From the outset, I should admit to an undying affection for Milton Friedman, who passed away Friday at the age of 94. That affection is not so much determined by my agreement with—or even understanding of—many of his economic theories and policy ideas. Mr. Friedman was, of course, a brilliant economist, and I am not. My esteem for Mr. Friedman was instead a product of his obvious passion for the dismal science, his tireless devotion to making it relevant to laymen, and his faith in people, common people, to manage their own affairs, which I find to be a charming (if somewhat quaint) notion.
So successful and complete have been Friedman’s theories of inflation, money supply, and government spending, it would be easy for folks in my generation to forget that it took constant arm-twisting during the 1960s and 1970s to supplant the Keynesian economic theories then dominant. The result of Friedman’s efforts are most readily found in my generation’s conservative members, who now reflexively support—whether they realize it or not—policy positions that Friedman either developed or supported for half a century. I, too, was one of their number for many years during my youth and, still today, count myself as being in broad agreement with many of Friedman’s basic concepts; however, I lack Mr. Friedman’s faith in people and find myself revisiting lately policy positions currently out of favor.
Over the past decade, I’ve come to think of abstract public policy (especially in the realm of economics) in terms of poles, or extreme positions, between which we seem fated to swing. Further, it is rare that these positions hold any inherent universal ‘rightness.’ The Keynesians saw how the state could help national economies recover after the Great Depression by basically applying bits of socialist planning to market economies, a kind of economic vaccination against the dreaded disease of full-blown Marxism-Leninism. And in their turn, Mr. Friedman’s theories were right for his time; he could see the deadweight in the American economy before others, and that vision enabled him to develop a system for unlocking the latent economic value, for cutting through the rolls of red tape that had accumulated during the Keynesian years. While I may prefer one to the other, it is difficult to argue with the historical results of either set of approaches, for whatever its faults might have been, Keynesian economics did preserve market capitalism during a period of extreme geopolitical stress, a point often glossed over by today’s diehard free-marketeers.
Just as Keynesian economics ultimately led to excesses, Friedman’s theories—and those of similar cast—will also become victims of their own success, requiring remediation—and that point may not be so far in future as some may think.
There are a few areas, either directly or indirectly influenced by Milton Friedman, that will require some degree of remodeling in the near future, for reasons that may not be entirely clear to us in the present. I say this not because I find that Friedman is incorrect in his basic approach to economics, but because times and conditions change, and what might be politically good and right for 1980 may not be right for 2030, or 1930.
The biggest area is the regulatory policy governing banks and the trading of securities. In 1932-33, the US Congress passed a set of revolutionary banking laws, collectively known as the Glass-Steagall Act, which sought to safeguard the US banking system against the rapacious and speculative behavior of unsavory market players. First and foremost, the Act forced commercial banks to divest themselves of their investment-banking businesses. This Act, along with subsequent legislation, basically separated the four pillars of the financial-services industry—commercial banks, investment houses, insurance companies, and accounting firms. It did so because of the inherent conflicts of interests among and between these businesses. When President Clinton signed the Gramm-Leach-Bliley Financial Services Modernization Act of 1999, the regulatory walls between some of these businesses were eliminated. This act of deregulation, of course, has helped to lift the bottom lines of financial-services organizations by providing more opportunities for growth. It has also provided consumers with more choice as well as with newer, more sophisticated financial products. But inevitably, abuses occur; conflicts of interest form; and the fiduciary responsibilities of bankers are weakened by the competing desire to line their own pockets and those of their colleagues.
I am of the opinion that regulations such as Glass-Steagall—and more recently, the Sarbanes-Oxley Act—are not so much meant to fix a broken system, but to restore confidence in a system when it has been damaged due to scandal. These regulations are all about perception, not reality. Go back and listen to the speeches of Franklin Roosevelt during the early 1930s and you will begin to appreciate how this is so. Never does FDR attempt to quantify to what degree—precisely—investment-bank activities contributed to commercial-bank depositors losing their money. Glass-Steagall, and the political discourse surrounding it, was less an application of economic theory and more a political decision, meant to signal to the American people that it was safe to deposit money in banks, which was of course a fundamental requirement of industrial capitalism. If there are no depositors, obviously there is no capital.
