12/1/08: Tom Ashbrook, WBUR-Boston, talks with Nobel Prize-winning economist, Paul Krugman, on the deepening recession during the call-in interview show, "On Point." Krugman teaches at Princeton, writes a column for the New York Times. He is the author of "The Return of Depression Economics and The Crisis of 2008."
Tom Ashbrook: You're still worried about the economy going into free fall, even now? After all the billions that have been put out there? Free fall?
Paul Krugman: Sure looks like free fall. All the numbers that have been coming out are really scary. We have a new report on manufacturing which is the worst since 1981 and that was the worst recession since the Great Depression. There was a difference then. Then interest rates were quite high and you could fight it by cutting interest rates. Right now the interest rates that you can cut are basically at zero. So we are in "deep yogurt," as the first President Bush used to say.
TA: How are we going to know if we're going deeper into the yogurt or moving out? What are you looking for now?
PK: I'm looking at the usual gauges. We're looking at employment and manufacturing which, though it's not anymore the core of the economy, is still a good indicator. We know this economy is headed down quite fast, that in spite of the attempts that have been made to heal the financial markets, they're still pretty grievously wounded. There just isn't enough demand out there, enough spending to maintain employment. This is depression economics. That doesn't mean this is a depression, but we have depression-type economic problems.
TA: We'll talk a lot about how you'd like to see that free fall arrested. But if it's not, paint the picture for us. What are we up against? What does free fall look like if it goes on?
PK: Okay. If it goes on, then we're probably looking at unemployment rates reaching 9 or 10% by the end of next year. Maybe higher. That means something like 10,000,000 or more Americans, who are not in poverty, falling into poverty. Then something like 6,000,000 people falling into what we call "extreme poverty" -- which is less than half the poverty line or lower -- so really desperate straits. It means very large numbers of people losing health insurance because most people's health insurance is tied to their jobs. So if you lose your job or are forced into a worse job, health insurance goes. We're really talking about more or less catastrophic impacts on tens of millions of Americans. This is not good! We're not talking about people selling apples on the street just yet. But we're talking about something which is really pretty bad.
TA: You're talking about the response being -- your prescription -- pull out all the stops. Be bolder than FDR! A new New Deal. What does that mean?
PK: When we talk about FDR, we think of the New Deal spending vast sums of money. But actually, although it was more than other potential president at the time would have done, it wasn't that big relative to the economy. And there were pullbacks. So in 1937 when the economy was still, by normal standards, quite depressed, FDR was convinced that now was the time to start "being responsible" again. So he cut WPA employment in half and raised taxes and the economy slid back into a sort of reprise of the fall at the beginning of the Great Depression. He was pretty cautious, in part because the economics wasn't there. People had not yet reached ...
TA: ... achieved the economic understanding, the scholarly work about great depressions. We were in the middle of it!
PK: That's right. People were trying to figure the thing out and of course it's not as though we have perfect understanding even now. If we did, we wouldn't have gotten into this mess. So the point is, FDR offers lessons in what not to do as well as what to do. The big lesson right now is that you've got to do enough. Because there really isn't anything to fall back on if government spending is not enough. If government spending falls short and still leaves the economy sinking, normally you'd say, "Well, Ben Bernanke at the Fed can cut interest rates." Except he can't. They're hard up against zero. So we can't do anything there. So you really have to go big enough to turn this thing around or it's going to be quite ugly.
TA: What does that look like? President Obama's naming his economics team last week, moving into national security this week. A lot of people are going to be whispering in his ear, "You've got a megaphone and you've been using it." Three months, six months, a year. Describe the scale of intervention, of stimulus, of spending, of action that you're envisioning...
PK: Well, my back-of-the-envelope a few weeks ago said that we need 4% of GDP -- which is $600 billion. The news has gotten worse since then, so that looks like a lowball estimate. But you've got to do a huge amount.
TA: What can that consist of ?
PK: Best estimates are that there are something like $350 billion of infrastructure spending -- roads, bridges, rail lines, things that can be got online pretty quickly and more or less ready to go. So that could be a big part of it. You can provide a lot of aid to state and local governments because while the federal government is trying to -- at least gearing up to -- increase spending to help us deal with it, a lot of state and local governments are being forced to cut back. Which is a really bad thing. You can provide aid to the unemployed. There will be more unemployed people. The aid we're giving is very stingy. It expires too soon. We can give more. And those people will probably spend the money if they receive it. And you can go on down the list. But those -- aid to people in distress, aid to state and local governments, and infrastructure spending -- are going to be the core of it. ...
