Liberal Economist Krugman Explains Populist Backlash Will Cause Geithner Plan to Fail

Talk about unintended consequences. All this populist anger ginned up by congressional Democrats, the media and the Obama administration is going to hinder the Treasury Department's strategy to rescue the banking system.

Paul Krugman, the liberal New York Times columnist and winner of the 2008 Nobel Prize in economics explained to Bloomberg News on March 24 that this is just what is happening.

According to Krugman, the backlash caused by bailed-out American International Group (AIG)  compensation debacle and efforts by Congress to limit other expenditures - private jets, office redecorations, salaries, etc. - is causing otherwise healthy financial institutions to shy away from accepting and keeping Troubled Asset Relief Program (TARP) money from the federal government.

"Well, I think that pushes us further in the direction of what I just described - that sort of guarantee plus nationalization because all of the plans they've tried so far - they're trying to avoid stigmatizing anybody," Krugman said. "This is the whole thing - you don't want to say, ‘Well this bank is bad and that one.' So they tried to get everybody to take TARP money, even some of the firms that didn't need it."

Goldman Sachs (NYSE:GS) is reported to be in talks with the government to return TARP money according to Bloomberg. And David Viniar, the investment bank's chief financial officer, said Feb. 4 that running the company without government money "would be an easier thing to do."

"Then it turns out there are popular demand that there be some restrictions on companies that do stuff with government money," Krugman said. "And firms that don't really need the money don't really want to live under those restrictions."

But according to Krugman - this will cause problems because the healthy and unhealthy banks will be separated and that could force a run on the unhealthy banks. That could obligate the federal government to nationalize certain institutions.

"So what we're actually seeing is - the Goldman thing is actually a breakdown of the strategy that is reflected in the Geithner plan," Krugman said. "It's basically saying you cannot do this with a plan that does not in fact try to distinguish between banks that are in trouble and banks that are not."