The Problem(s) with Banking

Paul Krugman’s latest is titled “Is a Banking Ban the Answer?”  and once again I am resisting the urge to name-call.

It’s funny, I don’t really have an educated opinion on the actual discussion here, which is around fractional reserve banking and how to best minimize risk going forward as it relates to required minimum reserves.  I would love to know what John Hussman thinks about this article, and the topic in general.

My issue with this post is the part about the financial crisis of 2008, and how it relates to the banking industry.  Krugman writes:

Are we really sure that banking problems are the whole story about what went wrong? I’ve made this point before, but look at any measure of financial stress: what you see is a huge peak in 2008 that quickly went down:

Yet the quick return to normality in financial markets (achieved, to be sure, through bailouts and guarantees) did not produce a quick recovery in the real economy; on the contrary, we’re still depressed and many advanced countries are now on the edge of deflation, more than five years later. This strongly suggests that while bank runs may have brought things to a head, the problems ran deeper; in particular, I’m strongly of the view (based in part on Mian and Sufi’s work) that broader issues of excess leverage, and the resulting balance-sheet problems of many households, are key.

What’s wrong with this picture (literally)?  It appears as if, and Krugman writes as if, all things being equal, there was financial stress, and it went away (or at least back to “normal”).  But all things are not equal.

  1. FASB changes allowing mark-to-unicorn happened at exactly the time financial stress went down.  What a coincidence.  And are still in place today.  FAS-157 was introduced in 2007 to require mark-to-market using some sort of fair value justification.  Prior to that, hard to value assets were carried at no more than cost.  Now, who knows?  They can value assets at whatever value they choose.  This means that whatever stress existed due to assets losing value may or may not have gone away, but it definitely appeared to go away.
  2. Once the bailouts occurred, TBTF was established as the baseline for the big banks.  The Fed has calculated the excess profits that the banks get for this now codified policy.  This insurance has eliminated a lot of financial stress, because now we know that the stress won’t actually result in TBTF bank failures.
  3. It seems that Krugman is implying that household balance sheet issues have been eliminated, or at least reduced.  This is simply not true.  Many household balance sheets were improved through foreclosure.  Enough households suffered foreclosure that it reduced the country’s household mortgage debt:fredgraph1

But what about the rest of the household debt load?  It had a brief period of reduction, but we are back at it:fredgraph2

Maybe the real economy has not recovered so quickly because measures of it are more accurate, or harder to manipulate.  Maybe the fixes that allowed the financial stress measures to bounce back so quickly actually are holding back the real economy.

It’s as if Krugman is looking for a way to excuse the banking industry as victims of the crisis, rather than as its principal actors and architects.  Another way to look at is that banks caused the crisis, took the public money and guarantees, have completely failed to fix any of the underlying issues, continue the same practices today, and want to know why the rest of us can’t just get over it and get with the(ir) program.  And the real economy is failing to respond accordingly.

 

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