Paul Krugman goes wobbly

Paul Krugman has been one of the most relentless critics of the Obama Administration's handling of the banking crisis, complaining early and often that the capital injections, the stress test plan, the Public-Private Investment Program to create a market for toxic asset sales, etc. etc. are rewarding failure, avoiding hard choices, "perpetuating zombie banks, blocking economic recovery."

He may be right. But he's showing some green shoots of doubt. Here's his current assessment of the stress test strategy:

What we’re really seeing here is a decision on the part of President Obama and his officials to muddle through the financial crisis, hoping that the banks can earn their way back to health.

It’s a strategy that might work. After all, right now the banks are lending at high interest rates, while paying virtually no interest on their (government-insured) deposits. Given enough time, the banks could be flush again.

After forecasting that the banks will not be well capitalized for a long time in the absence of massive government recapitalization, Krugman hedges again:

Can the economy recover even with weak banks? Maybe. Banks won’t be expanding credit any time soon, but government-backed lenders have stepped in to fill the gap. The Federal Reserve has expanded its credit by $1.2 trillion over the past year; Fannie Mae and Freddie Mac have become the principal sources of mortgage finance. So maybe we can let the economy fix the banks instead of the other way around.'

Then the pivot back to doomsday:

But there are many things that could go wrong.

Well, yes. But there are also many things that could go wrong with nationalization -- or any other plan. This is not to say that Krugman's core critique -- that Obama and Geithner are fostering zombie banks and shrinking from the full-scale industry restructuring that's need to put banking on a sustainable footing -- does not remain cogent.

But the Cassandra cry to which he devotes the second half of today's screed is pretty lame. He
worries that "the prospects for fundamental financial reform are fading." Evidence? That H. Rodgin Cohen, who was reportedly being considered for a deputy Treasury secretary position said a few days ago, "I am far from convinced there was something inherently wrong with the system."

Red alert! A prospective appointee is insufficiently zealous; ergo, Obama is going to wimp out on regulatory reform. Could happen, I guess. It's not yet clear how willing Obama is to break eggs, or heads, on any front where hard-core resistance threatens his core principles.

Nonetheless, it looks to me as if Krugman has downgraded his threat level a shade or two below orange.