TA: If $600 billion is no longer enough, what does your back-of-the-envelope say now? Is it a trillion? More?
PK: At this point I'd say, "Give me six or seven billion." That's probably not enough to produce a full recovery, but it's at least enough to break the impact. It's true that it gets a little hard to come up with fast-acting projects that get much bigger than that. But let's at least do that.
TA: I don't even know what this means exactly anymore, but let me ask it anyway. Do we have the money?
PK: There's a real issue, right? Even the US government can't borrow unlimited amounts. So we may be talking about a budget deficit of a trillion dollars next year. Maybe more than that. So there's going to be a lot of borrowing. You know, a trillion here, a trillion there, and soon you're talking about real money. The way I like to think of it is this: Advanced countries that have stable governments (I think we're still one of those, though at some points in recent years I've wondered about that!) have an enormous capacity to raise revenue. If they have a credible reputation that they will do what's necessary to pay their debts in the long run, they can go a long way into debt before they find themselves unable to borrow. The US had debts that were 125% of GDP at the end of World War II. That's more than double what it's got now. Even countries of questionable stability like Belgium have had debts of 100% of GDP without being shunned by the bond market. So we've got a fair bit of running room -- not unlimited but enough. So if we do the kinds of things I'm talking about in one year, two years, even three years, we shouldn't have a problem. If it's more than that, then we're starting to be in an even worse position than I think we'll be.
TA: You may have read George Will over the weekend. He's talking kind of about you! He says, "A new New Deal would vindicate pessimists" -- and he's talking about conservatives there who say that history "is not one damn thing after another, it's the same damn thing over and over!" The idea of going back and trying a new New Deal? He says, "Forget about it!" There's the interpretation that it didn't work the first time, that this is bad medicine. And it's not only Republicans with cold feet and sweaty palms about the deficit it would require.
PK: Sure. People are nervous. A lot of the conservative line about the New Deal is basically bunk. There's a lot of stuff based on treating 1938 as the year that defines the New Deal, and that's the year when Roosevelt actually gave up on his spending programs. In 1937, he decided to go orthodox and bring us to recession in 1938 -- and then conservatives say, "See? New Deal-type spending doesn't work!" Because unemployment went up in '38. A lot of it is also just failure to understand what the problem was. But it is true that the two relevant examples -- FDR in the '30's and Japan in the '90's -- used public works spending. While you can argue that it helped, it didn't in either case bring them out of the slump. But if you look at it more closely, you discover they really didn't do it on an adequate scale in each case. It was, in the end, a public works program that ended the Great Depression -- a very large public works program known as World War II. We don't have to do it on that scale, I hope, this time! But the question for the conservatives here is, "What is your answer? Are you really saying is that what we really need to do is let the free market work? Let wages fall? Liquidate farmers? Liquidate the workers..." We have a pretty good idea of what needs to be done and we should act on that because the consequences of not acting on it would be terrible.
TA: As you wrote [ref.: Krugman's 2000 book, "The Great Unraveling: Losing Our Way in the New Century"], we were never going to have to face this again. We had learned from a very, very deep and painful experience and we were never going to go back and risk a great depression. But here we are! Why?
