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Taming the Beast
By Paul Krugman
The New York Times
Monday 24 March 2008
We're now in the midst of an epic financial crisis, which ought to be at the
center of the election debate. But it isn't.
Now, I don't expect presidential campaigns to have all the answers to our current
crisis - even financial experts are scrambling to keep up with events.
But I do think we're entitled to more answers, and in particular a clearer commitment
to financial reform, than we're getting so far.
In truth, I don't expect much from John McCain, who has both admitted not knowing
much about economics and denied having ever said that. Anyway, lately he's been
busy demonstrating that he doesn't know much about the Middle East, either.
Yet the McCain campaign's silence on the financial crisis has disappointed
even my low expectations.
And when Mr. McCain's economic advisers do speak up about the economy's problems,
they don't inspire confidence. For example, last week one McCain economic adviser
- Kevin Hassett, the co-author of "Dow 36,000" - insisted
that everything would have been fine if state and local governments hadn't tried
to limit urban sprawl. Honest.
On the Democratic side, it's somewhat disappointing that Barack Obama, whose
campaign has understandably made a point of contrasting his early opposition
to the Iraq war with Hillary Clinton's initial support, has tried to score a
twofer by suggesting that the war, in addition to all its other costs, is responsible
for our economic troubles.
The war is indeed a grotesque waste of resources, which will place huge long-run
burdens on the American public. But it's just wrong to blame the war for our
current economic mess: in the short run, wartime spending actually stimulates
the economy. Remember, the lowest unemployment rate America has experienced
over the last half-century came at the height of the Vietnam War.
Hillary Clinton has not, as far as I can tell, made any comparably problematic
economic claims. But she, like Mr. Obama, has been disappointingly quiet about
the key issue: the need to reform our out-of-control financial system.
Let me explain.
America came out of the Great Depression with a pretty effective financial
safety net, based on a fundamental quid pro quo: the government stood ready
to rescue banks if they got in trouble, but only on the condition that those
banks accept regulation of the risks they were allowed to take.
Over time, however, many of the roles traditionally filled by regulated banks
were taken over by unregulated institutions - the "shadow banking
system," which relied on complex financial arrangements to bypass those
safety regulations.
Now, the shadow banking system is facing the 21st-century equivalent of the
wave of bank runs that swept America in the early 1930s. And the government
is rushing in to help, with hundreds of billions from the Federal Reserve, and
hundreds of billions more from government-sponsored institutions like Fannie
Mae, Freddie Mac and the Federal Home Loan Banks.
Given the risks to the economy if the financial system melts down, this rescue
mission is justified. But you don't have to be an economic radical, or even
a vocal reformer like Representative Barney Frank, the chairman of the House
Financial Services Committee, to see that what's happening now is the quid without
the quo.
Last week Robert Rubin, the former Treasury secretary, declared that Mr. Frank
is right about the need for expanded regulation. Mr. Rubin put it clearly: If
Wall Street companies can count on being rescued like banks, then they need
to be regulated like banks.
But will that logic prevail politically?
Not if Mr. McCain makes it to the White House. His chief economic adviser is
former Senator Phil Gramm, a fervent advocate of financial deregulation. In
fact, I'd argue that aside from Alan Greenspan, nobody did as much as Mr. Gramm
to make this crisis possible.
Both Democrats, by contrast, are running more or less populist campaigns. But
at least so far, neither Democrat has made a clear commitment to financial reform.
Is that simply an omission? Or is it an ominous omen? Recent history offers
reason to worry.
In retrospect, it's clear that the Clinton administration went along too easily
with moves to deregulate the financial industry. And it's hard to avoid the
suspicion that big contributions from Wall Street helped grease the rails.
Last year, there was no question at all about the way Wall Street's financial
contributions to the new Democratic majority in Congress helped preserve, at
least for now, the tax loophole that lets hedge fund managers pay a lower tax
rate than their secretaries.
Now, the securities and investment industry is pouring money into both Mr.
Obama's and Mrs. Clinton's coffers. And these donors surely believe that they're
buying something in return.
Let's hope they're wrong.
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