Why the Banks Should Be Broken Up

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.