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Krugman: Stress Tests "Self-Esteem" Class That No One Fails (VIDEO)

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With the banking industry suffering from a crisis in confidence as much as liquidity, Paul Krugman says the Treasury Department will likely sugarcoat the stress test it is applying to the banks so that all of them are deemed solvent.

"This stress test, I have to say, it is sounding like a class of self-esteem: 'You are all wonderful, each in your own way,'" said the Nobel Prize winning economist. "I don't think they are going to let anybody fail."

Appearing on ABC's This Week, Krugman was prompted by a remark from host George Stephanopoulos, who noted that the political (and actual) capital being afforded to the Obama administration was running out.

"Politically, you cannot get more money for the TARP and the second stimulus plan," said Stephanopoulos. "That would then lead to the temptation in the Treasury Department to sugarcoat what they are going to see from the banks, so that they don't have to ask for more money."

Indeed, to this point, all 19 banks who have been submitted to the Treasury's stress test -- designed to figure out how these institutions will hold up under a deeper recession -- have passed. But regulators also note, per the New York Times, that it is a test "that a bank simply will not fail: if the examiners determine that a bank needs 'exceptional assistance,' the government, that is, taxpayers, will provide it." Only some of the data on the stress test will be made public.

As for the broader economy, Krugman did ring a more optimistic note than in times past, but with a healthy dose of qualification. He said that Barack Obama's chief economic adviser Larry Summers "is right" in his assessment that the sense of the economy falling of the table was likely ending. But he noted that similar indications of a recession leveling off were experienced during the Great Depression, only to be followed by worsening conditions.

"We are moving towards at least a pause," said Krugman. "All the news said that the economy is getting worse ... industrial production is falling, unemployment is rising, all the measures you use about the health of the economy continue to deteriorate, but they are getting worse more slowly. So Larry is right. We were crashing but it looks like it is leveling off. But if you look at history, there were several points like that during the Great Depression, so it is not clear that this is the end of the story."

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