The fact you attack him without knowing what he actually says is revealing.

On the other hand, if you think fiscal policy is corrupt you have the uncomfortable reality that there hasn't been much of it: the White House scaled back the needed stimulus from a projected 1.2 trillion to 800 billion and overall government spending STILL fell. This is why U6 is over 16 percent now: private sector demand collapsed and nothing has stepped in to fill the gap. If you think there has been too much corruption with the fiscal stimulus you are also pretty much alone. People seem generally content funding additional transfers to local governments to keep public services running. I haven't read a lot of popular anger over fiscal priorities. I have read a lot of people who are angry at banking policy though.

None of this is insider information. Nor do you sound informed to be citing bloggers who were crying wolf about deficit spending at a time when US borrowing rates were falling or sounding the alarm about inflation at a time when the US economy was moving in the other direction. You might be right in slamming on the American political system since it gives voice and power to these people, but I don't see what your criticism has to do with the one guy in the NYTimes who is trying to get the brakes put on bad policy and has constantly criticized both left and right and been proven time and time again right on the money with his critiques.

Also -- you should drop the right-wing fool/idiot claptrap if you expect people to take your posts seriously. It makes you sound confused instead of smart -- especially when the blog you cite approvingly reverses the words while seeming to mean exactly the same thing.

[Gfranc]

Fair enough and interesting reading...thanks for taking time to write the replies. When I speak of corruption, I’m speaking primarily in banking. Banks know this game. Banks also know the position that the fed is in, and what decisions it must make. I can agree that Krugman is likely the wrong target, but I still don’t' think that Keynesianism is. Wouldn't you agree that the majority of the mess we're in right now was and is caused by misapplied Keynesian theory? Misapplied subsidies, interest rates, monetary policy? What I'm trying to understand still is how anyone believes (including Krugman) that Keynesian theory can ever be successful in a political system as we have now or in a banking system as we have now. The fed has simply been a tool for achieving whatever Washington and corporate elites plan next. I have a hard time believing it will ever be anything but. Taking that power away from Government and living with natural fluctuations in the economy seems a far better option.

We got off the original track here… I can tell you why this original post sparked my interest, and it’s that I was angered by #OWS’s attacking business and corporations, when the vast majority of them (my employer) are innocent and profoundly important. I was intrigued by your reply but I disagreed that they weren’t attacking manufacturing or retail. What else is “corporate greed”? Then you stated that the “ Federal Reserve is funneling free money to banks” and I thought, of course they are. I kept hearing Krugman’s arguments that they didn’t do this or didn’t do that…and my thought was, when are you (Krugman) going to realize that they aren’t going to? When will you realize that this theory will never be applied in a manner that is actually helpful? As long as we live in a divided state, with a fed that is manipulated and a banking industry that is guaranteed by their importance to the fed philosophy… the application will always create messes like this one. I firmly believe the next one will be even bigger.

Krugman may be right on his grievances, but I think he’s wrong to ever believe it will be done right. We simply keep getting left with fewer and fewer options.

[trevelyan]

The 2008 banking crisis was caused by the private sector borrowing heavily in short-term markets while using swaps, derivatives and complex financial instruments to paper over risks and in some cases outright fraud. Banks collapsed because lending dried up when the market corrected and they couldn't raise money to pay back their creditors. The falling value of their assets combined with their newfound and absolutely insane leverage (sometimes 60-1) to push their liabilities greater than their assets very quickly. The rush to the exits by panicking investors did the rest: the weekend before Lehman collapsed it was trying to raise 50 billion in the (unregulated) repo markets.

What does any of this have to do with Keynes or government spending? Absolutely nothing. The private sector took advantage of financial deregulation in the late 1990s and 2000s to leverage up and start betting in new markets. The trigger was the dismantling of the Glass Steagal act which prohibited bank holding companies from owning speculative investment houses. The economy was certainly weakening in 2008, but it did not need to collapse into Depression-era levels of unemployment and misery.

