Krugman, Again

I'm not picking on him. Honest.

From PK's post of 7 October 09:

Everyone agrees that this is a stopgap, and we want to get the Fed out of the business of private lending over time.

But here’s my question: why does it have to be a return to shadow banking? The banks don’t need to sell securitized debt to make loans — they could start lending out of all those excess reserves they currently hold. Or to put it differently, by the numbers there’s no obvious reason we shouldn’t be seeking a return to traditional banking, with banks making and holding loans, as the way to restart credit markets. Yet the assumption at the Fed seems to be that this isn’t an option — that the only way to go is back to the securitized debt market of the years just before the crisis.

Why? Are we still convinced that securitization is a far superior system to conventional banking, and if so why?

Inquiring minds want to know.

Wellsir, if it has to be a return to shadow banking, that's because shadow banking is the most profitable option. That's why those who choose it, will choose it.

Allow me to rephrase:

If it has to be a return to X, that's because X is the most profitable option. That's why those who choose, will choose it. It has to be, because that is where the profit is. I don't make predictions, PK. Shadow banking is your prediction. But if it comes to pass, it comes because that's where money is to be made.

Don't look for causes in the changes of the last year or two. Look for some change that occurred in the 1980s, or at the end of the 1970s perhaps. As you say,

...before the 1980s — the public put its money in banks, and banks made loans to borrowers...

I'm not an expert on this, and my memory is not the best. But bank deregulation does come to mind. And tax code changes, and the like. Things that changed possibilities and changed potential profit -- particularly in finance.

In the same post, PK, you write:

Call me naive, but why does Fed policy seem to assume that the only way to repair credit markets is to return to the status quo ante, circa January 2007?

I refer you to mine of April 18, where I refer to Bernanke's remarks and then say

So if everything works out according to plan, we restore the economy back to where it was a year or two ago, before everything fell apart.

Well, then we'll be in trouble. Because if we get back to that time again, we will only be ripe for economic collapse again.

I think we agree on this point.