Paul Krugman says ...

8 Words of Wisdom for Week Ending 4/3/2009 #7

Lawrence Summers, the head of the National Economic Council, responded to criticisms of the Obama administration’s plan to subsidize private purchases of toxic assets. “I don’t know of any economist,” he declared, “who doesn’t believe that better functioning capital markets in which assets can be traded are a good idea.”

Leave aside for a moment the question of whether a market in which buyers have to be bribed to participate can really be described as “better functioning.” Even so, Mr. Summers needs to get out more. Quite a few economists have reconsidered their favorable opinion of capital markets and asset trading in the light of the current crisis.

But it has become increasingly clear over the past few days that top officials in the Obama administration are still in the grip of the market mystique. They still believe in the magic of the financial marketplace and in the prowess of the wizards who perform that magic.

The market mystique didn’t always rule financial policy. America emerged from the Great Depression with a tightly regulated banking system, which made finance a staid, even boring business. Banks attracted depositors by providing convenient branch locations and maybe a free toaster or two; they used the money thus attracted to make loans, and that was that.

And the financial system wasn’t just boring. It was also, by today’s standards, small. Even during the “go-go years,” the bull market of the 1960s, finance and insurance together accounted for less than 4 percent of G.D.P. The relative unimportance of finance was reflected in the list of stocks making up the Dow Jones Industrial Average, which until 1982 contained not a single financial company.

It all sounds primitive by today’s standards. Yet that boring, primitive financial system serviced an economy that doubled living standards over the course of a generation.

In the aftermath of the Great Depression, a system evolved that helped even out the impact of our recessions. It all but eliminated banking panics. Any student of history knows that before the Great Depression, each recession or depression could be worse than the one that proceeded it. Why, then, did conservatives seek to dismantle those institutions that protected the American people from economic calamity? Why did we usher in an age of deregulation in 1980 that has brought us to the brink of financial ruin? The questions are rhetorical.

Ultimately, we are facing a system that has become fundamentally broken. It just doesn't seem that the Obama Treasury Department recognizes this. Paul Krugman says it better than almost anyone else can ...

To be fair, officials are calling for more regulation. Indeed, on Thursday Tim Geithner, the Treasury secretary, laid out plans for enhanced regulation that would have been considered radical not long ago.

But the underlying vision remains that of a financial system more or less the same as it was two years ago, albeit somewhat tamed by new rules.

As you can guess, I don’t share that vision. I don’t think this is just a financial panic; I believe that it represents the failure of a whole model of banking, of an overgrown financial sector that did more harm than good. I don’t think the Obama administration can bring securitization back to life, and I don’t believe it should try.

Source - The New York Times