Original Article

Classical libertarianism: The economic perspectives of Milton Friedman including his likely views on the ‘proper’ role of government in the subprime mortgage debacle Received (in revised form): 18th November 2008

James L. Bicksler is Professor of finance and economics at Rutgers University, Rutgers Business School and Associate Director, Center for Research in Regulated Industries. His teaching and research interests include corporate governance, pension fund economics, investment portfolio strategies and retirement funding strategies.

ABSTRACT This study presents the libertarian ideas of Milton Friedman, the Nobel Prize in Economics awardee in 1976 and the most influential libertarian of the twentieth century. Specifically, the foundations of Milton Friedman’s libertarianism, which are private property rights, competitive markets, economic, political and civic freedoms and the limited role of Federal government, are articulated. Further, public policy issues where Milton Friedman’s suggested reforms have been successfully implemented in varying degrees are also detailed. They include (1) floating the dollar, (2) ending the military draft, (3) repealing interest rate ceilings, (4) treasury innovations such as auctions and inflation indexed bonds, (5) ending rent control, (6) deregulation in industries such as banking and telecommunications and (7) promoting market completion and individual choice in primary and secondary schools. Also, presented are Milton Friedman’s likely economic assessments of the Federal government’s, including both the Federal Reserve System and the Department of Treasury, economic stimulus programmes to resuscitate the economy from the subprime mortgage debacle. These inferences about Milton Friedman’s likely economic assessments are based upon his published economic writings and a recent interview with his long-time collaborator, Anna Schwartz. Mr Friedman’s likely economic assessments, as a short list, include (1) the grade for the monetary policy of the Federal Reserve System in the subprime mortgage debacle was below average because it did not address the fundamental problem of the financial markets being unable to accurately price the risky securitised subprime mortgage products and the mistaken belief that credit default swaps (CDSs) would adequately hedge their future asset risks, (2) that the Paulson II economic stimulus plan lacked any rigorous and systematic economic justification because it rewards financial institutions that have performed poorly and because it results in partial nationalisation of the financial services system, (3) the Paulson plans result in a

Correspondence: James L. Bicksler Department of Finance and Economics, Rutgers Business School, Rutgers University, 180 University Avenue, Newark, New Jersey 07102, USA

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large increase in government size via a large increase in government expenditures and (4) there will be multiple challenges to capitalism as the primary resource allocator. Also discussed are the determinants of the subprime mortgage debacle including (1) the increased demand for securitised mortgage products resulting in significantly lower mortgage lending standards for home loan borrowers and (2) the belief that CDSs could/would reduce the risk associated with the ownership of subprime mortgage tranches. These two phenomena have led to a number of sinister economic results such as (1) the absence of market clearing transactions and hence (2) market prices for securitised subprime mortgages, (3) meaningful assessments of the probabilities of default/ bankruptcies of many firms in the financial services industry.

International Journal of Disclosure and Governance (2009) 6, 21–39. doi:10.1057/jdg.2008.31 Keywords: Adam Smith’s invisible hand of self-interested individuals; classical libertarianism; credit default swap (CDS); economic; political and civic freedoms; Emergency Economic Stabilization Act of 2008; troubled assets relief program (TARP)

INTRODUCTION This paper presents the libertarian views of Milton Friedman, which stresses the advantages of a competitive market price system, private property and the role of self-interested individuals in resource allocation. The economic resultants of Milton’s views are enhanced economic, political and civic freedoms, minimal roles for (1) government, (2) public regulation and (3) an activist, discretionary Federal Reserve. A separate section is devoted to Milton’s likely economic public policy evaluations such as the Paulson plans, including bailouts, designed to resuscitate the economy from the subprime mortgage debacle.

THE PERSON, ECONOMIC TRUISMS AND PUBLIC POWER PERSPECTIVES Being an economist who is at Rutgers University where Milton Friedman received his undergraduate degree, I have long taken and will continue to take, to my dying days, pride in Milton Friedman’s contributions to economic theory and empiricism (that is, the life cycle permanent income hypothesis and optimal monetary policy and its linkages to the real economy). Milton was awarded the Nobel Prize in Economic Science in 1976. When Milton received the Nobel Prize in Stock-

