In his NY Times column Sunday, Paul Krugman tries, in vain, to construct a case for bank regulation in light of the problems at JP Morgan. As usual with Krugman, there’s much to disagree with, but I want to focus on his utterly ham-handed version of the history of US banking, which bears shockingly little resemblance to reality.
Krugman thinks he has the critics of regulation nailed with his take on US financial history:
Why, exactly, are banks special? Because history tells us that banking is and always has been subject to occasional destructive “panics,” which can wreak havoc with the economy as a whole. Current right-wing mythology has it that bad banking is always the result of government intervention, whether from the Federal Reserve or meddling liberals in Congress. In fact, however, Gilded Age America — a land with minimal government and no Fed — was subject to panics roughly once every six years. And some of these panics inflicted major economic losses. So what can be done? In the 1930s, after the mother of all banking panics, we arrived at a workable solution, involving both guarantees and oversight.
This passage is an utter abuse of history in several ways.
Most important, what Krugman calls the “right-wing mythology” is largely correct: government intervention is responsible for the systematic problems with the US banking system. That, however, is not the same as “bad banking.” Banks, like any other business, make mistakes all the time. Bad banking happens in free markets, but markets provide incentives and knowledge signals that help banks avoid and correct such mistakes. The question is not whether there is or isn’t “bad banking,” but which institutional environment minimizes and corrects it best. What doesn’t happen in free markets are the systematic mistakes that lead to panics and massive bank failures…