Krugman Misses Boat on TBTF Banks

Today Paul Krugman claimed:

From Ben Bernanke’s encomium to Milton Friedman:

It was in large part to improve the management of banking panics that the Federal Reserve was created in 1913. However, as Friedman and Schwartz discuss in some detail, in the early 1930s the Federal Reserve did not serve that function. The problem within the Fed was largely doctrinal: Fed officials appeared to subscribe to Treasury Secretary Andrew Mellon’s infamous ‘liquidationist’ thesis, that weeding out “weak” banks was a harsh but necessary prerequisite to the recovery of the banking system. Moreover, most of the failing banks were small banks (as opposed to what we would now call money-center banks) and not members of the Federal Reserve System. Thus the Fed saw no particular need to try to stem the panics.

The point is that breaking up the big players, then saying that it’s OK to let banks fail because no one player is crucial to the system is not a solution.

He knows better and I’m disappointed at his misleading rhetoric. What he wrote is highly deceptive. Nobody today is urging that banks be allowed to fail in the way they failed in 1930-32. Then there was no FDIC, no protection of depositors, and no real mechanism for an orderly dissolution of the existing management and transfer of what was valuable to a new, stronger bank.

What folks are asking for today is that the biggies (the TBTF) be broken up so that they can be, if necessary, handled the same way the rest of the banks are today. To imply that critics of TBTF’s are asking that banks be allowed to fail in the same way as 1930 is total nonsense.