PK: Well, I think the core of it is the fact that we recreated the banking risks of 75 years ago. What happened after the Great Depression or during the Great Depression was people looked at the enormous bank runs -- it was really a banking collapse that dealt the fatal blow, not the stock market crash -- and put up an elaborate safety net for the banks. So bank deposits were insured. Banks themselves were regulated, required to hold capital, required to have reserves and have special lines of credit with the Federal Reserve. All of this was designed to prevent stuff from happening and we all see the movie, "It's a Wonderful Life," which shows the bank run. The thing is, at the time the movie was made, that couldn't have happened. That bank run was something that happened in the '30's. But by the time "It's a Wonderful Life" was made, there were all sorts of guarantees to prevent that from happening. Fine. And for sixty years everything seemed calm. What happened, though, was that we gradually grew ourselves a second banking system, a system largely designed to do an end-run around all those regulations. So we had all of these things -- asset-backed commercial paper, auction-rate securities, various kinds of things that were effectively doing the job of banking or giving people what they thought was ready cash but using that money to fund longer-term investments. All of it outside the regulatory framework. All of it with no safety net. People call that the "shadow" banking system or the parallel banking system. By the eve of this crisis, it was bigger than the traditional banking system. And it collapsed. It's basically a 21st century version of the bank runs at the beginning of the 1930's. Instead of crowds of people in the street, pounding on bank doors, we have hordes of people in cyberspace clicking on their mouses. But it's effectively the same kind of thing. The triggering event was the collapse of the great housing bubble. But what turned that event into the catastrophe we now see is the fact that, while not watching it, we had grown up this extremely vulnerable financial system.
TA: I think a lot of people are confused about how and whether that really gets reformed. Because with hedge funds and all the rest, it still seems off in an unregulated, informal, free world. And that's been championed! We've had many commenters on this show who earlier said that we're getting great efficiencies out of this. This is the march of progress! Do you see it being reined it? Can it be? Has it become integral to our global economic system? What do you do with that shadow banking system?
PK: I think it's possible. Never underestimate the ability of modern governments to get things to regulate if they put their minds to it. People who say we can't do this? If there was a 1935 version of this program on the air, we would have had economists explaining that you just can't regulate banks! There'll always be a way around it! In fact, it was possible. So we have a rough idea of what it would involve. The details of bank regulation is an arcane, difficult field. But necessary. We know we need to have capital requirements. We know we need to have restrictions on the kind of investments you can make if you're financing them with short-term assets that have to be rolled over continuously. It's going to be tough. It's going to require a lot of lawyers as well as a lot of experts on regulation. And it's going to require international cooperation. Because if somebody can set up a shadow banking system in Dubai that promises people higher returns and convinces them they don't need to worry about risks, then it undermines the whole effort. So you have to have a lot of stuff. But we do this with conventional banks. We actually have international agreements. "Basel 2" is the agreement that regulates bank capital everywhere. It can be done. It's going to be very elaborate and hard. But the prospect of another Great Depression concentrates the mind!
TA: Do you think the economic team that Barack Obama has put together is like to want to do it? You've got Lawrence Summers in there, who was with Clinton in the '90's. Tim Geithner, who's been in the middle of things in New York. Both of these guys with their links to Robert Rubin and Citigroup which just got bailed out. Is this a team likely to implement the kinds of changes in the shadow banking system you're talking about?
PK: Well, Geithner actually was quite early in warning about the dangers. But he did it in the kind of ambiguous, multiple interpretations way that central bankers always talk. So he wasn't a forthright as might have liked -- that was the nature of his job. But I think he understood this even before everything fell apart. So I'm optimistic. Summers was a champion of financial deregulation in the '9o's. But I think he's a very smart guy and I think he's learn a lot as have we all. I've probably always been to the left of Summers but he and I have, on these issues, both further left than we were ten years ago because of the enormity of the thing. Mostly what you need are people who are openminded and smart and that, for sure, is true of the new Obama team.
TA: Let's turn to our callers. Gene, from Myrtle Beach, SC.
Gene: I have a major concern with the real estate portion of this financial crisis that we're in now. I can remember back in the middle of '04 when, in California where I was living at the time, 46% of the mortgages were said to be interest only. That, combined with adjustable rate mortgages that are out there in numbers I'm not aware of, when they go to refinance and the properties are well below what the market was when they purchased them, that seems to me to be ... the elephant in the room in many instances. How do you think that can be resolved? Because that, to me, speaks to refrigerators, carpeting -- there are so many residual impacts that it kind of mirrors the auto industry issue that we're going to be confronting this week.
TA: How do we get out of the housing bubble?
PK: You can try to mitigate. There are a lot of losses that cannot be avoided there. You can have initiatives that give everybody incentives to try and work these things out. It turns out that foreclosing on a house is a very expensive proposition. It typically not only hurts the person being kicked out of the house but costs an enormous amount to the lender as well. There's only so much you can do there. And it's true: the housing prices are still something like 10 or 15% (at least) above where they have to go eventually. As they drop to realistic levels, a lot of people are going to end up defaulting on their mortgages. The main thing you can try to do is to minimize the secondary consequences. What's happened is that the losses on mortgages, which then translate through to all kinds of assets that are backed by those mortgages, have depleted the capital of our financial system and left many institutions in deep trouble. What we need to do is recapitalize the financial system. Basically, taxpayer money is going to be used to put enough cash in so that these firms can operate. That should be done not for free; it should be done for a share in ownership.
