Garn-St. Germain Depository Institutions Act

Paul Krugman, an avowed liberal economist with the New York Times, writes a definitive piece about the Garn-St. Germain Depository Institutions Act as the cause of the todays economic crisis. He blames Reagan deregulation for the demise of lending standards and points to events set in place in 1982 for the savings and loan crisis in 1988 and the housing bubble today.


But as I have learned over the last several months, nothing is ever simple, rarely definitive, and one has to look closely for an agenda in every written word. Krugman makes a simple correlation to a policy pushed by Reagan (with overwhelming bipartisan support) to 1. address different lending practices of savings and loans and traditional banks, 2. create new accounting standards for capital investment in savings and loans, and 3. to address failing savings and loans due to extreme volatility and transitions from high interest rates to lower interest rates.


One of the minor changes in a complex law allowed savings and loans to alter the debt to income ratio lending standards, a move designed to free up and encourage capital investment through tinkering with the availability of the money supply.


Krugman boldly and singularly blames this last effort for causing the 1988 savings and loan bailout (Reagan's fault) and the housing bubble last year.


Reagan's policy may have some relevance to today's economic crisis, but Krugman's tome is a purely partisan attack, for several reasons. First, an obvious and very relevant cause of the real estate failure in the late eighties was due to a Democrat effort to close loopholes for real estate investments in the 1986 tax bill. For several years, there was an incentive to invest in real estate written in the tax code. One can debate the validity of this tax incentive, but the removal of the tax incentives immediately dried up investments in real estate and billions of dollars of investment became worthless. This was a large contributing factor to the failure of savings and loans, which was completely ignored in Krugman's definitive case against Reagan.


You can read a fair analysis of the savings and loan crisis here.


More interesting, and pertinent to todays discussion are the following topics.


First, many of our legislators today failed to learn from the savings and loan crisis. If Krugman is correct that lowered lending standards caused the savings and loan crisis, you would think Washington politicians would have been opposed and appalled at the creation of artificially low interest rates (Federal Reserve), lowered lending standards to encourage home ownership (President Clinton, President Bush, Congress, Fannie Mae, and Freddie Mac), and the securitization of debt (Fannie Mae, Freddie Mac and Wall Street).


Second, you would think voters would start to second guess the economic estimates from our politicians as to the severity of our economic crisis. If you read the fair analysis of the crisis, you will be intrigued by the terrible estimates of the severity of the problem. Initial estimates of the savings and loan crisis began at $30-50 billion. In the end, the cost of the crisis approached $200 billion.


The real lesson is this. Government intervention always has unintended consequences and government predictions are always wrong. Today, the Obama Administration is predicting 3.5% annual growth for this year. My previous posts have clearly discredited that number. Just 3 months ago, White House projections said the worst case scenario for unemployment was 9.5% (the basis for the banking stress tests). Today, we are already at that number. Finally, losses due to the economic crisis are estimated to be $1.2 trillion. If history is our guide, each of these estimates will be significantly low. My previous posts indicate unemployment may reach 12-15%, and total projected losses due to the real estate bubble will be around $3 trillion.


For Krugman to offer a fair analysis, he should admit the economic problems can not be attributed to any political party, but to the entire Washington political culture. As long as politicians and the Federal Reserve believe the economy can be managed through monetary and tax policy, there will be uncontrolled bubbles because there is never political will to put the brakes on credit, and a recognition that government can not change common sense economic principles because the laws of unintended consequences are always present.


The actual reason for the economic bubble is a Keynesian theory that government can manage an economy--the very heart of Krugmans liberal ideology.


May Ronald Reagan rest in peace.


Update. It looks like I am not the only one pointing out Krugman's bias. Here is a link to an MSNBC economic report that has a different take on the same Krugman column.