Krugman reiterates and expands

21 03 2009

Krugman has followed up his earlier piece rejecting Treasury’s bank plan with a reiteration and deeper explanation of his serious concerns.  He is so “vehement” in his opposition to  the plan because he feels:

… that this will be the administration’s only shot — that if the first bank plan is an abject failure, it won’t have the political capital for a second. So it’s just horrifying that Obama — and yes, the buck stops there — has decided to base his financial plan on the fantasy that a bit of financial hocus-pocus will turn the clock back to 2006.

The real distinction as he clearly points out is whether you think the current financial crisis was cauased mainly because of undue panic in the financial markets or if you think the banks took massive risks and actually made bad investments.

President Obama, Secretary Geitner and to some extent, Fed Chairman Bernanke seem to believe (or need to believe?) in the panic explanation. Even with such august company on the panic side, I have to agree with Krugman’s analysis (as I almost always do) – these were in effect toxic assets from the beginning, it just took awhile for that toxicity to work its way through the system.  As the government and the Federal Reserve both worked to prevent the insolvency of Bear Stearns by forcing a merger with JPM Chase they were clearly aware that the cause was the underlying sub-primce mortgage and hedge fund investments that Bear had tried to save, but was unable to.  In July, 2007, Bear Stearns disclosed that two of its  sub-prime hedge funds had lost nearly all of their value amid a rapid decline in the market for sub-prime mortgages.

The panic trigger was pulled when the powers that be allowed Lehman Brothers go under in the fall of 2008 and the subsequent failure of Congree to pass the $700 billion bank bailout package the first time.

Wide-spread investor panic wasn’t the cause, but the result.

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