Paul Krugman wrote an op-ed in the New York Times today called "Sanders Over the Edge." He's been doing a lot of shovel work for the Hillary Clinton campaign lately, which is his right of course. The piece eventually devolves into a criticism of the character of Bernie Sanders, but it's his take on the causes of the '08 crash that really raises an eyebrow.
By way of making a criticism of the oft-repeated Sanders charge that the big banks need to be broken up, Krugman argues that banks were not "at the heart of the crisis."
This is Krugman's assessment of who was responsible:
"Predatory lending was largely carried out by smaller, non-Wall Street institutions like Countrywide Financial; the crisis itself was centered not on big banks but on 'shadow banks' like Lehman Brothers that weren't necessarily that big."
Forget about the Sanders-Clinton race, because it's irrelevant to the issue. Krugman is just wrong about this.
The root problem of the '08 crisis lay in a broad criminal fraud scheme in the mortgage markets. Real-estate agents fanned out into middle- and low-income neighborhoods in huge numbers and coaxed as many people as possible into loans, whether they could afford them or not.
Those loans in turn were bought up by giant financial companies on Wall Street, who chopped them up into a kind of mortgage hamburger. Out of this hamburger, they made securities. These securities were then sold to institutional investors like pension funds, unions, insurance companies and hedge funds.
In the typical scenario, the investors buying these toxic mortgage securities weren't told how risky the merchandise was. Many thought they were investing in AAA-rated real estate, when in fact they were buying up the flimsy home loans of part-time janitors, manicurists, strawberry pickers, people without ID or immigration status, and so on.
There were two major classes of victims in this scheme: homeowners and investors. About five million people went into foreclosure after the crash, and investor losses globally ran into the trillions. It was an unparalleled event in the annals of white-collar crime.
Virtually the entire financial industry had a hand in this. The ratings agencies were complicit because they blessed a lot of these mortgage securities with high ratings when they knew they didn't deserve them. Companies like AIG had a role because they created a kind of pseudo-insurance for these mortgage securities that disguised the risk they posed.
And Krugman is right that companies like Countrywide and First Century, the sleazy "mortgage originators" who sent teams of over-caffeinated real-estate hustlers into neighborhoods offering crooked loans, were primarily responsible for a lot of the street-level predatory lending.
But Krugman neglects to mention the crucial role that big banks played.
The typical arc of this scam went as follows: Giant bank lends money to sleazy mortgage originator, mortgage originator makes lots of dicey home loans, the dicey home loans get sold back to the bank, the bank pools and securitizes the loans, and finally the bank sells the bad merchandise off to an unsuspecting investor.
The criminal scenario that was most common was a gigantic bank buying up huge masses of toxic loans from a Countrywide or some other fly-by-night operation and knowingly selling this crap as a good investment to some investor.
We chronicled an example of this in "The $9 Billion Witness," the story of JP Morgan Chase whistleblower Alayne Fleischmann, who lost her job after trying to stop the bank from selling a parcel of bad mortgages. JP Morgan Chase ended up saddled with a $13 billion settlement after it admitted to making "serious misrepresentations" to mortgage investors.
What's so baffling about Krugman's column is that there is a massive amount of documentary evidence outlining this behavior, committed by virtually every major bank in America. There was a $7 billion settlement paid by Citigroup, which incidentally is the company that Bill Clinton originally repealed the Glass-Steagall Act to create. Citi admitted to hawking merchandise that violated their own internal credit guidelines.
Citi also bilked investors out of huge sums, and we know a great deal about its behavior because it too had a whistleblower, named Richard Bowen. Bowen sent the SEC over 1,000 pages documenting "fraud and false representations given to investors."
Wells Fargo's settlement is another blunt repudiation of Krugman's point, because in the case of Wells, the bank itself was engaging in predatory lending at the street level, not just selling crappy mortgages to investors.
Wells had to pay $175 million to settle charges of overcharging 4,000 minority homeowners in a case that saw evidence come out that the bank specifically targeted black customers (referred to in one office as "mud people") for "ghetto loans."
Let's not forget also that not only were the big banks intimately involved in the signature fraud of the era — the creation and repackaging of toxic mortgage loans — they were also involved in wide-ranging foreclosure abuses.
Companies like Bank of America, Citi, Wells Fargo and Chase ended up being stuck with an additional $25 billion settlement just for the tawdry document-fudging "robosigning" scheme that helped accelerate the foreclosure crisis.
And did Krugman miss the other headlines from this era? Did he miss HSBC being nailed for laundering hundreds of millions of dollars for Central and South American drug cartels? How about the money-laundering scandals involving Chase, the British Bank Standard Chartered, the German Commerzbank AG and others, in which banks washed cash for crooks and rogue states?
And did he miss the LIBOR rate-rigging scandal that forced the likes of Barclays, UBS, Rabobank, the Royal Bank of Scotland, and Deutsche Bank to pay massive settlements for manipulating interest rates? How about the Forex manipulations that led to still more settlements for the likes of Goldman, BNP Paribas, HSBC and Barclays?
Krugman would likely argue that all those little things like laundering money for narco-terrorists, monkeying with world interest rates, and systematic cheating in the currency markets had nothing to do with the crash.
He would technically be correct in this. But the entire argument for breaking up the banks, which incidentally didn't originate in the Senate with Bernie Sanders or even Elizabeth Warren but with Ohio's Sherrod Brown and then-Delaware Sen. Ted Kaufman, was conceived with the idea that leaving over-large banks intact invited not only the potential for future bailouts, but future regulatory problems.
As MIT economist Simon Johnson pointed out in 2010, these institutions have become so big that they can confront and defy the government. Moreover the failure to punish the banks for the great mortgage frauds of the crisis years left all of these companies with the knowledge that the authorities were afraid to aggressively enforce the law, for fear of disrupting a fragile economy.
When UBS and HSBC escaped with slap-on-the-wrist settlements for the LIBOR and money-laundering offenses, respectively, Sherrod Brown redoubled his efforts to break up the banks, insisting that these episodes proved these companies were now too big to be regulated. By 2013, Brown said, it was clear that "these megabanks are out of control."
The call to break up the banks is not some socialist clarion call to end capitalism. (Well, it might be from Bernie, but not from everyone.)
In fact, it's just the opposite. The lessons of the crash era are that these megabanks have grown beyond the organic controls of capitalism. They were so big and so systemically important in '08 that the government could not let them go out of business.
This alone was an argument for breaking them up. The banks emerged from '08 with the implicit backing of the federal government. They became quasi-state entities, almost immune to failure. Not just Bernie Sanders worried about this. Voices as diverse as Louisiana Republican David Vitter and Krugman's own New York Times editorial board have argued for hard caps on bank size.
What's happened in more recent years, with LIBOR and the money-laundering scandals and Forex and the London Whale episode and so on, is that these firms also proved too "systemically important" to regulate and prosecute. They grew too big not only for capitalism, but for criminal law.
When a company is not only too big to fail, but too big to prosecute, it's too big to exist. Krugman may believe otherwise, but he shouldn't pretend that others – including his own paper – don't have legitimate concerns.