BUSINESS
04/08/2016 05:37 pm ET

Who Has Two Thumbs And Is Wrong About The Financial Crisis?

This Krug man.
Paul Krugman is not too big to fail. 
Brendan McDermid / Reuters
Paul Krugman is not too big to fail. 

Somebody is wrong on the Internet, and his name is Paul Krugman.

It is hard for liberal America when Krugman is wrong, because he is liberal America's best -- and most important -- economic columnist.

In a column on Friday devoted to hitting Bernie Sanders for a long list of transgressions, Krugman said the financial “crisis itself was centered not on big banks but on 'shadow banks' like Lehman Brothers that weren’t necessarily that big.

You read that correctly: Big banks didn’t cause the financial crisis, and Lehman Brothers, which was a shadow bank, known less creepily as a non-bank financial institution, wasn’t even that big.

Lehman Brothers had a peak market cap of $60 billion just 18 months before it collapsed. When it failed, it was the fourth-largest U.S. investment bank, and with $600 billion in assets became the largest bankruptcy in the country’s history.

But never mind the numbers. Even Paul Krugman can agree that Paul Krugman's column today is wrong.

In 2012, he wrote a blog post headlined “It Was Lehman Wot Did It,” arguing that the failure of Lehman Brothers in September 2008 started the financial crisis.

Referring to a chart showing that the value of risky bonds plummeted right as Lehman went under, Krugman skewered conservative economists who argued the firm’s historic bankruptcy was not really that big a deal:

Anyone else have the impression that something happened in the second half of September 2008?

Now, I would argue that Lehman was more of a trigger than an ultimate cause, that the overhang of household debt rather that continuing disruption of the financial sector is what’s holding us back now. But trying to diminish the centrality of Lehman to the crisis with arguments to the effect that most of Lehman’s big counterparties survived — because the government bailed them out — is just amazing.

Lehman was of course, not just really big -- its failure also triggered a panic about the solvency of other big financial institutions, as Krugman points out. But trying to separate Lehman’s size from its role in starting the financial crisis is bizarre: Lehman was the trigger for the financial crisis because it was big. Its size, and the interconnectedness its magnitude necessitated, is why Lehman’s collapse was far scarier than the failure of two Bear Stearns hedge funds that were deep into mortgage securities in the summer of 2007.

Krugman’s argument, which he has made before, is that big commercial banks didn’t create the toxic morass of worthless mortgage securities that almost toppled the world economy. Instead, it was “shadow banks” -- hedge funds, investment banks, money market funds, securitization vehicles -- that did us in.

It's true that the shadow banking system ran amok in the years before the crisis. But the division between it and the big commercial banks isn’t tidy. They’re intimately connected, and laying blame for the financial crisis on the shadow banks misses a key point: Without huge banks, the mortgage bubble machine could not have worked.

Big banks lent billions of dollars to the shady mortgage originators Krugman rightly vilified. Big banks gleefully took the millions of terrible, often fraudulent mortgages those originators created and securitized them. And then, they sold them and traded them. Big banks love to say they provide the funding that makes the economy go -- and in the case of the mortgage bubble, there is no question that they provided the liquidity that inflated the bubble to historically dangerous levels.

It seems weird to have to argue in 2016 that yes, too-big-to-fail banks were at the center of the financial crisis, but here we are. That’s what the Financial Crisis Inquiry Commission found. Federal Reserve Chairman Ben Bernanke, former IMF chief economist Simon Johnson, former Federal Deposit Insurance Corp. Chair Sheila Bair, former bank bailout Inspector General Neil Barofsky, FDIC Vice Chairman Thomas Hoenig, and Sen. Elizabeth Warren (D-Mass.) have all concluded that “too big to fail” was, in fact, central to the crisis.

None of this means shadow banking isn’t dangerous and shouldn’t shoulder some blame for the financial crisis. Similarly, attempting to write big banks out of the history of the financial crisis, and claim that anyone who blames them “misses the point,” as Krugman does, reduces the history of the financial crisis to campaign talking points.

You can’t fault Hillary Clinton or Bernie Sanders for trying to one-up each other on the campaign trail, but you’d expect better from Paul Krugman.

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