Blame Milton Friedman
Or, how I learned to stop worrying and love the bailout
KEVIN D. WILLIAMSON
At the suggestion of our editor, Rich Lowry, I’ve been reviewing some correspondence leading up to National Review’s endorsement of what became known as the Troubled Asset Relief Program, TARP. I was energetically opposed to our endorsement of that action and, upon reviewing my notes from the debate, it strikes me that I may even have been intemperate in my rhetoric. I trust Mr. Lowry will have forgotten my references to his “diseased mental siftings” and my sneering at “the panicked rantings of country-club Republicans in Greenwich, Conn.” In retrospect, that seems a bit much. I was happy that he shared my skepticism on the subject of bailouts for the automotive industry, TARP II, and other federal interventions.
Those who endorsed National Review’s line on TARP may be pleased to know that I have been rethinking my position. There are those conservatives who ask themselves, “What would Jesus do?” There are those who ask, “What would Ronald Reagan do?” There are even a few who ask, “What would Russell Kirk do, other than pour himself a scotch and shake his head sadly before writing another 1,000 pages?” I ask myself, “What would Milton Friedman do?”
Milton Friedman would have supported a bank bailout.
Or it seems he would have, given that a bank bailout is more or less what he prescribed for the last great financial crisis, the one leading up to the Great Depression, which he dwells upon at some length in his Monetary History of the United States, 1867–1960. The vulgarized version of Friedman: The Federal Reserve helped turn a routine if severe recession into the Great Depression by tightening the supply of money and credit. But as economists as different as Paul Krugman and Tyler Cowen have pointed out, the more accurate version is this: The Fed helped cause the Great Depression by allowing the supply of money and credit to tighten. The distinction is important. How did they allow it? By declining to bail out the failing banks.
As Professor Krugman points out in his essay “Who Was Milton Friedman?” what evaporated in the early years of the Depression was not the monetary base, which consists of all the currency in circulation plus bank reserves, but the money supply, which is equal to all the currency in circulation plus bank deposits. It wasn’t currency that disappeared from 1929 to 1933, but bank deposits. Why? Because the banks went kaplooey and the Fed did nothing to stem the tide of bank failures. And so a banking bailout is implicit in Friedman’s criticism of the Fed’s Depression-era policy. Friedman and his co-author, Anna J. Schwartz, approvingly invoke the Lombard Street rules of Walter Bagehot, the patron saint of central bankers, which hold that in times of crisis the central bank ought to support the banking system: “Lend freely, at penal rates, against good collateral.” It is difficult to imagine how, in Friedman’s view, the Fed could have intervened to prevent the Great Depression without executing something equivalent to a bank bailout. A bailout in the form of free lending is not so different from a bailout in the form of capital investment or soaking up “distressed” assets. None is a synonym for “Let the markets work.”
Along with the Federal Deposit Insurance Corp. and other institutions of that kidney, the Fed’s existence is an implicit judgment that bankruptcy law and normal market processes are insufficient in the case of banks. That may be a faulty judgment, but it is a very longstanding one, and it is owed some consideration. Friedman argues that the creation of the Fed preempted a repeat of the private-sector bailouts of the sort organized by J. P. Morgan during the Panic of 1907. By the time of the Depression, the big banks that were Fed members had its support and felt no need to intervene in the affairs of their weaker competitors. The Fed was created, in many ways, to allow the government to do what J. P. Morgan had done in 1907, since J. P. Morgan would not always be around to put his and his friends’ personal fortunes behind the banks.
For obvious reasons, this all was very much on the mind of Ben Bernanke, who, just before his elevation as chairman of the Fed, gave a speech on Friedman, banks, and the Great Depression: The Fed could have been more aggressive in lending cash to banks (taking their loans and other investments as collateral), or it could have simply put more cash in circulation. Either action would have made it easier for banks to obtain the cash necessary to pay off depositors, which might have stopped bank runs before they resulted in bank closings and failures. Indeed, a central element of the Federal Reserve’s original mission had been to provide just this type of assistance to the banking system. . . . Moreover, most of the failing banks were relatively small and not members of the Federal Reserve System, making their fate of less interest to the policymakers. In the end, Fed officials decided not to intervene in the banking crisis, contributing once again to the precipitous fall in the money supply. Free-marketeers tend to think of our orientation not only as an economic position but also as a virtue. (It is.) But there is a danger in letting that belief congeal into dogma and, in consequence, allowing abstractions to obscure realities. It is true that the root evil here was government intervention in the economy: The Fed’s over-loose money after Dot-Bomb and 9/11, combined with tax incentives and the market-distorting actions of Fannie Mae and Freddie Mac, helped create the housing bubble; various government policies then helped turn that bubble into a global disaster. The subprime meltdown was not a failure of what is so often mischaracterized as “unbridled capitalism.” It was as much a failure of regulatory excess as of Scrooge McDuck, literally-rolling-in-it excess.
But it is not necessarily wise to start practicing austerities at the moment of crisis. Those who opposed the bailouts were, I think, seeking to restore the virtues of the free market — at precisely the wrong time. It is as though we had been diagnosed with lung cancer and responded merely by swearing off cigarettes. What about radiation therapy? What, are you crazy? Radiation gives you cancer! And people get sick in hospitals!
I suspect that many of us who opposed the bailouts did so based on unjustified optimism. Surely, we thought, the citizens of this commercial republic will have learned their lesson and will hasten to enact reforms that are consistent with their experience and liberal values. Those of us who believed that must somehow have missed the contemporaneous ascent of Barack Obama, whose election as president does not suggest that the nation is ready for a heaping helping of Adam Smith. Professor Cowen demands:If you are a libertarian, is not our current course more favorable for liberty than would have been a repeat of 1929–1931? If not, I would be curious to hear your counterfactual version of how matters would have proceeded, without the financial bailouts. Is it that you think the regional banks would have raised the financing to pick up the entire bag and keep the banking system afloat? Or is it that natural market forces would have somehow avoided a wrenching surprise deflation? Or do you think the authorities for some reason would have not nationalized the major banks? . . . If we had not done the bailouts we did, we would, within a few months’ or weeks’ time, have received a much worse and costlier bailout run by Congress and Nancy Pelosi. How does that sound? Sounds like hell on earth, professor.
I did not and do not believe that the crisis was such that organized usury was going to go the way of the brachytrachelopan. Anything ancient enough to have Old Testament strictures against it is going to be with mankind forever. But with a more radical and unmitigated crisis — one that saw the electorate sucker-punched by a few million bounced paychecks, for instance — the populist reaction probably would have been more vigorous than the one we experienced. Barack Obama was not the product of a bull market. Neither was Hugo Chávez.
The Best of All Possible Worlds is not on the menu, and we have only to choose from penny worlds, each defective in its own way. The ideologue in me says: We ought to live in a country in which a solution to the crisis that is consistent with the best of our values had a chance of being enacted. But we don’t. Likewise, those who supported the bailout must surely believe that we ought to live in a country in which the damage it is going to do will be minimized, in which it is temporary, and in which we will act with all deliberate speed to undo those federal incursions into the economy — a world in which the ratchet of statism turns both ways. Good luck with that.
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