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Paul Krugman Doesn’t Understand The 2008 Financial Crisis

Nobel-prize winning economist and New York Times columnist Paul Krugman does not understand the 2008 financial crisis. How this occurred is a mystery, given Krugman clearly has access to all the available information and analysis that has led many observers to correctly comprehend what happened.

In a recent column primarily concerned with perceived deficiencies of presidential candidate Senator Bernie Sander’s campaign messaging, Krugman offered a thoroughly incorrect analysis of the 2008 financial crisis:

The easy slogan here is “Break up the big banks.” It’s obvious why this slogan is appealing from a political point of view: Wall Street supplies an excellent cast of villains. But were big banks really at the heart of the financial crisis, and would breaking them up protect us from future crises?

Many analysts concluded years ago that the answers to both questions were no. Predatory lending was largely carried out by smaller, non-Wall Street institutions like Countrywide Financial; the crisis itself was centered not on big banks but on “shadow banks” like Lehman Brothers that weren’t necessarily that big. And the financial reform that President Obama signed in 2010 made a real effort to address these problems. It could and should be made stronger, but pounding the table about big banks misses the point.

Absolutely wrong. The Too Big To Fail banks were undeniably at the heart of the financial crisis. While it is true that mortgage origination firms like Countrywide played a major role, they alone could not have created financial crisis without working hand-in-hand with the “big banks.”

The big banks were, after all, who Countrywide and others were ultimately selling those bad loans to. But more than that. The big banks took the mortgage-backed securities (MBS) and sold them throughout the world, laying down ordnance that would explode in 2008 and rock the markets to their cores.

And, to make the point even clearer, the big banks not only seeded time bombs throughout the global financial system, but knew they were doing so. That claim, which began as speculation early-on in the crisis and has been conclusively proven over the last eight years, led to record-setting multi-billion dollar settlements by the big banks.

To give one smoking gun example, former JPMorgan compliance officer Alayne Fleischmann provided eye witness testimony to the Department of Justice that, while working in the compliance department of JPMorgan, she saw JPMorgan executives engage in securities fraud by relabeling and mislabeling MBS products that were then sold to unwitting clients. Not long after, those securities blew up in those clients faces.

Partly as a result of Fleischmann’s expert eye-witness testimony, JPMorgan Chase & Co. agreed to pay a record $13 billion settlement to “resolve federal and state civil claims arising out of the packaging, marketing, sale and issuance of residential mortgage-backed securities (RMBS).” The settlement included an admission that JPMorgan made “serious misrepresentations to the public – including the investing public – about numerous RMBS transactions.”

OK, so just one of the “big banks?” No. Every one of the big banks paid massive fines for their involvement in triggering the 2008 financial crisis. In some cases, those settlements included crimes committed by mortgage originators such as Countrywide (Bank of America), but a reading of the settlement documents makes it undeniably plain that the originators were just one part of the larger chain of fraud that led to the 2008 meltdown.

Goldman Sachs paid $5.1 billion to resolve investigations “relating to the firm’s securitization, underwriting and sale of residential mortgage-backed securities from 2005 to 2007.”

Citigroup paid $7 billion for its role in the 2008 crisis, which included an admission that “Citigroup acknowledged it made serious misrepresentations to the public – including the investing public – about the mortgage loans it securitized in RMBS.”

Bank of America paid $16.65 billion to “settle several of the department’s ongoing civil investigations related to the packaging, marketing, sale, arrangement, structuring and issuance of RMBS, collateralized debt obligations (CDOs), and the bank’s practices concerning the underwriting and origination of mortgage loans.” That settlement included Countrywide and Merrill Lynch.

So, yes, the big banks were at the heart of the crisis–a claim both made by the government and conceded by the big banks themselves via the payment of large settlements.

And it was the largeness of the banks, only possible through deregulation passed by Congress and signed by President Bill Clinton, that made them systemically important and “Too Big To Fail.” That dynamic led policymakers to bail out those banks, and continues to ensure that, if the big banks are not broken up, there will be future bailouts.

That “shadow banking” was the only or even primary culprit is simply not true, as has been pointed out by the Financial Crisis Inquiry Commission and numerous others.

Sorry Paul, but those are the facts. That an economist could be so misinformed (if not disingenuous) on such a vital economic issue is extremely disappointing.

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Dan Wright

Dan Wright

Daniel Wright is a longtime blogger and currently writes for Shadowproof. He lives in New Jersey, by choice.