Krugman Is Half Right

By William K. Black
Quito: May 16, 2015

Paul Krugman has a nice column entitled “Fraternity of Failure” dated May 15, 2015.

In Bushworld, in other words, playing a central role in catastrophic policy failure doesn’t disqualify you from future influence. If anything, a record of being disastrously wrong on national security issues seems to be a required credential.

But refusal to learn from experience, combined with a version of political correctness in which you’re only acceptable if you have been wrong about crucial issues, is pervasive in the modern Republican Party.

Krugman moves from foreign policy to economic policy and sees the same fraternity of failure among Republican economists.

Take my usual focus, economic policy. If you look at the list of economists who appear to have significant influence on Republican leaders, including the likely presidential candidates, you find that nearly all of them agreed, back during the “Bush boom,” that there was no housing bubble and the American economic future was bright; that nearly all of them predicted that the Federal Reserve’s efforts to fight the economic crisis that developed when that nonexistent bubble popped would lead to severe inflation; and that nearly all of them predicted that Obamacare, which went fully into effect in 2014, would be a huge job-killer.

Given how badly these predictions turned out — we had the biggest housing bust in history, inflation paranoia has been wrong for six years and counting, and 2014 delivered the best job growth since 1999 — you might think that there would be some room in the G.O.P. for economists who didn’t get everything wrong. But there isn’t. Having been completely wrong about the economy, like having been completely wrong about Iraq, seems to be a required credential.

What’s going on here? My best explanation is that we’re witnessing the effects of extreme tribalism. On the modern right, everything is a political litmus test. Anyone who tried to think through the pros and cons of the Iraq war was, by definition, an enemy of President George W. Bush and probably hated America; anyone who questioned whether the Federal Reserve was really debasing the currency was surely an enemy of capitalism and freedom.

It doesn’t matter that the skeptics have been proved right. Simply raising questions about the orthodoxies of the moment leads to excommunication, from which there is no coming back. So the only “experts” left standing are those who made all the approved mistakes. It’s kind of a fraternity of failure: men and women united by a shared history of getting everything wrong, and refusing to admit it. Will they get the chance to add more chapters to their reign of error?

Krugman’s explanation is compelling, except that it ignores the rival fraternity of failure inhabited by economists and finance “experts” who support the New Democrats and New Labour. Krugman chooses three economic prediction issues to discuss: was there a housing bubble, would the Fed’s liquidity programs in response to the crash cause hyper-inflation, and would Obamacare be a huge job-killer? He faces tight word count limits and one can only discuss a few examples in any column. The three examples he chose are certainly legitimate. But the examples he chose focus on Republican errors, are not the most important economic errors, and are not as clean as he implies in purportedly differentiating between Republican error and Democratic Party economist success.

The Housing Bubble

Economists who tend to support the Democratic Party like Dean Baker were the ones who got the housing bubble correct – and early. But, overwhelmingly, economists who tend to support the Democratic Party either got the bubble wrong, or made minimal efforts to warn about the bubble and call for public sector actions to burst it.

The reason the vast majority of economists, regardless of political affiliation, got the bubble wrong has next to nothing to do with partisan “tribalism.” The reason they got it wrong is because orthodox economists of all political persuasions believed in economic myths that had been falsified by white-collar criminologists 75 years ago. For a bubble to occur, market prices for that good (and a vast array of financial derivatives for which that good constitutes the “underlying) must systematically move in the wrong direction away from the “efficient” price – for many years and (in the case of housing) by over $1 trillion cumulatively. Orthodox economists, believed in the efficient market hypothesis and knew such bubbles were impossible.

The most logical explanation for such a bubble is a rational explanation – widespread “accounting control fraud” by lenders and loan purchasers. Orthodox economists make a standard assumption of rational behavior, including by criminals. But orthodox economists have a primitive tribal taboo against the “f” word – fraud. When it comes to bubbles, therefore, orthodox economists overwhelmingly simply assume mass irrationality. They would rather drop their most cherished assumptions about economic behavior than admit the reality that there are elite white-collar criminals and that their crimes can become epidemic when the incentive structures are so perverse that they produce a criminogenic environment. .