When viewed as a political act, rather than a grand statement of economic theory, Glass-Steagall was an astounding success, enabling American banks to marshal significant capital resources during an era of severe global economic decline (who can forget, for example, the old film footage between the wars of Germans attempting to exchange their marks, quite literally, by the wheelbarrow, because of the ravages of inflation and the lack of confidence in the financial system). Things were bad throughout the 1930s in the US, but at the very least, Americans had great confidence in their bank deposits, mostly because Glass-Steagall allayed their fears that some Wall Street genius would lose the cash. The creation, as well, of the Federal Deposit Insurance Corporation (FDIC), which placed a federal guarantee on bank deposits, also helped.
As mentioned earlier, one can see a kind of parallel between the Glass-Steagall legislation and the Sarbanes-Oxley Act of 2002 (SOX), which, ostensibly, was geared toward preventing the types of scandals witnessed at companies like Enron, Tyco, and WorldCom. The Act was supposed to fix the accounting and financial-disclosure problems that enabled sick companies to pose as healthy ones defrauding investors of billions of dollars. But how much of a problem, exactly, was the old reporting system?
Again, if you view SOX as a solution to an accounting problem, then the law makes little sense, as many studies have demonstrated that Enron-style problems were not very widespread; however, ordinary Americans had no way of knowing this. All they knew is that some suits had swindled hard-working people of their money, or as Woody Guthrie once sang,
Yes, as through this world I’ve wandered
I’ve seen lots of funny men;
Some will rob you with a six-gun,
And some with a fountain pen.
As a result, confidence in the stock markets plummeted. SOX, like Glass-Steagall before it, was meant to restore that confidence. It, too, is a little much in the burden it places upon public companies, but the point was not economic efficiency—it was entirely political, and insofar as that is concerned, it has worked.
Maybe SOX is the Glass-Steagall Act of the 21st century, seeing as how the ordinary American tends to have much more of his personal wealth tied up in the markets—via pension funds, 401(k)s, IRAs, and so on—than in his bank account. Besides, the FDIC guarantee—the one part of Glass-Steagall that wasn’t scrapped—hasn’t budged in 26 years! It’s still only $100,000 per account, right where they set it in 1980. As a guarantor of wealth, it is significantly less important today than it was for our parents and grandparents. For perspective, consider the cost of a four-year college education at one of New York state’s public universities. In 1980, it would cost you a little under $10,000, or roughly 10% of the depositor guarantee. By 1999, the price tag was over $51,000, or over half of the guarantee. Of course, in the intervening seven years, the price is now even higher. For the post-Boomer generation, you’re likely to fund your children’s college education with a Coverdell Education Savings Account or a so-called 529 College Savings Program, which in turn invests a good portion of the money in the public equities markets, so again, the FDIC insurance is less important, the veracity of public companies in reporting their financial condition more so. Even if you’re not an inveterate day-trader, you’re likely to have a high percentage of your personal assets tied up in equities, and suddenly, the political justification for SOX becomes crystal clear. As a society, we simply cannot afford to have public confidence in stock markets wane.
SOX, of course, is very a un-Friedman-like solution to the problem. In fact, the New York Sun republished yesterday on its website a 2005 interview with Friedman during which reporter Josh Gerstein asked the éminence grise about SOX. Friedman replied,
Sarbanes-Oxley is terrible. It ought to be eliminated. It’s costing the country a great deal. It’s holding back innovation and development….It goes too far. It does exactly the wrong thing. Sarbanes-Oxley says to every entrepreneur, “For God’s sake, don’t innovate. Don’t take chances because down will come the hatchet. We’re going to your head off.” We want a risk-taking society, not a society afraid of taking risk.
Of course, Friedman is right, but only in a strictly deterministic universe, only in a kind of Newtonian world of rational action and reaction, but that’s not the world we live in. We call it depression and flu today, but the older term—panic—is much more accurate in describing the behavior of people (as opposed to the more abstract ‘systems’) when their money begins to vanish. As great as his gift for the science of economics was, I’ve come to think Friedman’s sense of politics and people was a little unformed and, therefore, his public policies sometimes merely reductive. Sometimes, in politics, we have to do things, not because they are right—or efficient, or productive—but because not do to them would sow resentment and discord between winners and losers. Sometimes deadweight and red tape are the price we pay for the perception of fairness.
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