Save the Banks, Save the Economy?

Paul Krugman has an excellent column this morning hitting many of the same themes we discuss in our new book. As he puts it:

In the end, the story of economic policy since 2008 has been that of a remarkable double standard. Bad loans always involve mistakes on both sides — if borrowers were irresponsible, so were the people who lent them money. But when crisis came, bankers were held harmless for their errors while families paid full price.

And refusing to help families in debt, it turns out, wasn’t just unfair; it was bad economics. Wall Street is back, but America isn’t, and the double standard is the main reason.

In some of the early reviews of our book, our argument is caricatured as saying we should have let the banks fail and we should have saved homeowners. We do not make such an extreme claim. In fact, we commend both Ben Bernanke and Tim Geithner for some of their policies that were directed at stopping dangerous runs in the banking system. We agree that bank runs threaten the payment system and the entire economy, and policies should be undertaken to prevent such runs.

The problem we have with the Geithner view of the world is that it is far too extreme — it is a “save the banks, save the economy” view which has been thoroughly discredited in both the United States and Europe. The fact that Geithner still adheres to this view despite all the evidence to the contrary is truly remarkable.

The problem with the economy in 2008 and 2009 is not that banks are not lending enough. It’s absurd to argue that we need more bank lending when demand is collapsing throughout the economy.

Here is the passage from our book that speaks on this issue:

When a financial crisis erupts, lawmakers and regulators must address problems in the banking system. They must work to prevent runs and preserve liquidity. But policy makers have gone much further, behaving as if the preservation of bank creditor and shareholder value is the only policy goal. The bank lending view has become so powerful that efforts to help home owners are immediately seen in an unfavorable light. This is unacceptable. The dramatic loss in wealth of indebted home owners is the key driver of severe recessions. Saving the banks won’t save the economy. Instead, bolstering the economy by attacking the levered-losses problem directly would save the banks.

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