Late last week Princeton University economist and New York Times columnist Paul Krugman wrote a piece on his NY Times blog that history will view as the best evidence to appear in at least several decades of the utter irrelevance of mainstream economics. The piece purported to respond to a Wall Street Journal editorial by Mark Spitznagel in which Mr. Spitznagel argued broadly the Austrian economists’ line that all government spending favors one group over another and more specifically that the Fed’s Quantitative Easing (QE) programs of recent years favor banks and the rich.
Mr. Krugman could have argued his New Keynesian shtick that government investment can prevent deflationary spirals in economic downturns and all would be as it was. Instead, he chose to argue (Plutocrats and Printing Presses – NYTimes.com), an astonishing amount of evidence to the contrary, that Fed QE policies have not disproportionately benefited banks and the very rich and were in fact enacted against their wishes and interests.
The basis of his argument has two parts:
(1) conservative economists argue that QE is “printing money,” they also argue that printing money causes inflation, banks hate inflation (because loans get repaid in less valuable dollars), therefore banks opposed QE and
(2) that banks earn profits from the difference between long term interest rates and short term interest rates (NIM, or Net Interest Margin), QE has reduced this difference, therefore the banks have seen their profits fall from QE.
Were these arguments used when writing about a (1) solvent banking system whose (2) profits still came from making prudent loans to creditworthy borrowers and (3) whose shadow banking system was immaterial (couldn’t destroy the global financial system), then Mr. Krugman might have had a point. The facts, however, suggest that if bank loans and other bank assets were fairly valued the big banks would be conspicuously insolvent, that the entire impetus of banking consolidation and deregulation (as explained by bankers) was to reduce the impact of NIM on bank profits, and that building out the shadow banking system was the way that banks intended to accomplish this.
The housing crisis that began in 2006 is well known to most people, but it was part of a much larger build-up of debt by households and corporations at the behest of bankers. Among the “innovative” home mortgage types that put people who couldn’t afford regular loans into houses were “adjustable-rate mortgages” (ARMs). What set off the initial stages of the financial crisis was the realization that (1) a large percentage of people who had taken out mortgages couldn’t repay them under any circumstances and (2) if rising interest rates caused the mortgage payments on ARMs to rise then a much larger group of people would also default on their home mortgages. In 2007 – 2008 both of these realizations caused the value of the mortgage loans held by banks either directly or through securitizations (the banks’ own creations) to fall precipitously.
The same principle that rising interest rates cause the market value of loans and loan-type instruments to fall applied to an unprecedented quantity of assets held by banks in 2008, and still does today. However, the opposite is also true, when interest rates fall the market value of loans on bank books and in financial markets rises. As too much un-repayable private debt in the economy was what made the banks insolvent, lowering both short and long term interest rates has had far more impact on restoring the banks to faux health by raising asset values than profits from interest margin (NIM) possibly could have. The banks killed their ready supply of credit-worthy borrowers along with the economy in the 2000s— the only game they could play was to restore the market values of the garbage assets that they held. The Fed willingly accommodated this strategy.
The Fed wasn’t alone in its efforts to save the banks at all costs– the utterly corrupt actions by ex-New York Fed Chair, now Treasury Secretary, Timothy Geithner, and current Fed Chair Ben Bernanke to move bad loans made by the banks to other government agencies including FHA, Fannie Mae, Freddie Mac and an astonishing array of seemingly unrelated others, was tied to Fed asset purchases through QE. Readers may remember the low interest, non-recourse government loans that were used to induce hedge funds to buy garbage assets at no risk to themselves (non-recourse) to (1) get the assets off of bank books and (2) to create faux market prices for garbage assets based on contrived economics to thereby induce less sophisticated buyers to pay higher prices for the assets. The Fed itself bought assets at higher prices that it had driven higher.
The way that the Fed’s QE directly benefited the very richest Americans, in addition to the most recent vintage of richest Americans being bankers, is by running up the value of all financial assets. Fed Chair Bernanke gave a veiled explanation of how this works in his Jackson Hole speech from 2010 that can be found online. Mr. Bernanke calls his method the “portfolio balance channel,” and it it is premised on two basic economic concepts, supply and demand and substitution. When the Fed buys assets it takes those interest-paying assets out of circulation and replaces them with cash. This reduces the supply of interest bearing assets in financial markets and replaces them with cash with which to buy other assets. It also reduces market interest rates thereby making stocks and other assets (substitution) more attractive.
But we need not rely on theory to see if this works the way that Mr. Bernanke theorized that it would. There are a significant number of rigorous analyses that were done demonstrating that when the Fed (or the ECB) is buying assets through QE financial markets rise and when the Fed stops buying they fall. The evidence is both unambiguous and voluminous. And in an anecdotal sense, there was some skepticism from Wall Street in 2009 when QE began but few if any doubters remain—it is absolutely the perceived wisdom on Wall Street that the reason that financial asset prices have been rising when they have is because the Fed is causing them to. The only question still out there for Wall Street is whether or not the Fed will continue to run prices up further?
How does running up the prices of financial assets directly benefit the richest Americans? Ironically, every three years the Fed also produces a survey of income and wealth distribution in the U.S. that is available on the Fed’s website. The data is broken out by income and wealth deciles. The quick answer to who benefits from rising financial asset prices is that the rich do because they own all the financial assets. See for yourself on the Fed’s website.
So far the Fed has tried to save the banks by keeping interest rates low and through various programs to dump toxic assets on the rest of us and it has revived the fortunes of the kind folks who looted the banks and stolen our wealth (the very rich) by running-up stock prices. The Fed did this with QE1, QE1.5, QE2, QE2.5, “Operation Twist” and various less publicized programs with similar intent. The banks and bankers have absolutely loved these programs—read their research and you will see. On his very own blog Mr. Krugman referenced UC Berkeley economist Emmanuel Saez’s recent report stating that since the recession theoretically ended in 2009, the top one percent of income earners has received 93% of income gains. Mr. Saez’s research illustrates that it is the revival of capital gains from rising financial asset prices (including stock options granted to corrupt executives) that is behind the gains.
Finally, Mr. Krugman claims that the only way that banks could have benefited from the Fed buying assets was if the Fed overpaid for the assets. Fed Chair Bernanke publicly stated at the time Fed purchases commenced in 2009 that the Fed was going to overpay for the MBS (Mortgage-Backed Securities) it purchased in order to induce banks to sell them to the Fed. This was widely reported in the financial press at the time. It was also widely viewed as part of the ongoing (never ending) bank bailouts. Readers may recall the news reports from all of the Wall Street banks of perfect trading records (banks earned profits from trading financial assets every day) for several quarters in 2009. If the banks are winning then someone else is losing—thank you Federal Reserve. If Mr. Krugman can’t find credible contemporaneous reports of this then he should try a little harder.
Last, there is no ax to grind here with Paul Krugman. Mr. Krugman has put a human face on his politics for which he should be thanked. But legitimate criticism of his economics includes the absence of the class struggle that Wall Street and the Federal Reserve clearly understand as evidenced by their actions—they are fighting for America’s rich and their policies are intended to benefit them alone. The sleight of hand that sustains mainstream economics is the claim that we all benefit if the system benefits. Take a look around and you’ll see that no, we don’t all benefit. In fact, were it not for the ideological drivel disguised as mainstream academic research, this would be evident to even the least interested among us. When in doubt, look a little harder.
Rob Urie is an artist and political economist in New York.