Paul Krugman on Ireland

A recent column by Paul Krugman sheds light on the financial crisis in the US by comparing it to the situation in Ireland. In short: It’s the regulation, stupid.

Here is the argument in a nutshell.

[T]he shape of Ireland’s crisis was very similar: a huge real estate bubble — prices rose more in Dublin than in Los Angeles or Miami — followed by a severe banking bust that was contained only via an expensive bailout.

Ireland had none of the American right’s favorite villains: there was no Community Reinvestment Act, no Fannie Mae or Freddie Mac. More surprising, perhaps, was the unimportance of exotic finance: Ireland’s bust wasn’t a tale of collateralized debt obligations and credit default swaps; it was an old-fashioned, plain-vanilla case of excess, in which banks made big loans to questionable borrowers, and taxpayers ended up holding the bag.

So what did we have in common? The authors of the new study [by three Irish economists] suggest four “ ‘deep’ causal factors.”

First, there was irrational exuberance…

Second, there was a huge inflow of cheap money…

Third, key players had an incentive to take big risks, because it was heads they win, tails someone else loses....

But the most striking similarity between Ireland and America was “regulatory imprudence”: the people charged with keeping banks safe didn’t do their jobs. In Ireland, regulators looked the other way in part because the country was trying to attract foreign business, in part because of cronyism: bankers and property developers had close ties to the ruling party.