America’s Economic Model a Joke?
Paul Krugman argues that recent economic crises demonstrate that America has failed at corporate governance, banking, and the rule of law.
Paul Krugman notes that we used to lecture other countries about economics but that argues recent failings have demonstrated we have no standing to do so:
The accounting scandals at Enron and WorldCom dispelled the myth of effective corporate governance. These days, the idea that our banks were well capitalized and supervised sounds like a sick joke. And now the mortgage mess is making nonsense of claims that we have effective contract enforcement — in fact, the question is whether our economy is governed by any kind of rule of law.
I hesitate to debate economics with a fellow that not only has a PhD in the subject but has won the Clark Medal and a Nobel Prize in the field, given that I’m 0-for-3 on those fronts. But, while I truly respect Krugman’s intellect and expertise, that’s got to be the dumbest paragraph he’s ever written. At least, I should hope he’s never written anything dumber.
Enron and WorldCom demonstrated that it’s possible for American companies to cook the books to give the impression that they’re in massively better shape than they really are for a brief period. And then get caught. And have the company’s executives sent off to jail. Yes, corporate governance can fail given a criminal conspiracy involving the CEO, the CFO, and the outside auditors. But what’s the evidence that there’s a widespread problem?
The banking crisis wasn’t a failure of capitalization or supervision but rather a bubble mentality. Lending to buy houses was a virtual license to print money for more than a decade and a herd mentality developed. But managers who decided in, say, 2004 to pull in the reins in a significant way would have been fired long before the bubble burst.
The latest mortgage mess, by contrast, is in fact evidence of poor management. There’s simply no excuse for not keeping track of assets and ensuring that the paperwork is all in order. That’s the essence of banking! But it’s absurd to say that it’s evidence that we’re not governed by the rule of law. The system is fully prepared to deal with the current situation. Banks can’t foreclose without the proper documentation. If they can’t prove they own the house, the can’t enforce the contract that they don’t have.
Are all these crises demonstrations that our system needed/needs some reform? Of course! Complex systems need tinkering and rethinking from time to time. And the nature of complexity is such that it often requires an actual crisis to justify fixing things. But our basic model is just fine. We had greater growth during the good times than developed countries using more constrained models. And they suffered collapses at least as damaging as we did when the crisis hit, so they sacrificed the boom without additional protection against the bust.
But, while I truly respect Krugman’s intellect and expertise, that’s got to be the dumbest paragraph he’s ever written. At least, I should hope he’s never written anything dumber.
Don Boudreaux over at Cafe Hayke seems to be making it his personal mission in life to pick out Krugman’s dumb comments.
Enron and WorldCom demonstrated that it’s possible for American companies to cook the books to give the impression that they’re in massively better shape than they really are for a brief period. And then get caught.
The irony in both cases is that neither was brought down by the government. Krugman claims a lack of oversight, but in both cases (and others besides) there were government regulators who could and should have been able to spot the problems, but instead they were spotted by concerned citizens (in the latter’s case, the concerned citizens were working for WorldCom).
There’s simply no excuse for not keeping track of assets and ensuring that the paperwork is all in order. That’s the essence of banking!
Sure there is. If your revenues from mortgages is not the interest income from the mortgage itself but rather the costs associated with generating the mortgage itself, then you have a very powerful incentive to generate as many mortgages as you possibly can, regardless of their quality and regardless of how well-organized your paperwork is.
I don’t get the arc of this piece. We should disagree with Krugman that things are bad? Not because things are good, but because they might get better?
Yesterday we went over the MERS saga, and fraud within banks on foreclosure. That was only the latest.
This sentence:
“The banking crisis wasn’t a failure of capitalization or supervision but rather a bubble mentality.”
Capitalization or supervision seems an odd grouping.
But doesn’t it bite at the ongoing discovery of ratings fraud?
Ye Gods, is the theme of this piece that “But our basic model is just fine”?
How many trillion in wreckage do we need before we start a little self-criticism?
The “basic model” promulgated at sites like OTB say from 2000-2006 was laizze faire capitalism.
It was a bizarre “I can see only one kind of failure” world view. Proponents saw government failures in the past, but maintained a careful amnesia with regard to market failures. They, and the then Fed cheif and the then SEC cheif pushed the ideas that markets were self-correcting. Take away government control and oversight and everything would be fine.
