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Monday, June 01, 2009

Paul Krugman: Reagan Did It

"Reagan’s biggest legacy":

Reagan Did It, by Paul Krugman, Commentary, NY Times: “This bill is the most important legislation for financial institutions in the last 50 years. It provides a long-term solution for troubled thrift institutions. ... All in all, I think we hit the jackpot.” So declared Ronald Reagan in 1982, as he signed the Garn-St. Germain Depository Institutions Act.

He was, as it happened, wrong about solving the problems of the thrifts. On the contrary, the bill turned the modest-sized troubles of savings-and-loan institutions into an utter catastrophe. But he was right about the legislation’s significance. And as for that jackpot — well, it finally came more than 25 years later, in the form of the worst economic crisis since the Great Depression.

For the more one looks into the origins of the current disaster, the clearer it becomes that the key wrong turn ... took place ... during the Reagan years. ...

Federal debt as a percentage of G.D.P. fell steadily from the end of World War II until 1980. But indebtedness began rising under Reagan... The increase in public debt was, however, dwarfed by the rise in private debt, made possible by financial deregulation. The change in America’s financial rules was Reagan’s biggest legacy. And it’s the gift that keeps on taking.

The immediate effect of Garn-St. Germain, as I said, was to turn the thrifts from a problem into a catastrophe. The ... fact is that deregulation in effect gave the industry — whose deposits were federally insured — a license to gamble with taxpayers’ money, at best, or simply to loot it, at worst. By the time the government closed the books..., taxpayers had lost $130 billion, back when that was a lot of money.

But there was also a longer-term effect. Reagan ... essentially ended New Deal restrictions on mortgage lending ... 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. ...

We weren’t always a nation of big debts and low savings: in the 1970s Americans saved almost 10 percent of their income... It was only after the Reagan deregulation that thrift gradually disappeared..., culminating in the near-zero savings rate ... on the eve of the great crisis. ...

All this, we were assured, was a good thing: sure, Americans were piling up debt,... but their finances looked fine once you took into account the rising values of their houses and their stock portfolios. Oops.

Now, the proximate causes of today’s economic crisis lie in events that took place long after Reagan... — in the global savings glut..., and in the giant housing bubble that savings glut helped inflate.

But it was the explosion of debt over the previous quarter-century that made the U.S. economy so vulnerable. Overstretched borrowers were bound to start defaulting in large numbers once the housing bubble burst and unemployment began to rise.

These defaults in turn wreaked havoc with a financial system that — also mainly thanks to Reagan-era deregulation — took on too much risk with too little capital.

There’s plenty of blame to go around... But 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.

    Posted by on Monday, June 1, 2009 at 12:43 AM in Economics, Financial System, Regulation | Permalink  TrackBack (0)  Comments (94)

          

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