Paul Krugman's Just-So Story About Banking

Paul Krugman has been one of the loudest advocates of so-called boring banking. Make banks into water utilities and take out all of the innovation and we won’t have huge bubbles and crises. As he says, let’s go back to the days of toasters and a free checbook and stop there. Nassim Taleb says the same thing.

But while Krugman may be right that this would cut back on the extremes we saw in the financial bubble (probably) you can’t debate its merits unless look at the drawbacks to it, and that’s what Krugman is less interested in doing.

Charles Davi responds to Krugman at The Atlantic, arguing that boring banking will not save you. First, he notes, bubbles are hardly anything new. We’ve had bubbles in all kinds of economic conditions, so the idea that this will make bubbles die is silly.

But beyond that, there will be direct economic costs to this boring banking strategy:

Krugman paints the recent history of banking with broad strokes – in contrast to James Surowiecki’s reasonably detailed article on the subject – drawing primarily on what is little more than the coincidence of boring banking and economic stability. In essence, he claims that we did our best when banking was boring. Presumably, we are to infer that this coincidence compels us to accept that boring banking is indeed the cause of economic stability. Answering such a complex question with such a simple and obviously flawed form of argumentation would normally smack of idiocy. But in Krugman’s case, it smacks of paternalism. Krugman is undoubtedly smart enough to know that abstracting from historical coincidences is an unacceptable method of discovering theories of causation, even for an economist. So, with this, I invite Mr. Krugman to explain why boring banking is superior to interesting banking. In the meantime, here are some things to consider before smashing banking back into the Stone Age.

Securitization takes money from the capital markets and funnels it into the consumer credit market by bundling individual loans, lines of credit, and mortgages that would otherwise be unattractive to investors on a piecemeal basis. Tremendous sums of money are funneled to consumers using this process, particularly in the mortgage space. If the boring banking regime precludes securitization, we can expect this capital to either sit idle or go elsewhere, thereby depriving consumers of credit and spending power.

Tyler Cowen has pointed this out before. Look at Spain — where banks are considered boring and they don’t have much securitization. Not only are banks still failing, but the economy is simply much less dynamic, with 15% unemployment even before the global recession actually hit.

What’s also odd about Krugman’s view is that he’s such a big pro-spending guy. To him, the definition of a healthy economy is one in which consumers are loose with the pocket books and don’t save anymore than we need to. Because you could actually argue that a less dynamic capital system would be healthy if it means that during booms, consumers weren’t being bombarded with credit card and loan offers. But then consumer spending will never get anywhere near its potential, even with all the stimulus in the world.

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