I guess you can’t fault people for trying.
What you can fault them for is totally missing the lesson. When the shit hits the fan, try to be honest about it. As Alan Greenspan did, in a moment of clarity:
As I said at OTB years ago, what made America great was lightly regulated market democracy, not “throw the brakes out the window” market mania.
“The banking crisis wasn’t a failure of capitalization or supervision but rather a bubble mentality.”
The banking crisis wasn’t failure of regulation? Well if Krugman’s statement is the dumbest ever made this is a close second. I think Krugman exaggerates our regulatory woes (particularly now) but to claim there weren’t massive failures of regulation both at Enron and more seriously in the period 2001-2008 borders on the delusional. Even Alan Greenspan now concedes that such failures occurred. The banking crisis was caused by a confluence of factors much more substantive than a “bubble mentality” which is a symptom not a condition. In order they were 1) cheap money 2) lax regulation 3) reckless banking 4) fiscal profligacy.
“The banking crisis wasn’t a failure of capitalization or supervision but rather a bubble mentality. Lending to buy houses was a virtual license to print money for more than a decade and a herd mentality developed. ”
Largely true, but problems intrinsic to the finance sector also matter. Banks had begun to rely heavily upon hedging risk. They thought that they could essentially eliminate risk with proper hedging. They were wrong.
We also had governance issues as regulators ignored signs of trouble. The federal government did not let the states act to reduce risk. The federal government kept changing rules to make it easier for banks to take risk. But, on a global scale, we still did better than a lot, maybe most, other countries. Outside of finance, most of our corporate governance is ok.
Steve
Justin Bowen says:
Friday, October 15, 2010 at 09:08
“The irony in both cases is that neither was brought down by the government. Krugman claims a lack of oversight, but in both cases (and others besides) there were government regulators who could and should have been able to spot the problems, but instead they were spotted by concerned citizens (in the latter’s case, the concerned citizens were working for WorldCom).”
Even if this were entirely true which it’s not, you’re describing FAILURES OF REGULATION which arose because the regulators were either asleep at the switch or philosophically preferred to look the other way. Thus you are endorsing Krugman’s opinion although you don’t appear to realize it.
This is key. It is a key self-check on our philosophies to do a little “comparative anatomy” between similar crises around the world.
Basically, the market democracies played the securitization game together and largely went down together.
Some did worse than us, with less oversight, like Iceland. Some did better than us, with more oversight, like Canada.
(Funny how “we can’t be like Canada” is a long term theme in America … but they seem to be showing themselves just a little smarter.)
I’m not sure where to file Dr. Krugman’s column. Under “rich irony”, perhaps? I seem to recall that Paul Krugman was a consultant to Enron in 1999. If he had problems with the company, wouldn’t that have been a good time to air them? Rather than lend his name and reputation and whatever cachet that brings to the company? Don’t consultants have fiduciary responsibilities, too?
Well Dave, that kind of revolving door is one of our problems. Not doubt.
That said, the Enron timeline shows problems just getting started in 1999:
http://en.wikipedia.org/wiki/Timeline_of_the_Enron_scandal
Was Enron up-front with “consultants” on what Andrew Fastow was doing off the books? At that point? Ever?
“But, on a global scale, we still did better than a lot, maybe most, other countries. Outside of finance, most of our corporate governance is ok.”
Since we’re talking about finance this statement seems contradictory. And if it’s saying our governance of finance was better than a lot then it has to rank as the third dumbest statement. Other than Britain most of the other major European countries and Canada did an infinitely better regulatory job than we did. To the extent they suffered it was largely backwash from the US collapse. There’s also the factor of scale. The US is the center of the world financial system. This is not Iceland or Ireland or Russia. We’re managing the lynchpin of global finance in this country and we made an awful job of it.
Dave Schuler says:
Friday, October 15, 2010 at 09:41
“I’m not sure where to file Dr. Krugman’s column. Under “rich irony”, perhaps? I seem to recall that Paul Krugman was a consultant to Enron in 1999.”
I’m afraid this comment betrays a certain naivety about what consultants do.
BTW, this is not to say that I don’t agree with Dr. Krugman that we have serious systemic problems. As a former business partner of mine once put it, I may agree with what he says but I deny to the death his right to say it.