This problem of dogma is compounded by the problem that the orthodox responses to a bubble are clumsy, slow, and awful in terms of their “collateral damage” to the Nation, particularly those most in need. Basically, the orthodox response is to throw the economy in a recession – hoping to kill off the bubble and reduce the severity of the eventual recession it would have caused when it collapsed on its own. Worse, the orthodox policy recommendation to avoid future bubbles is permanent monetary austerity and higher interest rates to deter bubbles – producing rolling recessions and weak growth. Indeed, orthodox economists are so dubious of their ability to correctly identify a bubble and so cognizant of the grave harms and risks posed by trying to use orthodox responses to bubbles that their standard recommendation is to do nothing even if they suspect that a bubble is developing.

The vastly better response to a bubble like the housing bubble is unknown to orthodox economists and is never taught to students. The answer is to (1) put the fraudulent lenders and loan purchasers out of business by vigorous supervision, enforcement, and prosecution and (2) to limit their growth by effective regulation and bans on loan products most conducive to fraud. The regulators and prosecutors must break the “Gresham’s” dynamic that can make fraud epidemic.

We did this as regulators in 1984-1986 and deliberately burst the developing real estate bubbles in the Southwest before they could cause any national, much less international, economic crisis. It was certainly not pain free and we were aided by passage of the 1986 tax reform act that ended some of the most perverse real estate tax incentives, but it worked brilliantly and represents even today the most successful policy intervention against a bubble. The same strategy would have prevented the Great Recession, but the anti-regulators refused to follow our lead.

Inflation and Monetary Stimulus

This was an odd formulation by Krugman because it ignored fiscal stimulus which is where economists that tend to support the Democratic Party had their greatest success relative to economists that almost invariably support the Republican Party. Krugman’s point on the “hyper-inflation” crazy-hawks is correct, but it would have been even more forceful had Krugman brought in fiscal policy.

Obamacare as a Faux Job Killer

This too could have been explained in a manner that would have added support to Krugman’s thesis. The key to recall, that Krugman knows but did not mention here, is that Obamacare is a direct steal from a far-right-wing “think” tank that overwhelmingly supports Republicans. Further, Republican economists frequently supported the plan and Mitt Romney famously was the first to implement the plan when he was Governor of Massachusetts. Now, however, one would risk being torn apart at a Republican gathering by announcing support for the ultra-right-wing health insurance plan. Krugman, years ago, explained many of the defects of Romneycare/Obamacare. Of late he has also explained that while Romney/Obamacare is a poorly designed plan because of the dogmas of its right-wing drafters, it is also much better than “no care.” “No-care” was the prior system.

Republican economists act like virtually all Republicans in constantly inventing myths and horror stories about Romney/Obamacare. At this juncture, the problem is plainly one of ethics. The Republican economists are so eager to curry favor with Republican politicians that they lie as a matter of routine when they try to picture a hard-right-wing health insurance program as a near-Communist conspiracy.

But What If We Looked at Democratic Economists on the Most Critical Issues?

The single most important economic issue of the last three decades has been the three “de’s” – deregulation, desupervision, and de facto decriminalization. On that issue, which has driven our three most recent financial scandals, economists who are prominent New Democrat supporters have been disastrous. Yes, the Republican economists are often even worse. On the most important economic issue the dominant economists of both parties have simply formed rival fraternities with the same membership requirement – a track record of failure.

The Garn-St Germain Act that prompted the federal v. state regulatory race to the bottom that generated the savings and loan (S&L) debacle was drafted by a Republican economist (Dick Pratt), but it enjoyed broad bipartisan support and faced no opposition from economists associated with the Democratic Party. Not a single outside academic economist associated with the Democratic Party supported our struggle to reregulate, resupervise, and prosecute the industry and the elite frauds driving the S&L debacle. Democrats and Republicans formed a bipartisan effort to defeat our efforts against the fraud epidemic. Speaker Wright led the opposition in the House and four of the five Senators who did Charles Keating’s bidding in his jihad against our efforts to reregulate the industry were Democrats.

Of the two Democratic economists President Reagan sought to appoint to leadership positions running our regulatory agency, one (George Benston) was Keating’s man and a ferocious proponent of the three “de’s.” The other (Larry White) was always instinctually a fraud-denier and an opponent of regulation. To White’s credit, he overcame these instincts in a number of important decisions, but he was never able to overcome his dogmas sufficiently to become a leader against the fraud epidemics raging in the industry.