TA: We've been doing that, right?
PK: Yeah, although we've been doing it in a funny way. We've been doing it with the government doing as much as it can not to get any of the privileges coming with ownership! So they've been trying to get shares with no voting rights. At this point? Enough of that! We need to be serious. In effect what we're going to end up doing -- this is a prediction but also, I think, the right thing -- we're going to end up with a temporary, partial nationalization of the financial system. Temporary, because nobody really wants the government to be in the business of being the economy's banker for an extended period of time. But right now what we need to do is keep this system operating, keep it running. And then regrow it, reprivatize it as things calm down. But that's what you do. This whole thing was $8 trillion worth of fictitious wealth created by the housing bubble. That's going away. At least $1 trillion of those losses are falling on financial institutions and filling that trillion dollar hole is something we have to do.
TA: And at the homeowner level, are you into some kind of intervention there to bail individuals out, prop up the value of their homes or at least the financing to keep them?
PK: Propping up the value of the homes, no. That's like trying to tell the tide not to come in. The home values are going to drop down to a normal relationship to incomes and rents and all of that. You can't really do that. Helping them stay in the homes, working out deals? Yes. There is a problem. This does, to some extent, reward irresponsibility. But you don't want to get too hung up on that. In many cases people were misled by the lenders. There was an awful lot of fraud involved. This is what people were saying right at the beginning: the most complicated and confusing home mortgages were being foisted on the people least able to make sense of these things. Lower income people?... there was a lot of predation, basically. That's a partial excuse for the moral hazard. Moral hazard being letting people off the hook for the consequences of their own actions. And also, look! Everybody! Many, many people, behaved badly in the crazy middle years of this decade. We can't punish them all. It's in all of our interest to provide at least some recompense for what happened.
TA: Let's go to Dubuque, IA, and Marty.
Marty: I grew up in a community where most of our families made fairly decent working man's wages. There was a strong labor movement in this area back in the old days, and Saul Bellow, the great novelist, once wrote of Dubuque, Iowa, as being a beautiful, sprawling community. And that was 1956. But nowadays it's absolutely deplorable around here. They've gone backwards. The average working man makes less money than what my dad might have been making in 1975. It's really bad. And I'm kind of wondering what types of ideas we might have going forward to increase the working wage. Because, as you know, that's probably what's at the heart of this mortgage crisis. People just aren't being paid enough money to meet the payments.
TA: Paul Krugman, what do you say? Wages? Where does that go and how to they factor in? Do wages have to take the same hit that housing takes?
PK: No, not at all. Housing? That's an asset they're going to revalue. Wages -- this is a longer term problem. I don't know if it's at the core of housing crisis but it's at the core of a lot of trouble the country's in. Which is that fewer and fewer people are making a middle class income. What can we do about that? There are several things we know how to do. One of them in universal healthcare. That turns out to do a lot -- not just in making sure everybody's got access to adequate healthcare but also in terms of relieving the pressure. If you look, for example, at the auto companies and why they're in so much trouble, there's a lot of bad decisions but there's also the fact that -- unlike auto companies anywhere else in the world -- they have to bear the burden of paying for health insurance for their workers. They could continue to pay better wages if health insurance were universal in this country. You can talk about labor organization. We know that the unions don't have much bargaining power, if any, in the auto industry now because of international competition. But there are large parts of the US economy that could be unionized, or could at least be giving wages sufficient to make unions seem like not such an attractive option. Why isn't WalMart, with more than a million employees, unionized? And the answer, of course, is that we've had a very hostile political climate to unions. If you look at the decline of the union movement in the US, it has much less to do with impersonal market forces than many people think, and a lot to do with the fact that, starting with Ronald Reagan, employers were basically given more or less impunity for union-busting efforts. So there are other things we could try to do. It's always a good thing to try and have better education so we have a more skilled workforce. There are probably other things we can do to make the lot of working Americans better. But things to start with are, I think, healthcare and a better climate for labor movements.
