Misty watercolor memories: When Krugman was right

In his August 2005 column “That hissing sound,” Princeton economics professor and New York Times columnist Paul Krugman warned that housing prices constituted a bubble. Relying in part on a column by James Glassman which is accessible here, John Hinderaker took issue with Krugman’s column in “That hissing sound is Krugman.” John concluded that he believed there was little reason to fear a catastrophic collapse in home prices. In retrospect, it appears that Krugman was right and John was wrong.

John’s post was one of many older posts in which he took issue with Krugman. “Krugman sinks ever lower,” “Krugman: nailed again,” “Krugman the barbarian,” “Paul Krugman, around the bend,” and “Krugman flails wildly, misses” are five of John’s several posts that make mincemeat of Krugman columns. They show Krugman to be, shall we say, something of a partisan hack.

At his New York Times blog, Krugman takes note of John’s “delightful screed” on his housing buble column and gloats that he was right: “Memories, memories.” Can it be that it was all so simple then?

Given Krugman’s prescience about the housing bubble, I wondered what Krugman had to say about the contribution of Fannie Mae and Freddie Mac to the current crisis. Krugman appears not to have written about the subject while they were making their critical contribution to the bubble.

In July 2008, however, Krugman declared that “the storm over these particular lenders is overblown.” He absolved Fannie and Freddie of responsibility for the mess we’re in. Even looking at the phenomenon in retrospect, it appears to me, Krugman doesn’t get it right.

Here is Krugman’s analysis:

Fannie and Freddie had nothing to do with the explosion of high-risk lending a few years ago, an explosion that dwarfed the S.& L. fiasco. In fact, Fannie and Freddie, after growing rapidly in the 1990s, largely faded from the scene during the height of the housing bubble.

Partly that’s because regulators, responding to accounting scandals at the companies, placed temporary restraints on both Fannie and Freddie that curtailed their lending just as housing prices were really taking off. Also, they didn’t do any subprime lending, because they can’t: the definition of a subprime loan is precisely a loan that doesn’t meet the requirement, imposed by law, that Fannie and Freddie buy only mortgages issued to borrowers who made substantial down payments and carefully documented their income.

So whatever bad incentives the implicit federal guarantee creates have been offset by the fact that Fannie and Freddie were and are tightly regulated with regard to the risks they can take. You could say that the Fannie-Freddie experience shows that regulation works.

Conn Carroll comments at the Heritage Foundation’s Foundry blog:

[L]et’s stipulate that Fannie and Freddie never did “any subprime lending” … but not for the reason Krugman states. Freddie and Fannie never do any lending: They buy mortgages from lenders only, so that those lenders have more cash to make other loans (like subprime ones). But Krugman is either lying or being intentionally obtuse when he says “Fannie and Freddie buy only mortgages issued to borrowers who made substantial down payments and carefully documented their income.”

Krugman portrays Fannie and Freddie as innocent bystanders in the housing bubble but provides no data to support his assertions. Carroll links to this Washington Post article on HUD’s contribution to the current mess. The article notes that Fannie and Freddie’s purchase of subprime-backed securities peaked at 44 percent in 2004, in the midst of the housing bubble to which Krugman devoted his mid-2005 column.

Krugman blows off the involvement of Fannie and Freddie in “the explosion of high risk lending a few years ago[.]” Krugman appears to be unfamiliar with the contribution of Fannnie and Freddie to such practices as 100 percent loan to value mortgages and desktop underwriting. Rep. Maxine Waters paid tribute to Fannie and Freddie’s blessing of these practices in her defense of the two institutions at this House Financial Services Committee hearing.

In short, Paul Gigot aptly finds Krugman to be a member of what he dubbed “The Fannie Mae Gang” in an important July column. Why despite his prescience in diagnosing the housing bubble does Krugman leap to the defense of malefactors that, it seems to me, made a critical contribution to the phenomenon that Krugman decried in 2005? For the answer to that question, one would be well advised to consult any of John Hinderaker’s other Power Line posts on Krugman.

PAUL adds: Wrong predictions are an occupational hazard for every commentator. Krugman, though, may have produced the mother of all wrong predictions. In February 2003, he wrote that once we invade Iraq and Baghdad falls, President Bush will provide no monetary support for the reconstruction of Iraq. He further stated that Bush will preserve Saddam’s regime, replacing a few top officials with Americans, but permitting the remainder to retain power.

To make matters worse, Krugman presented this scenario not as a prediction, but rather as a certainty (e.g. “it’s clear that the generosity will end as soon as Baghdad falls” and “you don’t have to be an Iraq expert to realize that many very nasty people will therefore remain in power. . .and that the U.S. will in effect take responsibility for maintaining the rule of the Sunni minority over the Shiite majority”). We criticized Krugman for his wrong-headed analysis a few days later.

JOHN adds: This is the sentence in my post that Krugman singles out as incorrect: “[Glassman] argues, persuasively in my view, that there is little reason to fear a catastrophic collapse in home prices.” If I was wrong–that is, if the current decline in house prices constitutes a “catastrophic collapse”–then I had a lot of company: Barney Frank, Chris Dodd, Franklin Raines, Jim Johnson, the managers of Lehman Brothers, AIG and Bear Stearns, and countless others. It’s quite flattering that out of this distinguished company, Krugman singled me out as the one person who was wrong in disagreeing with his prediction of “catastrophic collapse.”