Monday, February 01, 2010

Krugman: "Too big to fail" is not the problem

Paul Krugman argues that the Fed didn't cause the housing bubble and "too big to fail" isn't responsible for the financial crisis.

Assuming Canada doesn't have a housing bubble, it would also invalidate Ben Bernanke's argument that the housing bubble was caused by a global savings glut. Of course, if the U.S. (and global) housing bubble was caused by a combination of factors, then low interest rates and high global savings could be necessary but not sufficient causes of the bubble.


  1. What's at issue here?

    Krugman is making an argument for some financial reform based on the real experience of neighbors up North.

    All he wrote was that the Canadians did not self-nuke their banks because they had a better set of financial controls in place.

    That's his point and it's a good one.

  2. kob said...
    "What's at issue here?"

    I originally linked to one of Krugman's blog posts. Then when I discovered he had a full article on the subject, I switched to link to the article. I have now switched back to the blog post.

    Both his blog post and his article discuss "too big to fail" and the "too low for too long" interest rates. However, the blog post is more focused on those topics.

    In the article, Krugman writes:
    "What did the Canadians do differently?

    It wasn’t interest rate policy. Many commentators have blamed the Federal Reserve for the financial crisis, claiming that the Fed created a disastrous bubble by keeping interest rates too low for too long. But Canadian interest rates have tracked U.S. rates quite closely, so it seems that low rates aren’t enough by themselves to produce a financial crisis.

    Canada’s experience also seems to refute the view, forcefully pushed by Paul Volcker, the formidable former Fed chairman, that the roots of our crisis lay in the scale and scope of our financial institutions — in the existence of banks that were “too big to fail.” For in Canada essentially all the banks are too big to fail: just five banking groups dominate the financial scene."

    So, "too low for too long" and "too big to fail" are two widely held views of the crisis that Paul Krugman says are incorrect.

  3. the problem with saying "the problem was ABC" or "the problem was XYZ" is that we are looking at each of those things in a vacuum and not based on the totality of the circumstances.

    Thus, because some other country had XYZ and they didnt have a bubble, people conclude XYZ isnt the problem which may or may not be true.

    The issue could be you need ABC and XYZ and even JKL before bubbles can form - so to say they had ABC and no bubble, therefore ABC isnt the "cause" of the bubble, very well could be false.

  4. Anonymous, that's likely true. You need x,y, and z as sufficient conditions for the housing bubble. And maybe there are a few different factors, x,y and z that could have cause it. But the important thing about Krugman's point is that with all the same contributing factors in Canada it only took one thing to prevent a bubble and collapse there: better regulation. So there are many factors and scenarios that can cause bubbles, crashes and other economic instability, but if good regulation is there it can trump them all. Similarly, no matter how low interest rates were, how much of a savings glut existed or how stupid borrowers were, better underwriting standards on loans would have stopped it all. And underwriting standards are just internal institutional regulations.

  5. But the important thing about Krugman's point is that with all the same contributing factors in Canada it only took one thing to prevent a bubble and collapse there: better regulation

    Kahner - I am not even sure you can say that re: "ALL the same contributing factors". Could have been the lower migratory patterns of Canadians vs. US residents was another contributing factor. Could have been exchange rates and the unmarketability of the Looney on the forex market was another contributing factor. Heck even the weather (perhaps they have a shorter selling season) could be another contributing factor.

    I do agree with you though on what to do on an ex-ante basis. Hopefully, good regulation will help trump the development of bubbles going forward.

  6. yeah, saying "ALL" the same contributing factors was loose language on my part. Obviously there are differences. But we agree on the main point that good regulation is the key. Unfortunately I don't believe good regulation will stop bubble going forward. I hope that maybe we can mitigate them a little, but the financial industry seems quite capable of killing or evading effective regulation and people are eternally greedy and short-sighted.