TA: Let me ask you about the economics of that. I mean, who wouldn't want higher wages for Marty and everybody else! But we've heard a lot in recent weeks about how Detroit's in so much trouble, and yet we've got non-union auto manufacturers in this country who are doing okay, who are not on the verge of bankruptcy. You're going to have people who say, "Well, we're up against foreign competition now. Their wages are lower. This is just the new reality." You're voting for accepting hard realities on the housing front. Is it possible we just have to take the hit on the wage front? Is that just a reality, too? Or is that too dreary?
PK: Well, talking about foreign competition and the wages lowering -- that's actually not true.
TA: Wages are higher in Mexico and China and India ... ?
PK: But remember, there's an auto industry in Germany which is exporting pretty successfully and they pay higher wages than we do. It's not that simple. Part of the issue is that we don't have uniform standards. At this point, by the way, the wages paid by the Big Three to new workers and the wages paid by in the foreign auto companies are not that different. The big difference is healthcare costs. That's something we can actually do something about. That's something we can address with policy. Look, you cannot simply dictate without limits. You can't actually say everyone's going to be paid $40 an hour. That can't happen. But history tells us that there's actually quite a lot you can do. History in the form of what happened after the New Deal, which pushed up wages for a lot of workers. And World War II was a great economic boom.
TA: Let's take a call from Victoria in St. Johnsbury, VT.
Victoria: ... My question has to do with consumer spending and the economy. It seems that a lot of measures of economic health have to do with how much American consumers are spending. And it seems in the last few years, a period of unprecedented affluence in this country and in other parts of the world. I wonder if we haven't exceeded our capacity for spending and are finding that much of the stuff that we've been buying clutters not just our houses and closets but our minds as well. I'm wondering if there's not a way for the economy to sort of downsize with relation to that kind of consumerism without destroying the world!
TA: Paul, I think a lot of people's minds are wrestling with this. Is it all about gearing back up ... and let's go shopping? Is there another way to have maybe a different balance and economic health?
PK: Victoria has a good point, although let me say a word on behalf of the American consumer. It's not all frivolities. Most people are not living high on the hog. There's spectacularly important work by Elizabeth Warren who's backruptcy expert at Harvard. She looked into what does lead people into piling up debt that leads them to bankruptcy. It turns it's now splurging on their credit cards and going and buying lots of consumer goods. It's mostly overreaching, trying to buy a house in a good school district so that their kids can have a decent education. You don't want to sneer at these over-consuming Americans. There's not nearly as much of that for people in the working class as legend would have it. What is true is that we've been living beyond our means for whatever reasons. It's a mixture. A lot of spending by well-off people -- taking out second mortgages on their homes, and so on. We've been having a zero savings rate for quite a while and that can't go on. Saving has to go back up. People have to live within their means. Trouble is, what takes the place of that consumer spending in the economy? It should be invested. It should be investment for the future. But it's not easy to get investment going when the financial markets have basically collapsed and financing isn't there. There's a very difficult transition period. If you want the reason why I'm pushing for these big fiscal stimulus packages with a emphasis on investment -- on infrastructure -- it's to fill that gap until we get things under control. It's very difficult to get to a sounder level of consumption all at once. Lots of us have been quoting St. Augustine, "Grant me chastity and continence, but not yet!" This is coming on too fast, and we need to bridge the gap until it's over.
TA: Let's stick with this for a second. Among economists out of there -- of great prominence -- you're one of the most progressive. And here you've got a caller who's kind of getting at this issue of ... okay, maybe it's not all frivolity, this spending, but I think whether you're liberal or conservative, people have this sense of can we keep this merry-go-round up. Does this growth work? Maybe it's for important things and yet we use -- what is it -- more than a quarter of the world's oil and energy and people are wondering, at a moment like this, such a crunch moment, if this is a sustainable wave that we've had. You're Mr. Progressive when it comes to economics. Is there another way? Or is it just growth and consumption of whatever kind? Is this just what "economics" means?