There are many problems with the three “de’s,” but the paramount problem is that they can create criminogenic environments that produce epidemics of “control fraud” that cause catastrophic damage. But orthodox economists of parties share the primitive tribal taboo against the “f” word. Orthodox economists of both parties share the same absurd standard assumptions that (implicitly) exclude fraud (it is impossible if there is perfect information and people act rationally).

Orthodox economists of both parties are proudly mono-disciplinary. They virtually never read any of the sophisticated modern research on white-collar criminology even though James Galbraith has explained (in his article prompted by a Krugman column) that our predictive success far exceeds economists’ predictive strength. Similarly, George Akerlof and Paul Romer explained in their 1993 article on “looting” that the S&L regulators got the fraud epidemic right from the beginning while the economists missed it.

Orthodox economists of both parties use almost exclusively econometric and modelling techniques that must produce systematic, massive error in the presence of epidemics of accounting control fraud. The mathematics on this is indisputable and these economists are proud to a point well-beyond arrogance about their purported quantitative expertise. Why then do they continue to use almost exclusively a failed methodology that they know must produce systematic, massive error in the presence of fraud? They also know that under their standard assumption about human behavior the bankers’ quants should design the models to systematically, and dramatically overvalue assets (by ignoring fraud) in order to maximize the quants’ (and their senior officers’) compensation.

Krugman is better on this subject than many economists. He famously got the California energy crisis correct by be willing to believe that Enron and its co-conspirators had formed a cartel to restrict supply. Cartels are another area in which economists supporting both parties were long insane. They claimed, contrary to all known experience (and Adam Smith’s famous warning) that cartels were, at worst, so ephemeral, with a half-life similar to Ununoctium, that they were not worth worrying about. Criminologists never made this mistake, but why would an economist read the criminology literature to learn about crimes like fraud and cartels?

It was the Rubinites in the U.S. and New Labour in the UK using orthodox economics as their weapon that constituted the Schwerpunkt of the assault against effective regulation under President Bill Clinton and Vice President Al Gore and Prime Ministers Tony Blair and Gordon Brown. Clinton’s destruction of Glass-Steagall and squashing Brooksley Born’s effort to protect us from fraud in financial derivatives through passage of the Commodity Futures Modernization Act of 2000 that gets the most attention, but the desupervision of the financial industry and the embrace of the regulatory race to the bottom were far more destructive. It was under Clinton and Gore’s assault that the underwriting rule we used in 1991 to drive liar’s loans out of the S&L industry was replaced with a guideline deliberately crafted to be unenforceable and useless. It was Clinton and Gore who began and primarily “accomplished” cutting the FDIC staff by more than three-quarters and the OTS staff of S&L regulators by more than half. I have just completed a series of articles detailing how Blair and Brown championed the City of London “winning” the regulatory race to the bottom by destroying the last vestiges of financial regulation, supervision, enforcement, and prosecutions in the UK.

Similarly, it was the Rubinites in the U.S. and the Blairites in the UK who spread the economic nonsense that a government with a sovereign currency (like the U.S. and the UK) was just like a consumer household. Under this myth, government deficits were immoral and harmful while budget surpluses demonstrated superior morality and were desirable. Blair and Brown turned the City into the financial cesspool of the world by championing the regulatory race to the bottom (which the City “won”), produced massive epidemics of control fraud that caused a financial crisis and threw the UK into the Great Recession, and then “bled the patient” through self-destructive and economically illiterate austerity while Labour’s economists generally remained silent about how insane these policies were or even provided support.

It was President Obama, having seen the catastrophe set in motion by the Rubinites (yes, greatly exacerbated by President Bush and his “wrecking crew”), who decided to place the Rubinites in power in his administration and to supplement them with Republican failures like Ben Bernanke and Timothy Geithner (who dropped his party affiliation to set up such promotions).

Here is how I explained Obama’s and Bush’s deliberate embrace of officials with a track record of failure it on April 3, 2009 in my first interview by Bill Moyers.

WILLIAM K. BLACK: These are all people who have failed. Paulson failed, Geithner failed. They were all promoted because they failed, not because…

BILL MOYERS: What do you mean?

