A lot of people here admire Paul Krugman. Yes, there is Stiglitz, Kuttner, etc., but no one gets cited more than Krugman. Yes, I understand, he is one of a relatively few high profile people with strong economics credentials and a bully pulpit on the left. I have been reading his blog for about a year now- off and on- which means I miss some of his posts.
But last May I did see this article, in which Krugman praises Ben Bernanke and the TAF:
Cross your fingers, knock on wood: it’s possible, though by no means certain, that the worst of the financial crisis is over. That’s the good news.
To be fair, Krugman did say that he wasn't certain the worst was over, but his worry in this article is that the worst being over, will result in insufficient reform on Wall Street, thus causing the 'next crisis' to be worse. Thus, his thinking is clearly that the worst was likely over. And he compared the crisis at the time to the 1998 Long Term Capital Management bail out.
I believe we’ve been lucky to have Ben Bernanke as Federal Reserve chairman during these trying times. He may lack Mr. Greenspan’s talent for impersonating the Wizard of Oz, but he’s an economist who has thought long and hard about both the Great Depression and Japan’s lost decade in the 1990s, and he understands what’s at stake.
Mr. Bernanke recognized, more quickly than others might have, that we were in a situation bearing a family resemblance to the great banking crisis of 1930-31. His first priority, overriding every other concern, had to be preventing a cascade of financial failures that would cripple the economy.
The Fed’s efforts these past nine months remind me of the old TV series "MacGyver," whose ingenious hero would always get out of difficult situations by assembling clever devices out of household objects and duct tape.
Because the institutions in trouble weren’t called banks, the Fed’s usual tools for dealing with financial trouble, designed for a system centered on traditional banks, were largely useless. So the Fed has cobbled together makeshift arrangements to save the day. There was the TAF and the TSLF (don’t ask), there were credit lines to investment banks, and the whole thing culminated in March’s unprecedented, barely legal Bear Stearns rescue — a rescue not of Bear itself, but of its "counterparties," those who were on the other side of its financial bets.
It’s still far from certain whether all this improvisation has resolved the crisis. But it was the right thing to do, and for the moment things seem to be calming down...
So nothing was done to remedy the vulnerabilities the L.T.C.M. crisis revealed — the same vulnerabilities that are at the heart of today’s much bigger crisis.
So to be clear. Last May, when a lot of other people including Mike Whitney at counter punch/smirking chimp/information clearinghouse etc, and even some diarists here, were already appreciating the full depth of the problem and had for months if not years, Krugman still thought it was comparable to L.T.C.M. in 1998.
And don't give me the "Krugman has a Nobel prize" crap. If having a Nobel Prize made you right, then we can throw Keynesian economics in the junk pile because a number of adherents of Real Business Cycle theory, which rejects Keynesianism, have won the Nobel prize. And we would have nothing to worry about because Milton Friedman, another Nobel prize winner, has said that the Fed must engage in quantitative easing during times like these and that is exactly what Bernanke is doing.
Furthermore, if having a Nobel prize made you right, then the entire economic downturn wouldn't even be a problem. Going back to Real Business Cycles, in 2004, Finn E. Kydland, Edward C. Prescott were awarded the Nobel prize in economics, for their arguments that recessions are always the optimal result:
The notion of 'real business cycles' therefore does not view a recession as a 'failure' in the ecocomy nor might a boom also be seen as a failure. How many times do we see politicians complaining about the 'bad old days of boom and bust'? Kydland and Prescott see business cycles as explantions of shock to the economy that are understandable reactions rather than failures.
Depression? No problem, it's optimal! Here is what Alex Tabarrok at Marginal Revolution has to say:
The idea is not so counter-intuitive as it may seem. Consider Robinson Crusoe on a desert island (I owe this analogy to Tyler). Every day Crusoe ventures out onto the shoals of his island to fish. One day a terrible storm arises and he sits the day out in his hut - Crusoe is unemployed. Another day he wanders out onto the shoals and finds an especially large school of fish so he works especially long hours that day - Crusoe is enjoying a boom economy.
In other words, recessions happen because workers choose to work less, and booms happen because workers choose to work more. The 8.1% unemployment rate? It's because people have been choosing to quit their jobs and stay home.
Yet this idea has been awarded the Nobel Prize. So by that logic, we should not worry about the recession at all because according to a Nobel-approved theory, it is really the best of all possible worlds.
Nor is this all just academic mumbo jumbo. I will be the first to admit that these two gentlemen probably have more intelligect than myself in the sphere of economics and probably contributed something to the academic world, even if the overall conclusion is ludicrous.
But having a Nobel prize in itself does not convey authoritativeness. There are many Nobel prize winners and their opinions are diverse. Why do we not listen to Edward Prescott, who said that Obama's stimulus plan is depressing the economy? Why Krugman over Prescott? Just because Krugman has a column in the New York Times?
Back to Krugman's piece. Why would Krugman declare the worst was over last May? Well, look at what was happening back then. Krugman's column appeared on May 5, a Monday, which means he wrote it over the weekend. The last trading day before that weekend was Friday, May 2. What happened on Friday, May 2? Well, the Dow Jones Industrial Average closed at what turned out to be the year's high of 13,058 after steadily rising from 11,740 back in March. It was a classic bear market rally, and Krugman's column proclaiming "the worst is over" rather embarassingly called the very tippity-top of that rally.
In other words, it seems that Nobel prize winning Krugman was influenced by rather crass sentiments of a short term bear market rally.
I still value Krugman's opinion, and I understand that as circumstnaces have changed, his reasons for praising the TALF back then may not hold water now. But he isn't some sort of oracle or god.
UPDATE: I changed the title a bit so that will not be misleading. Also, see my comment below on how Krugman thought the current crisis compared to L.T.C.M. and why it shows he was implying that the worst was over. At might be clearer to read the original article, which also contains this quote:
Maybe a Democratic sweep in November can revive the cause of financial reform, but right now it looks as if we’ll soon return to business as usual.
UPDATE 2: Also, corrected acronym of TAF (Term Auction Facility), a liquidity program started by the Fed in 2007.