Brummagem Joe:
There are multiple styles of consultancy. Some consultants tell their clients the truth; others tell them what they want to hear. I am of the first sort.
“There are multiple styles of consultancy”
I did it for three years after retirement. Although it was really a sinecure it was the most frustrating experience of my life.
“Since we’re talking about finance this statement seems contradictory”
From Krugman’s original statement.
“The accounting scandals at Enron and WorldCom dispelled the myth of effective corporate governance.”
FTR, I think that corporate governance outside of the finance sector is not perfect, but what is? I think we need a better way to handle pay for top execs. Still, on a global basis, we do ok. The finance sector is another story. There we suck, but so do a lot of other countries. Canada was good, but the Swiss had troubles also. The PIIGS were bad. Western Europe remains in trouble. An awful lot of countries have troubled banks.
Steve
“There we suck, but so do a lot of other countries.”
The regulatory failures in major financial centers in Europe other than in Britain weren’t remotely in our league. Individual banks might have had problems because they were overly invested here but it wasn’t systemic. The French,German, and Swiss financial systems were never teetering on the edge of collapse.
I have done it for 30 years and will probably die in harness. Past clients include Brunswick, McGraw-Hill, Sanmina-SCI, various entities at different levels of government.
steve says:
Friday, October 15, 2010 at 10:24
“Since we’re talking about finance this statement seems contradictory”
From Krugman’s original statement.
“The accounting scandals at Enron and WorldCom”
And these btw were issues of financial governance having nothing to do with say operational issues. All commercial governance is corporate.
Heh.
FWIW though, it would be about what Enron decided to tell Krugman in 1999, not vis-versa. Fraud was either just getting started, or tightly managed in the executive suite at that point.
Dave Schuler says:
Friday, October 15, 2010 at 10:34
“I have done it for 30 years and will probably die in harness.”
Ah… Stockholm syndrome. HO HO
Well, Krugman not only advised but also shilled for Enron. Writing articles promoting trend away from the planned economy.
JKB, remember the timeline. Everyone thought Enron was a modern triumph. They had the market economy working. They had the information systems on-line. They were wired.
They committed fraud, to generate the profits that we thought, for a time, were well-earned.
It was an accounting scandal in which they used off-book companies to hide what exactly they were doing. When it blew up the question was why no one was looking in those books, and how regulators could let them get away with it for so long.
So, if you really want to tie Krugman to that, do the real work, and tie him to the hidden off-the-books companies.
JKB says:
Friday, October 15, 2010 at 10:44
” Writing articles promoting trend away from the planned economy.”
Was he promoting or observing a phenomena? Either way that’s probably what he was getting paid for. He certainly wasn’t getting paid to regulate Enron.
(Enron, without the fraud, would have been a success .. a much more moderate success, with much lower profits, but alive today.)
“(Enron, without the fraud, would have been a success .. a much more moderate success, with much lower profits, but alive today.)”
Of course it would there are many such energy trading outfits extant today. These guys just committed a massive financial fraud that should have been picked upon by regulators long before. They were protected by regulatory sloth, corruption and friends in high places.
Well, a large part of the regulation of the market is the open and honest reporting of actual conditions. Writing articles with wink and a nudge to someone paying you isn’t open nor honest. To be fair, to all the so called reporters, telling the truth when everyone is making money will likely only get you shot but those are the breaks. Enron and Worldcom were supported in their fraud by go-along-to-get-along reporting. The banking crisis was supported by cheerleading in the press, all be it, often simply reporting the cheerleading by the politicians.
Frauds will occur. Where we’ve lost standing is that while it was probably proper to save the banks, it wasn’t proper to save the bankers. Most of Lehman’s executive staff need to be unemployed and unemployable. Nor is it proper for judges and lawyers to wink and nudge over foreclosure documentation. That has come to a head but still no one has been jailed for perpetrating a fraud on the court. All that happened is that homeowners’ lawyers got wise and started asking for proof instead of stipulation. So now, the banks will have to sort out their mess if they wish to prove standing. This is not a new problem, Calculated Risk had posts on it two or three years ago. So our loss of standing is not in the free market but in the crony government that protect their fellow alumni from the consequences of their ivy-league educated foolishness.