WILLIAM K. BLACK: Well, Geithner has, was one of our nation’s top regulators, during the entire subprime scandal, that I just described. He took absolutely no effective action. He gave no warning. He did nothing in response to the FBI warning that there was an epidemic of fraud. All this pig in the poke stuff happened under him. So, in his phrase about legacy assets. Well he’s a failed legacy regulator.

BILL MOYERS: But he denies that he was a regulator. Let me show you some of his testimony before Congress. Take a look at this


TIMOTHY GEITHNER: I’ve never been a regulator, for better or worse. And I think you’re right to say that we have to be very skeptical that regulation can solve all of these problems. We have parts of our system that are overwhelmed by regulation.

BILL MOYERS: Overwhelmed by regulation! It wasn’t the absence of regulation that was the problem, it was despite the presence of regulation you’ve got huge risks that build up.

WILLIAM K. BLACK: Well, he may be right that he never regulated, but his job was to regulate. That was his mission statement.


WILLIAM K. BLACK: As president of the Federal Reserve Bank of New York, which is responsible for regulating most of the largest bank holding companies in America. And he’s completely wrong that we had too much regulation in some of these areas. I mean, he gives no details, obviously. But that’s just plain wrong.

The point I was explaining was that prominent politicians frequently feel they can gain politically by taking policy positions that are destructive but popular. These politicians want to be able to trot out their economist in such circumstances and have him (more rarely, her) say something that is economic nonsense that the economist fabricates to make the politician’s terrible policy argument sound like it accords with economic history. Ethical economists, therefore, tend to be disfavored by prominent politicians. One of the inherent consequences of presenting nonsense economic positions is that the economist’s predictions will fail – repeatedly. An economist who is willing to repeat a fabricated economic claim that he knows to be false to support his politician’s latest insane policy proposal will have a record of failure that prominent politicians will love. This economist is willing to lie, repeatedly, for me when I need him to lie.

My proposal to Bill Moyers was that we try the opposite strategy. Fire the persistent failures and the cheats and hire people with a track record for integrity and getting things right.

WILLIAM K. BLACK: Now, going forward, get rid of the people that have caused the problems. That’s a pretty straightforward thing, as well. Why would we keep CEOs and CFOs and other senior officers that caused the problems? That’s facially nuts. That’s our current system.

So stop that current system. We’re hiding the losses, instead of trying to find out the real losses. Stop that, because you need good information to make good decisions, right? Follow what works instead of what’s failed. Start appointing people who have records of success, instead of records of failure. That would be another nice place to start. There are lots of things we can do. Even today, as late as it is. Even though they’ve had a terrible start to the administration. They could change, and they could change within weeks. And by the way, the folks who are the better regulators, they paid their taxes. So, you can get them through the vetting process a lot quicker.

Black and Krugman on Choosing Failures and the Resultant “Reign of Error”

In addition to identifying the same dynamic of deliberately choosing failures that I explained in 2009 that Krugman has now named fittingly the “Fraternity of Failure,” I notice that his same May 15, 2015 column used a phrase I had just used two days earlier in an article in my series of columns on New Labour.

Note to Blair: it would be a truly excellent thing for the world if financial regulators were to “always err on the side of caution” and to have only “one-way pressures” “to guard the public interest” rather than to aid and abet the City banksters’ “reign of error” and fraud. The fact that Blair felt that (mythical) UK financial regulators devoted “to guard[ing] the public interest” were a disaster tells you all you need to know about how deeply he was in the banksters’ pocket even before they made him “filthy rich” (in the immortal words of Blair’s Red Tory strategist, Peter Mandelson).

Krugman’s column aptly uses the same “reign of error” phrase in an analogous context.

It doesn’t matter that the skeptics have been proved right. Simply raising questions about the orthodoxies of the moment leads to excommunication, from which there is no coming back. So the only “experts” left standing are those who made all the approved mistakes. It’s kind of a fraternity of failure: men and women united by a shared history of getting everything wrong, and refusing to admit it. Will they get the chance to add more chapters to their reign of error?

(A tip as a criminologist: contrary to all the cop shows on TV where the boss pronounces “there is no such thing as a coincidence,” coincidences such as these are common. Anyone who understands statistics understands why.)

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