Monday, February 1, 2010

Krugman Does a Matched Pair for Banking

Paul Krugman’s February 1 column in The New York Times entitled “Good and Boring” compares Canada and the U.S. to get a sense of what might be the cause of the financial crisis.

The point is that when Canadian and U.S. experience diverge, it’s a very good bet that policy differences, rather than differences in culture or economic structure, are responsible for that divergence.

First, the similarities:

Both were confronted with the same flood of cheap goods and cheap money from Asia.

But the outcomes were different:

In the United States, mortgage defaults soared, some major financial institutions collapsed, and others survived only thanks to huge government bailouts. In Canada, none of that happened.

What’s unimportant?

  • Interest rates – both countries kept them low
  • Big banks – relatively speaking, Canada’s banks are bigger

What’s important?

  • Lending practices – Canada has more protections for borrowers
  • Leverage – Canada allows banks a lot less
  • Diversification – Krugman doesn’t mention this, but the flip side of Canada’s large banks is that they are better diversified across that nation

There’s a great deal of similarity here to the arguments that I’ve made in class that national features – like low interest rates – don’t do much to explain why Nebraska isn’t having much of a recession at all.

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