JKB says:
Friday, October 15, 2010 at 11:09
“Where we’ve lost standing is that while it was probably proper to save the banks, it wasn’t proper to save the bankers. ”
L’etat, c’est moi ……..the “bankers” are the banks.
To be honest flaws in the system don’t bother me. Resilience, the ability of the system to respond to the problems, does concern me and I’m very worried about the foreclosure fiasco. If it turns out the way some reasonably well-informed people are suggesting it might, it sounds to me like a license to steal.
As a moderate, I’ve always extolled the virtues of a “lightly regulated market economy.”
Broad systemic failures, things that are only cleaned up after their crash, might show that the “lightly regulated” part was missed or mismanaged.
What we’d ideally want would be a level of oversight to stop the “big” blowups without burdening “safe” transactions.
We erred on the side of deregulation. Maybe that was hard for some to understand 5 years ago, but by now we have more than a few illustrations.
anyone that reads about the one extreme example Krugman cites and doesn’t see that as a strawman argument by Krugman is not arguing in good faith …
If you don’t pay your mortgage for over a year you should expect to be foreclosed … how would you react if your employer failed to pay you for 1, 2, 3 months … would you still be working there ?
go ahead freeze all foreclosures … lets see how fast we can destroy the mortgage industry …
My Granddad did, in the Great Depression. One of the reasons we don’t see that now might be those unemployment benefits.
But to your whole point, if there were “one extreme example” only known by Krugman, then the Wall Street Journal probably wouldn’t be taking about “foreclosure Armageddon.”
I’d worry about 40 state attorneys general more than Krugman.
Dave Schuler says:
Friday, October 15, 2010 at 14:16
“To be honest flaws in the system don’t bother me.”
No system is flawless particularly when you have a lot of very clever people trying to game it. That’s what regulation is for. The foreclosure mess is a mess but it isn’t in the same league as the derivatives mess but as usual the chicken littles are predicting Armageddon.
“If it turns out the way some reasonably well-informed people are suggesting it might, it sounds to me like a license to steal.”
Dave, what do you think the entire mortgage and derivatives melt down was?
“But to your whole point, if there were “one extreme example” only known by Krugman, then the Wall Street Journal probably wouldn’t be taking about “foreclosure Armageddon.”
The media over hype a serious issue? Of course not they just don’t do that sort of thing.
“go ahead freeze all foreclosures … lets see how fast we can destroy the mortgage industry”
That is not going to happen of course. This is a mess but it’s amenable to the application of resource and inadequately resourced foreclosure processes are why we principally have this problem.
Is anyone paying attention to what is happening today?
The spending keeps going on, although I believe there is a spending commission that should come out with a report in a month or two.
The fed keeps easing and printing more money in the hopes of keeping the economy going? Inflation anyone?
And with that the dollar is going down the tubes?
Commodities going up.
Our jobs still keep going overseas, with the economists, the republicans, and democrats (Obama) all saying that we will benefit from “free trade.”
And while we lose the jobs, we had cash for clunkers, extension of unemployment benefits, various bailouts, casinos, and tax credits all for the purpose of appeasement and not treating the problems.
I think the bailouts and TARP, and whatever stimulus prevented a deeper recession, but we have done little more. Or at least Obama is not conveying anything. A lot more has to be done to compete with globalization and no one has figured that one out.
More tax cuts as we had years of tax cuts does not make sense if you don’t solve your problems. The fed can’t go lower than 0 on interest rates. And with our jobs going overseas, I see nothing happening for today and the future and more problems just piling up.
In my town with factories closed, just this week, the factory I worked in is down to their last 100 people out of 1300. The one guy I got into work with over 20 years seniority is laid off. And my next door neighbor, who was working at a Japanese plant in a town 10 miles was told that she was laid off. And the dry cleaners in my town is going to close up. Our last jewelry store closed up two years ago, other businesses have closed up, and this week our last dry cleaners. You cannot have a small business if the factories are closed. And yet the republicans keep chanting more tax cuts. Makes no sense to me.
I was unaware of the housing crisis as growth and housing was much slower in the Midwest. However, it seems to be a huge mistake by all on Wall Street, the democrats, the republicans, and Alan Greenspan if they targeted housing for growth while sending our manufacturing jobs overseas. Our policies and the ideologies have been wrong for a long time and it still goes on.
