Krugman and Me

I was pleased to read Paul Krugman's January 31, 2010 Op Ed piece in the NYT on lessons learned from Canadian Banks. He explored the reasons why Canadian Banks have held up well in this crisis . I don't usually agree with Paul, so I was very surprised about what he said in that article.

First, he dispelled the notion that our financial crisis was caused by low interest rates. Canada's rates were low as well.

Second , contrary to Paul Volcker's view about size and scope of US financial institutions, the problem was not that our banks were "too big to fail". He noted that essentially there are only 5 banks in Canada and they are all too big to fail. I hope he remembers these points when he starts bashing Big Banks again.

No, he stated the problem was rooted in lax regulation of mortgage lending and noted that Canada had "sharply restricted subprime type lending".

The list is growing-- Bernanke, Blair and now Krugman all agree that subprime lending, which was not done by Big Banks, was the trigger that set off the financial crisis which lead to the Great Recession.

The question now turns to why subprime lending in this country was not (to borrow a phrase from Krugman's description of the Canadian experience) " sharply restricted"?

One clue comes from what I heard Tina Brown say on Morning Joe today. She observed how the politicians had done such a wonderful job of deflecting the economic crisis from them to the Big Banks. Wow, Tina Brown said that?

Yes , it was the government that allowed this crisis to occur and it wasn't because Big Banks pushed subprime lending. There were other politically powerful interest groups beyond Wall St. who promoted subprime lending and fought against restricting it as the Canadians did.

It was the "American dream" that everyone should own a home, even if your credit was not good enough to get a properly underwritten loan. In Canada home loan borrowers must put down at least 20%. Some of our unregulated "fly by night" mortgage lenders not only didn't require anything down, but often offered loans in excess of the purchase price. Also, I'm sure Canadian banks didn't allow "liar loans" or loans to people with no incomes, no jobs and no assets.

So what we really need is more regulation and enforcement of rules governing the riskiest thing banks do --- make loans.

As a finance attorney I know that once the money goes out the door to the borrower the biggest risk the lender has is getting its money back. That's where our regulatory efforts need to be focused. Unfortunately, as another guest on Morning Joe said this morning--- that will mean it will be harder to get loans and that won't be so great for the economy.

However to paraphrase Aristotle--All things in moderation.

Eric