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Bailouts and the Wonderland U.S. Economy

Politics / Credit Crisis Bailouts Sep 10, 2012 - 04:40 AM GMT

By: William_Anderson


Best Financial Markets Analysis ArticleI guess it is good that the Democratic National Convention is over if for no other reason than Paul Krugman can get some sleep, given his heart was pounding with joy and admiration over the brilliance of the speakers. No doubt, all this fall he will coordinate his columns and blog posts with talking points from the Obama campaign and the DNC, and I am sure that some real howlers are in store for us lucky readers.

His latest column of gratitude and worship comes in the form of praising Barack Obama for his Wondrous Works in Giving the Economy Life Eternal, or at least a small recovery. He writes:

On Inauguration Day 2009, the U.S. economy faced three main problems. First, and most pressing, there was a crisis in the financial system, with many of the crucial channels of credit frozen; we were, in effect, suffering the 21st-century version of the bank runs that brought on the Great Depression. Second, the economy was taking a major hit from the collapse of a gigantic housing bubble. Third, consumer spending was being held down by high levels of household debt, much of which had been run up during the Bush-era bubble. 

The first of these problems was resolved quite quickly, thanks both to lots of emergency lending by the Federal Reserve and, yes, the much maligned bank bailouts. By late 2009, measures of financial stress were more or less back to normal. 

This return to financial normalcy did not, however, produce a robust recovery. Fast recoveries are almost always led by a housing boom – and given the excess home construction that took place during the bubble, that just wasn’t going to happen. Meanwhile, households were trying (or being forced by creditors) to pay down debt, which meant depressed demand. So the economy’s free fall ended, but recovery remained sluggish.

What Krugman wants us to believe is that by bailing out the banks and financial houses (which was pushed by the Bush administration and continued by Obama's presidency), the economy was saved. No, what happened was that the original downturn was not as great as it would have been had some other Kool-Aide-drinking banks also were forced to face the music -- complete with some executives losing their Connecticut mansions -- and the public find out very quickly which financial institutions were zombies and which were not.

Now, Krugman would argue that had the bailouts not occurred, the entire financial system would have collapsed. Granted, if the best thing the financial system could do was to engineer a housing bubble with more liabilities than the entire wealth of the world, maybe it needed the exit door. However, I suspect that we would have seen something quite less than the Apocalypse as Wall Street figures would have seen it in their interest to find a way out of the mess they had helped to create.

But there is more. Economist Mario Rizzo had a most interesting and insightful post recently on Facebook, writing:

The Democrats say that we cannot go back to the policies that caused the financial crisis and recession. Ok. So what were those policies: The irresponsible expansion of Fannie and Freddie? The excessively easy monetary policy of the Fed? Inadequate regulation of securities? I do not remember a single Democrat objecting to these policies during the period before the crisis. I do remember Barney Frank pushing more and more expansion of Freddie and Fannie, though. Oh, the Bush tax cuts. No economist I have heard of says that the tax cuts caused the crisis and recession. So what are they talking about? 

In fact, what do we have today? For one, it is a financial system full of zombie institutions with the bailouts obscuring which institutions are healthy and which are not. Furthermore, we have the clashing policies of easy money and picky regulations. Yes, the Obama administration is demanding that banks lend money out the wazoo, but the regulators don't want anyone to get those loans. One might want to try a policy in which the banks actually have to bear the consequences of bad and even reckless loans without having the Federal Reserve and the taxpayers standing behind to clean up the mess. I suspect that we would see some civilized behavior on Wall Street; instead, we see what, frankly, is a rigged game in which the government pushes down interest rates, limits the loan choices for banks via strict regulation, and then holds out the prospect of small-but-near-guaranteed returns from federal paper. Gee, I wonder where the banks will send their money.

And then there is the GM bailout. Krugman writes:

But, that said, Mr. Obama did push through policies – the auto bailout and the Recovery Act – that made the slump a lot less awful than it might have been.

 There is a bit of a problem here; the General Motors and Chrysler bailouts did not help the economy; they hurt it. Yes, they kept the United Auto Workers in cash, which was the real purpose, anyway. (More on this below.) However, they also diverted huge amounts of capital away from more productive sectors in order to fund a venture in Crony Capitalism or maybe even Crony Socialism.

I doubt that Krugman is familiar with Frederic Bastiat, and reasonably so, since Bastiat really emphasized opportunity cost and Krugman really seems to believe that by printing money, government can do away with that pesky little economic law. The GM and Chrysler bailouts not only were politically-motivated, but also were carried out with a political calculus, all the way down to determining which dealerships would be closed and which would stay open. (It seems that campaign contributions had something to do with the calculus of decision making.)

Bastiat was a master of understanding the larger picture, something that Keynesians are not able to comprehend. (Sorry, folks, the use of aggregates does not constitute a view of a "big picture" of economics.) Instead of looking to the UAW members who kept their jobs, Bastiat would have looked at the opportunities that were lost and the entrepreneurs who could not see their own ideas fulfilled because the UAW needed a bailout.

I notice another trend in Krugman, writings, and that is a very sneaky theme that goes something like this: The economy is going to recover very well, anyway, so we should re-elect Obama to "validate his record." Furthermore, Krugman wants us to believe that if Mitt Romney were elected and the recovery occurred, that would be very bad because he would wrongly get the credit for recovery. (Actually, I think it will be bad if either man wins the election, but that is another story.)

If Obama is re-elected and the economy slides down, then I am sure that Krugman simply will blame the Goldstein Republicans or even George W. Bush. Of that we can be sure.

While I did not watch the DNC (or RNC) conventions, I did see a hilarious Youtube of former Michigan Governor Jennifer Granholm claiming that Obama's auto bailout saved the entire U.S. manufacturing sector and with it, the whole economy. Not only is she completely unhinged, but the notion that forcing taxpayers to underwrite a horribly-unproductive industry is not the way to save anyone except for those who were politically-connected. Furthermore, her claim that the "entire auto industry" would have collapsed without the bailout is simply false.

I do find it instructive that Krugman never mentioned this mangling of the facts, but as I have said before, the guy is a political operative, not an economist. A real economist would not claim that throwing money into a political rathole constitutes a stimulus that leads to recovery.

William L. Anderson, Ph.D. [send him mail], teaches economics at Frostburg State University in Maryland, and is an adjunct scholar of the Ludwig von Mises Institute. He also is a consultant with American Economic Services. Visit his blog.

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    Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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