GA's Banking Crisis: A Brief Response to Mr. Krugman

Hello-- just a brief response to an article written by Paul Krugman in yesterday's NY Times...  His article is here. 

Interesting analysis, as always from Mr. Krugman. I agree with most of the points throughout his article-- namely, that Georgia's many small banks got caught up in the real estate lending frenzy and that it was too easy for people to treat their houses like bank accounts, pulling out large sums of money via loans (which, as you might recall, is what we did to help start our business-- so, interestingly, for people like us, this was a positive result, economically speaking). But I disagree with one small point and, in fact, with the overall theme.


The small point first-- the fact that Georgia leads in bank failures is less indicative of Georgia suffering more than that Georgia just has/had so many banks. Banks (used to / now are) very tightly controlled on the federal level and used to be restricted to operating within local community areas, often defined by counties. As you might recall, Georgia has the most counties of any state in the U.S. Result? Lots and lots of small community banks. No one's going to bail those guys out-- when they go down, they go down. And, in fact, because the amount required to insure deposits is far lower than that required for big or even medium-sized banks, the FDIC is much less hesitant about coming in and shutting them down. So, the quantity of bank failures is not really a telling factor in my opinion.

The big point that Krugman seeks to make is that the crisis in Georgia is directly related to a lack of strong consumer protection laws. That may have contributed to some degree. But it seems to me that most of what was going on was that there was a massive supply of money to lend, which was caused in large part by there being a huge securitized lending market. That is, those securitized bonds were in demand by investors (artificially stimulated or not, doesn't matter for this purpose), resulting in banks eager to lend as much as possible to enable them to bundle them up and sell them. The small banks weren't the major players there, but I'm sure in order to compete, they had to loosen their lending practices as well. Thus, it was simply massive money supply that caused the problem nation-wide, not just here. If you note, though, the areas where the crisis has been "worst" are areas that over the last 10-20 years saw the most net population increase: Phoenix, AZ; Florida; Atlanta, GA; San Francisco area, CA; Dallas, TX; Las Vegas, etc. It's not because regulations were loose in these places, it's because that's where the builders (and people moving there) saw the most opportunity and built the most houses.

So, while I think that consumer protection might be great and all, I think it can't be considered more than a minor factor playing into the banking crisis.