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Krugman or Paulson: Who You Gonna Bet On?
Is the sky falling, or the sun up? The Times' Keynesian forecasts a third depression. Paulson says humbug
History will show that the week before the nation's 234th birthday, Paul Krugman, Nobel Laureate and professor of economics at Princeton University, went all in on Keynesian orthodoxy. To regular readers of his column in The New York Times, this was not a surprise. Since the financial crisis began, Krugman has been adamant that the federal government must fearlessly run up deficits to compensate for weak private spending and keep the U.S. economy from death-spiraling into deflation.
Now his warnings have taken on an even more dire tone. The threat is not merely the dreaded "double dip." If the leaders of the developed world hold to pledges they made at the G-20 summit in Toronto and cut government spending, Krugman argues, we face nothing less than a "third depression"—perhaps not as singularly devastating as the Great Depression, which ripped the U.S. economy in half, but comparable to the Long Depression that followed the Panic of 1873, a grinding period of chronic social need and dissension.
If that makes you want to head for the hills with your shotgun and turnip seeds, consider another view, expressed the week prior at the London School of Economics. The speaker was not a decorated academic with visions of 1873, he was a profit seeker, pure and simple: John Paulson, the hedge-fund manager on whose behalf Goldman Sachs (GS) cooked up those killer collateralized debt obligations designed to pay off handsomely in the event of a housing crash. He was right about that one, you'll recall.
"We're in the middle of a sustained recovery in the U.S.," Paulson declared in London. "The risk of a double dip is less than 10 percent." The housing market is now, he says, an attractive buying opportunity. "It's the best time to buy a house in America," he said. "California has been a leading indicator of the housing market, and it turned positive seven months ago. I think we're about to turn a corner."
No mention of a third depression.
Paulson's bullishness is not new. Last spring, when Krugman was arguing that some major U.S. banks ought to be nationalized, wiping out equity holders, Paulson was busy building a massive stake in Bank of America. He and Krugman may not have disagreed about the fundamental health of the banking business—they just disagreed about what it meant. Paulson wasn't buying banks because he liked their second-lien books; instead, he had grasped that the Swedish-style takeover Krugman advocated was not going to happen, and that a tacit federal backstopping of the banking industry took most of the risk out of going long.
With the American taxpayer covering his downside, investing in U.S. financial institutions was easy pickings. Paulson's latest 13f filing with the Securities & Exchange Commission, which records his holdings as of Mar. 31, indicates nearly $2.995 billion of Bank of America common stock and $2.052 billion of Citigroup (C) common. Despite healthy advances from their spring 2009 lows, banks may have more room to run, particularly if Paulson is correct in the estimate he made to investors, according to The Wall Street Journal, that housing prices will rise as much as 10 percent next year.
Since his initial forays in banks, Paulson has ventured into riskier assets like casino stocks and vacant residential land in the utterly busted Florida and Southern California markets. As a private hedge fund manager, Paulson is not obliged to provide a complete picture of his investments; long positions could be hedged with shorts and derivatives that he does not have to divulge. But nothing in either his statements or reports about what he's buying suggests he is anything less than upbeat about the economy right now.
Some positive currents seem to be gathering force beneath the choppy stock market. U.S. credit-rating upgrades on corporate bonds exceeded downgrades this quarter for the first time since before markets froze, according to Bloomberg News. "I do see more upgrades coming," says Ann Benjamin, chief investment officer of leveraged asset management strategies at New York-based Neuberger Berman, where she helps oversee $7.5 billion of high-yield bonds and $5 billion of loans. "There's plenty of good companies out there that may be misrated."
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