WASHINGTON, April 11, 2014 – In his April 11 column in the New York Times, Nobel Prize-winning economist Paul Krugman wrote that Wall Street’s “vampires of finance” have come to Congress to ask for a repeal of the Dodd-Frank law.
Bankers say that this law over-regulates their industry, reducing lending and making it difficult for banks to remain profitable. Krugman claims that the law is working well and should be expanded. Who is right?
Dodd-Frank is a very complex bill designed to regulate the financial services industry with the intent of avoiding another financial crisis like the one in 2008. The bill touches almost every sector of the financial industry from small banks to the largest diversified financial giants. Krugman argues this regulation by government is needed.
His reasoning seems to be a Gruberization.
Gruberization is a term is associated with MIT economist Jonathan Gruber, who conducts studies supposedly geared toward finding unbiased conclusions. But the results of his studies seem to be determined before each study is actually conducted. Gruber then appears to work with data and selects a time period so the results of the study confirm his pre-study conclusions.
An example of this type of activity is seen when very learned economists, like Krugman, conclude that raising the minimum wage will not result in the loss of jobs but rather may lead to an increase in jobs. This reasoning behind this conclusion is analogous to someone who says he is strong enough to lift himself off the ground. Not only is this conclusion a Gruberization, but it contradicts a textbook authored by Krugman.
In his NYT column, Krugman notes that this law has had “a major chilling effect on abusive lending practices.” The reality is this law has indeed had a chilling effect on all lending practices. This tends to slow economic growth, as it minimizes the effect of an expansive monetary policy. As a result, the economy hasn’t seen strong economic growth at any time since the law was passed..
Krugman further notes that large financial institutions have been able to “evade regulation” by becoming more diverse. The reality is that more diversity is needed today, given the complex financial requirements of multinational firms and the world-wide banking community. Many large financial firms feel handcuffed by Dodd-Frank, especially considering a fear that this law allows regulators to “seize control of such institutions at times of crisis.”
What is most ironic is that economists like Krugman are in favor of more government involvement when, in fact, it was the government that caused the financial crisis in the first place.
Historically 62 to 64 percent of all households typically chose to own a home while the remainder chose to rent. Sociologists, beginning in the 1980s, informed Congress that in areas where the home ownership rate was 70 percent or higher there was a dramatic reduction in social problems like crime, teenage pregnancy, high rates of high school dropouts and drug abuse.
Congress, along with Presidents Clinton and Bush, supported a goal to increase home ownership nationwide to 70 percent.
In order to do that about 10 million households would have to be converted from renters to home owners, which meant that any problems preventing this outcome had to be eliminated. So the government encouraged all facets of the finance industry to create mortgages that required little or no down payment and that offered below-market interest rates, at least for the first few years of ownership.
Eventually these 10 million households were were “qualified” to acquire an average $200,000 mortgage, creating $2 trillion of consumer real estate indebtedness, almost all of which eventually defaulted. While the home ownership rate did reach 70 percent in 2008, the massive number of defaults led to the frantic financial maneuvering that eventually resulted in the massive financial crisis dubbed by some as the “Great Recession.”
Incidentally, the home ownership rate is 64 percent today. So much for a successful idea.
People like Paul Krugman and senators like Elizabeth Warren believe that more government involvement is needed even today. When listening to them, it is easy to get the feeling that they seem intimidated by the large numbers on Wall Street, leading them to believe that, in fairness, Wall Street “vampires” should earn less.
The opposing view says that government created the financial crisis, so if government just gets out of the way, stops meddling and returns to more normal banking regulation, the finance industry can function normally and the economy can really start to grow.
Ronald Reagan said it best. “Government is not the solution to our problem. Government is the problem.”