“The fed keeps easing and printing more money in the hopes of keeping the economy going? Inflation anyone?”
You do realise one of the principal reasons they are considering QE is that we are in serious danger of slipping into deflation. Such printing of money as has occurred over the past two years is sitting in their vaults bolstering bank reserve ratios.
“The media over hype a serious issue?”
If it’s serious, is it hype?
(Hype is smoke out of proportion to fire.)
Yes, I see deflation also. Pressure on housing and wages. But wonder if the pressure on housing is because of the housing crisis, and also on wages because there is some 2 billion cheap laborers who want our jobs. Long term, we keep printing money and if there is any signs of growth or velocity, then we could see inflation. At the moment, I find it confusing. We are trying so many things that are wrong, I just don’t know where we are ending up except a failing empire. We are appeasing but not fixing any problems.
If it’s serious, is it hype?
(Hype is smoke out of proportion to fire.)
Of course it can be. Fires can be large but not necessarily fatal. The media however can be relied upon exaggerate their consequences. The last year has replete with examples. The predicted demise of the Euro and the BP oil spill are classic examples. Both serious issues but completely over hyped. But you have a bit of a taste for these exaggerations I think.
Everyone, including Dave Schuler, points us to the Daily Caller coverage on this.
Read that and tell me there is not a lot of fire. Really, a lot.
http://dailycaller.com/2010/10/14/thedc-op-ed-one-nation-under-fraud/
john personna says:
Saturday, October 16, 2010 at 12:23
“Read that and tell me there is not a lot of fire. Really, a lot.”
Do you actually read what like I wrote. I said it’s serious issue but it’s a matter of degree. It seems to me you only need to read the latest scaro-rama from some blog and omg the sky is falling. It isn’t.
Explain how it isn’t.
For legal conveyance paper notes should be signed and transfered.
Instead they were scanned and shredded.
Big problem?
john personna says:
Saturday, October 16, 2010 at 12:36
“Explain how it isn’t.”
I don’t have to explain anything. I’ve just said it’s a very serious issue. What don’t you understand about the word SERIOUS. I just don’t buy your constant scaremongering. It’s juvenile.
Oh, but saying “I don’t have to explain anything” isn’t juvenile at all. I get it.
Heh, you want two things at once. You want this to be a “SERIOUS” but “the sky is falling. It isn’t.”
Because, you know, that way you can be semantically correct … or something.
john personna says:
Saturday, October 16, 2010 at 12:51
‘ Heh, you want two things at once. You want this to be a “SERIOUS” but “the sky is falling. It isn’t.”
I just don’t share your taste for turning every drama into a crisis. Instead of joining the greek chorus of bloviators (of which that link was a typical example) why don’t you just step back and ask yourself what is ithe nature of this problem. It’s basically a huge administrative/legal mess largely created because the holders of the debt and their collection agents nickel and dimed the foreclosure process. In many cases they hired a lot Mickey Mouse contractors who were incompetent or fraudulent and whose product was so egregious that administrative courts started it throwing out. But because at bottom it’s adminstrative it’s remediable if you apply the resources. If I’m Jamie Dimon, I give one of my smartest managers a blank check and say go fix this. He rents office space; hire thousands of clerks with real estate backgrounds (no shortage of those with the housing bust), lawyers and computer programmers(you could probably find work); buys thousand of computers and servers: and starts the process of getting the toothpaste back in the tube. And after 1-2 years most of it will be back in. This process will be aided by the fact that two thirds of foreclosures are in about six states. Ah but you say, what about all these potential lawsuits from homeowners? What grounds have they for action because they have suffered no loss? After all it was they who defaulted on payments and will live rent free for a couple of years because of the foreclosure muddle. Have you defaulted? Would you like to live rent free for a couple of years? Any loss these people have sustained is because of their own negligence. These foreclosures need to handled pragmatically and compassionately but these folks are not in the main victims. Ah but what about the AG investigations you say? Well these investigations are essentially into malfeasance committed during the original doc prep or during the foreclosure process. All this may be costly and involve some of the banks in some modest legal exposure but this is not like the Derivatives crisis. It doesn’t threaten the banking system it’s just going to prolong the unwinding of the housing bubble the effects of which are somewhat concentrated geographically. But didn’t we know that was going to take years anyway?
