Reading Krugman

This post originally appeared on The Finance Buff.

I think Paul Krugman has a blind spot. Yes, the Nobel Prize winning, Princeton University economist, and NY Times columnist Paul Krugman. I saw evidence of it in last week’s debate among economists over Treasury Secretary Geithner’s bank rescue plan, the so-called Public-Private Investment Program (PPIP).

In brief, under PPIP private investors would receive non-recourse federal loans to buy toxic assets from banks. The goal is to increase lending so as to reduce unemployment. (Was that too brief? If so, the dots are connected in Brad DeLong’s clever FAQ, and well-crafted numerical examples can be found here and here.)

The cynical won’t be surprised that the plan is similar to one pitched to the Treasury Department by institutional investors, or that some banks may be gaming the system. The plan is also similar to one proposed by Harvard Law Professor Lucian Bebchuk.

While the White House press corps was not terribly interested in PPIP, it lit up the economics blogosphere. MIT’s Ricardo Caballero thinks the plan “is well-conceived and deserves to be supported.” Johns Hopkins economics professor Christopher Carroll finds savvy the way it induces private investors to price assets. NYU’s Nouriel Roubini is cautiously optimistic. Many other sharp economists view the approach favorably, including Mark Thoma (Univ. of Oregon) and Brad DeLong (Berkeley).

There is a list of equally impressive opponents. Jeffrey Sachs of Columbia University thinks PPIP provides a one-way bet: heads investors win, tails the government loses. Financial Times columnist Martin Wolf calls PPIP a “vulture fund relief scheme.” MIT Sloan School’s Simon Johnson worries in a well thought out LA Times opinion piece that without nationalization banks will not sell enough of their toxic assets.

Finally, Paul Krugman is filled with despair over PPIP, calling it a “waste of taxpayer money.” He believes Obama is “squandering [the] credibility” he needs to win support for bank nationalization. (Krugman once worried that nationalization might be too expensive: Times change and opinions with them.)

As the liberal economist of record, Krugman’s critique of PPIP received a lot of press much of it uncritical. I think a little more critical reading is warranted, that his cry for nationalization now misses something crucial. Namely, he has a blind spot for the political and implementation risks and challenges. As John Heilemann wrote in New York Magazine, “Getting the economics right may be devilishly difficult—but the politics are even trickier, and just as crucial.”

One cannot be president and apolitical. Incentives and risks of governance compel Obama to think beyond economics even when considering economic issues. He is, no doubt, sensitive to his political capital, the issues over which to allocate it, and Congress’ appetite for alternatives to PPIP (like nationalization), among others. Brad DeLong points out that Obama does not easily achieve the 60 votes in the Senate he would need to take bolder action. (PPIP requires no additional congressional approval.) “Do we want to revive our economy, or do we want to punish the bankers?” DeLong asks, “I don’t agree that we can do both.” Matthew Yglesias elaborates,

“Doing something…without an additional vote makes it more likely that they can ask Congress to cast those tough votes on the budget and on health care rather than on bank bailouts.”

According to Obama aides, “Krugman’s suggestion that the government could take over the banking system is deeply impractical.” (Newsweek) Impractical politically but also because nationalization would require expertise and staff the Treasury Department does not yet possess. Therefore, like it or not, Geithner needs the banking industry’s cooperation to increase lending. He nearly lost it during the uproar over the AIG bonuses. He’d lose it for sure with a nationalization plan.

If nationalizing banks is a political non-starter then attempting to do so would destroy the credibility Krugman feels Obama is squandering with PPIP. Therefore, right now PPIP may be the only step forward. After all, a bank balance sheet has only two sides: assets and liabilities. Nationalization works the latter, PPIP the former.

My critique of Krugman is brash. He has a Nobel Prize while I have a Certificate of Appreciation from my employer. Yet it is hardly ever wise to consider an expert’s opinion thoughtlessly. Even experts can be poor sources of expertise. Even Nobel laureates make mistakes (like this or this). Whether you’re reading Krugman or TIE, it is not wise to reflexively trust what you read. You can take that to the bank.

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