PK: Well, okay. My great idol is John Maynard Keynes, the economist you have to understand to make any sense of what's going on now. And he did write an essay called "Economic Prospects for Our Grandchildren" in which he looked forward to a day in which people would have enough and where they really would not care very much about not having a bit more stuff. He's talking about how wonderful it would be when we'd have a more moral society because people would no longer be so acquisitive. And he thought that day might arrive when you had incomes which are sort of like what we have now in the US. It turns out that there are still things that... We can argue whether all the consumption we undertake is a good thing. There's a fine line there between serious analysis and just being a snob and not approving of ordinary people's tastes. That's a very tricky line to negotiate. It's one reason why economists, including myself, are very cautious about that sort of thing. There's no question that more goods -- more stuff -- adds less to your life as you have more of it. Life satisfaction does go up with income but it goes up a lot more when you go from being a desperately poor country to being a sort of okay country than it does when you go from being sort of okay to being a rich country like the US. Still, if we really want to think about these issues, it's not about whether people have the wrong tastes and go for the wrong stuff, we want to think about how we shape economic growth so that it is consistent in protecting the environment, so that it is consistent with a better planet. And you can do that. We don't have to be burning as much oil as we are. We don't have to be doing as much damage to the environment as we are. But that's mostly the advantage of getting the incentives right. So it's about policy, about getting environmental policy right. Philosophers have been lecturing people on the hollowness of materialism for thousands of years. I don't think they're getting anywhere!
TA: Rahm Emanuel, president-elect Obama's chief of staff, has been quoted as saying, "Never waste a crisis!" The implication being: use this crisis to push in a new direction with maybe a new agenda. Do you see that included in the kinds of changes you're talking about on healthcare, energy, the works?
PK: On healthcare for sure. Because it's legitimate. Although universal healthcare is a long-term policy, not a direct response to this crisis, one of the things an economic crisis drives home is just how fragile, how unfair, the system is. I've been trying to do some rough estimates of how many people will lose health insurance in this crisis. It's not easy to do. But it's certainly going to be in the millions. Why should a financial crisis on Wall Street, why should the misjudgments and bad faith of a few investment bankers lead millions of ordinary Americans unable to get the healthcare they need? So we can say that this crisis is a mind-opening event. It can push us towards understanding why a stronger social safety net is necessary. And the biggest hole in the American safety net -- which doesn't exist in any other advanced country -- is healthcare. Environment is going to be a tougher sell. I think there's a lot to be said -- ultimately, nothing else much matters if we ruin the planet. It's going to be harder to use this crisis to justify stronger environmental policies.
TA: Because of the economic cost of such policies at a vulnerable time?
PK: Yes, and because the argument I can make on healthcare that the crisis reveals to people -- drives home just how much we need it -- doesn't do the same thing for greenhouse gas emissions. So the crisis doesn't point in that direction. It is going to be hard. Suppose we were going to do a carbon tax, or the equivalent of a carbon tax through cap and trade -- even environmentalists might say, "Gee -- right in the middle of this slump is probably not the best time to do that!" Which doesn't mean we can't pass legislation, planning to do it not this minute. But I must say, this crisis is a much more natural fit for a healthcare agenda than an environmental agenda. All that said -- long answer to a short question! -- it's also pushing us in a more progressive direction. That whole sort of "business knows best, markets always work, government is always the problem not the solution" -- that whole line of argument has been pretty well discredited by recent events. And that's going to help us on environmental policy in time.
TA: Can I ask you about something that's still bugging me and that factors right into that debate? There's a lot of conservative perspective out there -- very strongly and consistently saying -- that it's exactly government intervention that was at the heart of this problem. Pointing at Fannie Mae and Freddie Mac and the hand of government in the housing market which is behind so much of this, and saying, "If it weren't for these quasi-governmental organizations, we would not be in this pickle." It's an argument made again and again. And it'll come back when the meaning of this economic crisis returns to politics again. For the historical record, what happened here?
