Krugman on Financial Reform

In his latest op-ed in the NY Times, Paul Krugman is not optimistic about the US Congress passing any financial reform legislation:

Health reform is the law of the land. Next up: financial reform. But will it happen? The White House is optimistic, because it believes that Republicans won’t want to be cast as allies of Wall Street. I’m not so sure. The key question is how many senators believe that they can get away with claiming that war is peace, slavery is freedom, and regulating big banks is doing those big banks a favor.

Some background: we used to have a workable system for avoiding financial crises, resting on a combination of government guarantees and regulation. On one side, bank deposits were insured, preventing a recurrence of the immense bank runs that were a central cause of the Great Depression. On the other side, banks were tightly regulated, so that they didn’t take advantage of government guarantees by running excessive risks.

From 1980 or so onward, however, that system gradually broke down, partly because of bank deregulation, but mainly because of the rise of “shadow banking”: institutions and practices — like financing long-term investments with overnight borrowing — that recreated the risks of old-fashioned banking but weren’t covered either by guarantees or by regulation. The result, by 2007, was a financial system as vulnerable to severe crisis as the system of 1930. And the crisis came.

Read the whole article to see just how the Republicans plan to block reform and let the Wall Street banks run wild, collapse again, and run up a multi-trillion dollar bill for American taxpayers.

I want to make one small point: Focus on the third paragraph above. It dates the start of the problems to 1980. What is special about 1980? Oh, that was the start of the "Reagan Revolution" whose cry was "deregulate, deregulate, deregulate" and who claimed "the only good government is no government". The icon of the Republicans, Reagan, started this descent into financial calamity with his ideology about "government is bad" and that you can trust private enterprise because they would never, ever think of breaking the law, or cheating, or cutting corners. Yeah, just go read Upton Sinclair's The Jungle or Tom Wolfe's Bonfire of the Vanities or even read the patron saint of free trade, Adam Smith:

People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices. It is impossible indeed to prevent such meetings, by any law which either could be executed, or would be consistent with liberty or justice. But though the law cannot hinder people of the same trade from sometimes assembling together, it ought to do nothing to facilitate such assemblies; much less to render them necessary.

Regulation is necessary to prevent the rapaciousness of those firms that would be tempted to adulterate the product, or bribe officials, or -- as in the case of the Wall Street Banks -- co-opt their regulators to allow them to indulge in excessively risky practices to profit short term at the expense of the taxpayer when the risks come home to roost in the long term.