Econ 210a, U.C. Berkeley: January 27, 2010: One Economics or Many?
Don't Block Ben!

Paul Krugman on the Return of Glass-Steagall

He writes:

Glass-Steagal, Part Deux: So what do I think about the new White House initiative on limiting bank size and restricting the activities of depository institutions?

  1. It’s OK as part of a broader financial reform, and is a good sign that the WH is getting ready to rumble with the banks.

but

  1. I’m from Missouri — show me. Actually, that’s a lie: I’m from New Jersey by way of New York, but whatever. I liked the Treasury reform plan from last spring, too. What remains to be seen is how much fight there is behind it.

As I’ve written repeatedly, I don’t think that too-big-to-fail is at the heart of our financial problems. Nor do I think a sharp separation between narrow banking depository institutions and other financial players is a silver bullet: unless the shadow banking system is really reined in, financial institutions will create things that look like deposits, act like deposits, but don’t have an FDIC guarantee; yet in crisis, there will be strong incentives to bail them out anyway.

Still, you have to admit that the growth of the shadow system was fueled, in part, by FDIC-backed players providing credit lines and so on to their shadow-banking arms, and that the sheer size of some players has posed real difficulties for resolving crisis. So in the context of a broader financial reform, this stuff could help.

This last part--the part starting with "Still..."--seems to me to be wrong. I have seen no evidence that pieces of the shadow banking system that could draw on FDIC-guaranteed funds (like Wachovia, Citigroup, and JPMorgan Chase) were any more highly fueled than pieces of the shadow banking system that could not (Countrywide, Bear-Stearns, Lehmann, Morgan Stanley, Goldman Sachs, et cetera). Moral hazard created by deposit insurance seems to me to be a red herring here.

And I would also note that the difference between Paul Krugman and Tim Geithner on the rest of it is a subtle one. Paul believes that "too-big-to-fail is [not] at the heart of our financial problems... a sharp separation between narrow banking depository institutions and other financial players is [not] a silver bullet." So does Geithner. But Krugman believes that any excuse for an administration rumble with the banks would be good--would lead them to make concessions and to surrender the votes of their tame congressmen on other more important points. Geithner, on the other hand, appears to believe that the administration has limited power, and should reserve that power for first-order problems and not get distracted.

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