PK: No excuses for Fannie and Freddie. They were created in a fundamentally unsound way. They were quasi-private, quasi-public. You had stockholders making money while at the same time benefiting from what was perceived as a government guarantee. This was not the way you want to run things. And they did some bad stuff. They did make some bad loans. They did behave badly. And they did some accounting shenanigans which were certainly unforgivable. That said, if you look at this crisis, Fannie and Freddie were largely off-stage when the bad lending that made the crisis possible took place. Precisely because of those accounting problems, they were pushed into the background. They did very little of the mortgage lending from 2003 onwards -- which is exactly when the housing bubble deflated to its gigantic height and when most of the loans which are now going bad took place. Their loans -- although they made more bad loans than they should have -- have not gone bad at anything like the rate at which the private sector's lending has gone bad. So if you're looking at the crisis -- if you just look at the numbers of who was holding mortgages, who was responsible for lending -- Fannie and Freddie manifestly, obviously, not at the core of the crisis. They were actually pulling back when things were going most off the rails. Congress forced lenders to lend to these minority groups -- that's also part of the story the right is telling. And the truth of the matter there is that the Community Reinvestment Act, which everybody talks about, applied only to depository institutions -- traditional banks. And that's not where most of the lending came from. Only one of the top 25 mortgage lenders was subject that Act. They're determined to find that government was the villain and to do that they have to completely ignore the facts of who actually made the bad loans and when.
TA: Question for you from our website. "Mr. Krugman, please discuss how the tax structure should be changed in order to help bring the new gilded age to an end." By which I guess our correspondent here is looking at income inequality.
PK: Yes. There's a fair bit you can do, although most of the surge in inequality has been in pre-tax income. But it's been exacerbated by a real reduction in the progressivity of taxes. So we've gone from -- if you go back to the days when that socialist, Dwight Eisenhower, was in the White House -- the top tax rate was 91%. And now it's 35%. Most economists, myself included, don't think a 90% tax rate is actually a good idea. But we certainly have sharply reduced taxes at the top end of the scale -- which has made things worse. Reforming the tax code is not in itself going to be enough to bring us back to a middle class society. But it certainly is a step in the right direction. We have to get over this notion that if you tax rich people even a dime more, that somehow they'll all go away and refuse to invest or be entrepreneurial. If you require some CEO to pay 38% of his income instead of 35% of his income in taxes, he'll just quit his job and go home? We have a lot of scope for being more progressive again in taxes.
TA: Obama has indicated he may put off those higher taxes for upper income groups while we're in this ditch. Are you with him on that?
PK: Yes. I actually never thought it was going to happen anyway until 2010. Legislatively, it's quite hard to change the tax code. The Democrats, unless Al Franken pulls it off and there's an upset in Georgia, are not going to have 60 seats in the Senate. So the great hope for rolling back the Bush tax cuts actually was the fact that Bush tried to hide the true cost of it -- wrote it so the tax cut turned into a pumpkin at the end of 2010. So I never thought it was actually going to happen until 2011 anyway. And look, raising taxes in the face of a recession is not great policy even if the tax cuts were very ill-advised when they took place. Ideally, we'd be able to completely restructure the tax code right now, instantly, and also in the process avoid having too great a tax increase. But that's too hard to do legislatively. I don't have a problem with that. I don't think that's a major concession on Obama's part.
TA: So we're looking maybe at Paul Krugman's enormous stimulus package coming down the pike in an Obama administration. Do you have any doubt even now that the world -- China -- will lend that money? You say, "Well, yes, if you've got an advanced country with a stable government, historically people will do it." But China has its own problems now. Is there any chance they'll just say, "Sorry, we kind of need this money to dig ourselves out of a hole."
PK: But that's not where the money is coming from. Remember, what we're doing is we're filling a hole in private demand. US consumers are starting to save again because they're scared. And US businesses are cutting back on investment because they can't get the money and also because they're scared. So what's actually happening is that there's a great increase in the net savings of the private sector -- the net cash flow from the private sector. Goldman Sachs is putting that at like 9% of GDP over the next year.
TA: So we'd finance our own stimulus program?
PK: Effectively, yes. Effectively what we're really doing is having government borrowing take the place of a collapse in private borrowing. It's not really new money from China. There's misunderstanding here. Most of this is not new money. Most of this is just trying to get government to do the spending that right now the private sector will not.
TA: Then it's not Chinese buying Tbills at the bottom of that pile?
PK: If the Chinese stop buying Tbills entirely, that would be a major cut-off in capital flow. But we're not really, in the end, depending on the Chinese to finance this. It is our own increase in savings and decline in investment that's paying for this.
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For more, see Paul Krugman's article, "What to do," in the 12/18/08 New York Review of Books.
