23 February 2009

Paul Krugman: The econoclast has become one of the highest-profile advocates of bank nationalization.

Craines NY
February 22, 2009 3:26 PM
Aaron Elstein

Paul Krugman: The econoclast

The New York Times columnist and Princeton professor is in his policy-influencing prime, and has become one of the highest-profile advocates of bank nationalization.

Paul Krugman couldn't help but do a victory dance last week when none other than Alan Greenspan, a most-ardent defender of laissez-faire capitalism, acknowledged that several big U.S. banks would probably have to be nationalized.

"Comrade Greenspan: Seize the economy's commanding heights!" Mr. Krugman crowed on his blog.

Mr. Krugman, 55, is in his policy-influencing prime as diviner of what made the economy collapse and what painful, pricey steps will be needed to fix it. From his twice-a-week perch as an opinion columnist for The New York Times, the Princeton University economics professor is the highest-profile advocate of a once-unthinkable step: The federal government must take over Citigroup and other sick banks and carve them up so they have a fighting chance to emerge again as private enterprises.

President Barack Obama is a fan, and even ideological foes like Mr. Greenspan have come around.

"We're all socialists now," Mr. Krugman says. "No one is talking about the markets solving this problem on their own anymore. We're going to rescue the banks. The question is how."

To Mr. Krugman, who won the 2008 Nobel Memorial Prize in economics for his research on trade patterns, the rescue path is obvious: The feds must pump more cash into Citi and perhaps Bank of America and a handful of other institutions, because no one else can provide them with the funds needed to cover the enormous losses they still face.

In exchange for that cash, he says, the government should receive a dominant ownership stake, just as it did when it rescued American International Group last fall. Then Uncle Sam, which had ample experience two decades ago seizing failed savings and loan institutions and taking custody of toxic assets, must reprivatize the cleaned-up banks as quickly as possible.

"'The logic is really pretty compelling,' Mr. Krugman says. 'The goal is to get the financial system functioning again, and this is the quickest way to do it.'"

Mr. Krugman came to this dramatic conclusion not long after Lehman Brothers and AIG went under, and the full extent of the financial crisis started to become clear. In late September, his Times blog linked to a nationalization plan drawn up by University of California economist Brad DeLong that Mr. Krugman called a "good solution." He has advocated for nationalization in more than half his columns so far this month.

"Krugman's been terribly influential in presenting an idea that scares people at first," says Simon Johnson, a professor at Massachusetts Institute of Technology and former chief economist at the International Monetary Fund.

Unsurprisingly, the concept is anathema to what's left of Wall Street. Critics say nationalization could not only wipe out bank shareholders but hurt bondholders—many of them other banks, which can't afford more hits.

Jamie Dimon: Stop the n-word!

"I think it's very important that people stop talking about nationalization," J.P. Morgan Chase & Co. Chief Executive Jamie Dimon said earlier this month at The Future of New York City conference, sponsored by Crain's. "Loose talk about nationalizations, insolvencies—I don't think most people who talk about insolvencies have any idea what they're talking about."

Mr. Krugman responds with a quip, "What else would he say?" More seriously, he adds that J.P. Morgan appears to be in sounder shape than other big banks.

The professor agrees that the government should find ways to protect bondholders. But he acknowledges he hasn't thought much about the mechanics of nationalizing a bank as big as Citi, which has $2 trillion in assets and faces another $173 billion in losses, according to CreditSights. Mr. Krugman suggests that more will be clear after officials in the Obama administration give a "stress test" to assess whether leading banks are technically insolvent—that is, whether their capital and reserves can cover the declining values of their loan portfolios.

Even Benn Steil, director of international economics at the Council on Foreign Relations, who has sparred with Mr. Krugman for years—"I hesitate to agree with Paul Krugman, particularly now," he says—believes the government has no choice but to nationalize some big banks. It can't continue shoveling money into them and guaranteeing losses, he says.

Mr. Popular

Continuing on the current path creates "zombie banks" that have incentives to take huge risks with their capital to recover losses, Mr. Steil says. "I wouldn't argue [nationalization] is a no-brainer or an easy thing to do, but compared to the other options, maybe it's the best."

Mr. Krugman's Times columns and frequent TV appearances have made him as big a celebrity as chief executives or star money managers were in the boom years. The New York native, who has a doctorate from MIT, now gets about 100 public speaking requests a month, according to his booking agent, Bill Leigh.

"There's enormous demand for economists who called the crisis right," says Mr. Leigh. His clients also include NourielRoubini , who made his reputation predicting banks' monstrous losses, and Robert Shiller, who forecast the end of the housing bubble.

Mr. Krugman won't divulge how much money his appearances command but says his fee has risen—though not to "Clinton levels," he insists. "I'm one of the 0.1% of the population whose income has gone up as a result of the crisis, but on the whole, I'd rather it didn't."

The Nobel laureate's personal finances were enhanced last December with a check for 10 million Swedish kronor, now worth about $1.1 million. Changes in foreign-exchange rates hurt the value some, Mr. Krugman says. Yet, like almost everyone else, he is electing to preserve his assets rather than deploy them.

"So far, that money is sitting in a very safe bank," he says.


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