Krugman Shouts “Fire” in a Crowded Theater

Paul Krugman has really picked up his game on the blogging front over the past couple of weeks, and I like the fact that he feels comfortable throwing ideas out there. But this morning, in a post headlined "Shouting “fire” in a crowded theater", he essentially does just what he says in the headline. Given the size of his pulpit, I think his post is irresponsible.

Stripping out the metaphors, this is what he writes:

Bank runs come in two kinds. In some cases, the bank run is a pure self-fulfilling prophecy: the bank is “fundamentally sound,” but a panic by depositors forces a too-hasty liquidation of its assets, and it goes bust. In other cases, the bank is fundamentally unsound — but the bank run magnifies its losses. We’re in the second case.

What Krugman is talking about here is the difference between banks facing a liquidity crunch (such as Bear Stearns, over the past few days) and banks which are fundamentally insolvent. Krugman is saying that Bear Stearns wasn’t just facing a liquidity crunch; it was also insolvent.

Now Bear Stearns says it has a book value of more than $80 per share. JP Morgan, on its conference call Sunday night, said it was perfectly happy with Bear’s marks, and basically agreed with that $80-per-share valuation. The WSJ’s Heard on the Street column today, by veteran reporters Peter Eavis and David Reilly, says that maybe you might want to shave a few bucks off the valuation of the level-three assets, but that the investment banks’ book values are still very much in positive territory.

Krugman’s saying they’re all wrong, and that Bear Stearns, along with other financial institutions, actually has a negative book value. He’s not giving any reasons why he’s right and they’re wrong, he’s just asserting it. And so I’d ask him: what makes you so sure that these institutions are insolvent? Because if you’re not sure, it’s irresponsible, in the present environment, to start shouting such things from the virtual rooftop of nytimes.com.