Obama has made three big policy mistakes in my opinion. The first was not nationalizing the failed banks as Krugman and many others advocated, wiping out the shareholders and recapitalizing the husks into smaller banks which posed no systemic risk to the economy and which could have engaged in lending that would have translated low interest rates into actual business lending. Instead the Obama administration did nothing out of a fear of provoking capital flight from the remaining banks and making nationalization inevitable. This left it to the Federal Reserve to try and keep credit flowing using the only tools at its disposal: low interest rates and creative lending. Bernanke gets a lot of flack but this was good policy which probably prevented financial apocalypse. It is just turning out to be really expensive in the absence of a political willingness to demand anything in return for the bailouts, since the banks are simply using the cheap capital to return to speculative and leveraged investment plays rather than renewing their lending to the private sector. Case in point: the government should not be borrowing from itself and paying the banks interest for the privilege.

The second was agreeing to extend the Bush tax cuts in a tit-for-tat exchange with the Republicans over health care. The administration justified this as a form of economic stimulus, but it was a horrible misuse of the term, since the relatively wealthy who benefit from the cuts tend to save/invest capital instead of spending it right away, which is the point of stimulus. Bush II did the same thing and that is one of the causes of the weak recovery from the last recession and the reason the Fed kept interest rates low after the first dot-com boom.

The third was the failure to pursue real Keynesian stimulus when aggregate demand plummeted. Standard economic projections in 2008 predicted a 2 trillion shortfall, and called for 1.2 trillion in stimulus to keep unemployment under 7 percent. And yet Obama's team never tried for more than 800 billion because they didn't think they could push it through Congress, and because the Republican party was trying to spark a debt crisis by questioning the solvency of the US government and calling for financial austerity!

I am sure there is a conservative blogger out there willing to dump the thing on Keynes and Krugman as "liberals" who promote "government spending". The sad thing is these people have been empirically wrong for ages, and their proposals of what needs to be done are dangerous and ignorant.

[Gfranc]

Fiscal austerity, as Friedman would agree, is unbelievably stupid at this time. However, because the government is so far in debt to begin with, adding debt through stimulus is guaranteed to be unpopular. The application of Keynesian policy deserves some dumping. When times get crappy it’s spend spend spend and lower interest rates, when times are booming its...maintain current monetary and lower interest rates? It seems they are only following Keynesian theory when times get tough. For political reasons, they are conveniently leaving out the difficult parts of application of Keynesian theory. Overspending and bad policy during times of plenty causes grief during times of trouble. From what I see, misapplication, including uncalled for low interest rates, deserves some blame.

Banks made bad loans (also) because their loans were risk free. They were leveraging because they could. I agree they shoulder the blame, but so do the guarantors of those loans, US Government.

Thanks again for the replies... I copied this and will review it several more times to further my understanding. I was obviously misguided.

I consider myself someone centrist, but I certainly lean towards limited government. Such talk of nationalizing banks to me is dangerous in the long term. I'm not even sure how that would be considered constitutional. But in our situation, hell, they are basically all quasi nationalized anyway. The current structure allows far worse in that only losses are nationalized. So our choice under current policy is to nationalize or recapitalize? We need better options and policy that allows for banks to fail when they make bad loans. But again, can Keynesian theory even be successfully applied in this environment? Don’t we basically have to have smaller banks or national banks in order for it to work? I agree with the idea that banks should be broken up. The TBTF are alive and well and bigger than ever. That is one of the #OWS grievances I can get behind. Most of the others, to me, are pure nonsense, but that is an entirely different discussion.

Again, thanks for the insightful discussion…time is limited.

[trevelyan]

Thanks for the thoughtful discussion.... Only one note: subprime loans were by definition those which did not quality for government guarantee. So Fannie/Freddie may be bad policy for other reasons, but they didn't cause the crisis -- they lost market share to private lenders throughout:

http://www.cepr.net/index.php/blogs/beat-the-press/george-wi...