No Joe, that’s not what happened:
http://www.nakedcapitalism.com/2010/10/guest-post-so-why-did-the-mortgage-servicers-use-robo-signers.html
Now, I’m still slow. I don’t get why “SERIOUS” is OK, and other turns of phrase are not.
But … read McArdle:
http://www.theatlantic.com/business/archive/2010/10/who-suffers-from-the-foreclosure-mess-just-about-everyone/64642/
I don’t know if she’s right, that it’s “impossible to sell a foreclosure,” but if it is … what the heck are you doing, going after me for “scaring” people?
Maybe this is just the biggest news story of October, 2010, and I want to talk about it.
BTW, did you actually read all of the Daily Caller piece?
That ties it from shredded notes, and missing signatures, to fraudulently recreated docs and perjury in courts.
It’s the arc that matters, as my two links above show. The mess at the end is only happening because some crazy high percentage of US mortgages are in MERS, and MERS did not convey the notes in a legal fashion.
Shorter: How do you fix the note, when there is no note?
http://www.ritholtz.com/blog/2010/10/the-foreclosure-mess/
john personna says:
Sunday, October 17, 2010 at 08:24
You just keep telling me how screwed up it is but I know that already. I’m well aware there are title issues which is why I said it was a administrative/legal mess but these are basically resolvable matters whatever Ritholz says. None of this is going to bring about the indefinite freezing of the entire US foreclosure process; the collapse of the banking system; the drying up of the mortgage market, a further say 30% collapse in real estate prices across the nation; or any other sky falling events you don’t actually specify. You need to focus on likely outcomes not get hysterical about the process. I’ve told you what will likely happen so we’ll see if I’m right.
So you’ve set yourself some kind of crazy strawman. If the problems are not “indefinite” then I’ve been “scare mongering.”
Think about it Joe. I’ve given early warning, and actually been conservative compared to actual fact. I didn’t even suggest that there would be a temporary halt to sales.
Now we’ve got informed commenters saying that government has a short time to announce a solution. Read Maudlin:
“I think this (and next week’s) is/will be one of the more important letters I have written in the last ten years.”
http://www.ritholtz.com/blog/2010/10/the-subprime-debacle-act-2/
Maybe you should jump on him for scaring people, for “turning every drama into a crisis”
Or, our you can flip back to “I knew this was SERIOUS all along” again.
You just hate it because you got on the wrong side of this and now you are stuck.
It’s much better to admit it. A growth experience.
john personna says:
Sunday, October 17, 2010 at 09:16
JP you obviously have the type of psyche that craves validation for alarmist opinions as the endless debates about inflation being deflation, double dip recessions, the dire consequences of the BP spill, etc etc demonstrate. I’ve never said anything other than that this is a serious issue but at bottom it’s a administrative and legal process problem which is capable of being brought to a resolution without crisis level outcomes. If you want to believe otherwise it’s fine by me but I’m reasonably confident that my version of how this will unfold will prove accurate.
john personna says:
Sunday, October 17, 2010 at 09:17
“You just hate it because you got on the wrong side of this and now you are stuck.”
Yeah that’s right, the sky will fall.
Joe, you are relying on some crazy line in your brain.
This problem is “SERIOUS” (all caps) but “the sky will not fall.”
What does that actually mean?
What specific claim did I make about outcomes did I make that you disagree with?
There is none. You just think I’m wrong, scaremongering, because I use metaphors that you would not use.
The Wall Street Journal can use “Armageddon” of course, but I can’t say “where they’res smoke there’s fire.”
Actually, it’s simple cognitive dissonance, isn’t it?
You agree with me about the problem(s), but you need me to be wrong at the same time.
“The Wall Street Journal can use “Armageddon” of course, but I can’t say “where they’res smoke there’s fire.”
I’ve long learned to take newspaper headlines with a pinch of salt and “Armageddon” seems just the teeniest bit of an exaggeration when you stack it up against the Derivatives crisis. I obviously take a more measured view than you probably because I’ve always rather disdained exaggeration since it’s not particularly conducive to rational behavior. Finis.
In other words, you have been trashing me in this thread, and when called on it, asked to show what specific claim I made that you disagree with, you have nothing.
Instead “finis.”