Paul Krugman on Greed

My post from last Sunday concluded with Bill Mahar claiming that the economic crisis in which we now find ourselves derives from Ronald Reagan essentailly declaring over 25 years ago that "Greed in good." In Monday's New York Times, Paul Krugman connected the dots to show how Reagonomics led to the current mess.

The more one looks into the origins of the current finacial disaster, Krugman states, the clearer it becomes that the key wrong turn — the turn that made crisis inevitable — took place in the early 1980s, during the years that Reagan ushered in an era in which a small minority grew vastly rich, while working families saw only meager gains.

Reagan broke with longstanding rules of fiscal prudence. The U.S. government traditionally ran significant budget deficits only in times of war or economic emergency. Federal debt as a percentage of GDP fell steadily from the end of World War II until 1980. But indebtedness began rising under Reagan and resumed its rise under the Bush administration, leaving us ill prepared for the emergency now upon us.

The increase in public debt was, however, dwarfed by the rise in private debt, made possible by financial deregulation. Reagan-era legislative changes ended New Deal restrictions on mortgage lending — restrictions that, in particular, limited the ability of families to buy homes without putting a significant amount of money down. These restrictions were put in place in the 1930s by political leaders who had just experienced a terrible financial crisis, and were trying to prevent another. But by 1980, the memory of the Depression had faded. Government, declared Reagan, is the problem, not the solution; the magic of the marketplace must be set free. And so the precautionary rules were scrapped.

Together with looser lending standards for other kinds of consumer credit, this led to a radical change in American behavior. Thrift gradually disappeared from the American way of life, culminating in the near-zero savings rate that prevailed on the eve of the great crisis. Household debt was only 60 percent of income when Reagan took office, about the same as it was during the Kennedy administration. By 2007 it was up to 119 percent. All this, we were assured, was a good thing: sure, Americans were piling up debt, and they weren’t putting aside any of their income, but their finances looked fine once you took into account the rising values of their houses and their stock portfolios. It was this explosion of debt over the previous quarter-century that made the U.S. economy so vulnerable, Krugman asserts. Overstretched borrowers were bound to start defaulting in large numbers once the housing bubble burst and unemployment began to rise.

There’s plenty of blame to go around these days. But Krugman asserts that the prime villains behind the mess we’re in were Reagan and his circle of advisers — men who forgot the lessons of America’s last great financial crisis, and condemned the rest of us to repeat it.