Monday, June 13, 2011

Krugman’s Awakening?

By Bill Wilson

It’s second time within a month, but I agree with the New York Times’ Paul Krugman. This time, he writes that “bankers and wealthy individuals with lots of bonds in their portfolios” can count on the government to “protect the interests of creditors, no matter the cost”.



Now, we would certainly disagree on which policies are intent on preserving creditor interests and therefore do not deserve to be enacted. Krugman is primarily concerned with opposition to deficit-spending, which he says is because officials believe such spending unbridled “might hurt the interests of existing bondholders.”



Only if it leads to a catastrophic default, I would note, because the national debt became so large that it could not be refinanced, let alone be repaid. But then, the reason to avoid a complete default is because it would presumably be harmful to everyone, not just creditors.



Leaving that aside, it must be noted that Krugman doesn’t completely hold the high ground when it comes to propping up creditors. He was a supporter of the 2008 bank bailouts, which on their face protected bankers who bet poorly on housing, because, he wrote, “the danger of financial panic if it doesn’t go through, makes it worth passing”.



When the first draft of the plan was released, he warned that “it seems all too likely that a ‘fair price’ for mortgage-related assets will still leave much of the financial sector in trouble”. Instead, Krugman advocated that if the plan was for government to buy mortgage-backed securities, that it “will only work if the prices Treasury pays are much higher than current market prices”.



His major gripe with the initial plan was that it was not clear if the government would take equity in troubled firms. In the end, equity was a part of the deal, and so Krugman agreed to the bailout. With a government stake in the firms that took TARP money, he had no problem with propping up investors who bet poorly on an asset, in that case, mortgage-backed securities.



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