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holm, the citation read ‘for his achievement in the fields of consumption analysis, monetary history and theory and for his demonstration of the complexity of stabilization policy’.1 For such accomplishments, Milton has, appropriately, earned a place in perpetuity in the Hall of Fame of Economic Ideas. Additionally, as one economic commentator has stated, Milton Friedman was the twentieth century’s most influential libertarian. Indeed, in my opinion, Milton Friedman, joint with Paul Samuelson, were, from the standpoint of history of economic ideas, the two economists of the twentieth century who had the greatest impact on shaping the future economic theory and inquiry. The economic foundations set forth by Milton are at the core of thinking about what constitutes systematic and rigorous arguments, concerning the array of public policy issues such as immigration, trade, elderly entitlements (that is, social security and health care), discrimination, promoting competition and individual parental and student choice in elementary and high school education via vouchers, foreign aid (that is, government subsides), bailout-asset bubble recovery strategies and so on. The gamut of Friedman’s libertarian views were initially set forth in Capitalism and Freedom2 with the assistance of his wife, Rose Director

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Friedman.3 This work was then supplemented and complemented by Free to Choose4,5 and a 10-part PBS television series on Free to Choose,4,5 both jointly co-authored or co-produced with Rose, and Tyranny of the Status Quo (1984), also joint with Rose in 1984, along with an extensive array of published journal papers.6–15 Friedman describes the essence of libertarianism as ‘free private property capitalism’. With regard to private property, Friedrich A. Hayek is of the opinion that ‘private property’ is the most important guarantee of freedom. Further, Milton Friedman has stated, ‘you can’t have a free society without private property’. Translated, Friedman’s libertarian framework is that economic and political freedoms are best and, perhaps, can only be achieved via institutions and markets that maximise the welfare of each individual party to the transaction, as judged by each individual party to the transaction and the transaction taking place in competitive markets where there is individual ownership of property rights. Note that much of the rationale for emphasising individual decision making in a private property economy is captured in Milton Friedman’s view that ‘Nobody spends somebody else’s resources as carefully as he uses his own. So if you want efficiency and effectiveness, if you want knowledge to be properly utilised, you have to do it through the means of private property’. This means, as Friedman states, that ‘the organization of the bulk of economic activity through private enterprise operating in a free market promotes economic welfare and political freedom’. The primary end results of competitive markets dominated by self-interested individuals are enhanced efficient resource allocation at the level of both the firm and the household, and the enhancement of the real growth of the economy.16,17 This reasoning goes back to Adam Smith’s seminal Wealth of Nations (1776), where Smith argued that the invisible hand of self-interested individuals promoted what was best for society.18,19 Specifically, Adam Smith stated that ‘he intends only his own gain, and he is in this as in many other cases led by an

invisible hand to promote an end which was not part of his intention’. That is, ‘It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest’. Alternatively stated, the essence of all of Milton Friedman’s public policy prescriptions was the demonstration via arguments of price theory that if there is an efficient allocation of resources at the firm level, it results in lower market clearing prices in competitive markets and these gains accrue to the benefit of individuals.19–26 Further, competitive markets encourage entrepreneurial and innovative activity which results in an expanded opportunity set of choices for consumers which again is a gain for society. This means that, in general, private markets are to be preferred to governmental regulated markets because they have superiority in allocating scarce resources. Certainly, private markets, if they are competitive markets, are to be preferred, without exception, to governmental regulated markets because they have superiority in allocating scarce resources.22–26 Adam Smith’s viewpoint of self-interested individuals operating in competitive markets, leading to enhanced resources allocation and societal economic gains differs markedly from the then prevailing mercantilistic structure of the economy.27 In mercantilism, there is a government/monarchy that focuses on a nation’s economic goals, particularly on export-balance of payment goals, and where there is zero focus and emphasis on enhancing opportunities for individuals and on individual self-interest.28 Several economic truisms related to libertarianism are as follows: 1. The relationship between economic freedom and political freedom is complex but there is definitely a linkage. It is complex because neither type of freedom must necessarily precede the other. For example, Friedman cites the Czech Republic, Hungary and other Eastern European countries as examples where political freedom preceded

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economic freedom. In contrast, Hong Kong was a country where there was an absence of political freedom but which had tremendous amount of economic freedom.29 These points are not necessarily understood by all individuals. 2. For example, US President George W. Bush in June, 2007, stated ‘China’s leaders believe that they can continue to open the nation’s economy without opening its political system; we disagree’. Friedman’s views on the interrelationship of economic freedom and political freedom are partially reflected in his thoughts about the future of freedom in China. Specifically, Friedman has stated that ‘The same thing will happen in China that happened in Chile. Political freedom will ultimately break out of its shackles. Tiananmen Square was only the first episode. It is headed for a series of Tiananmen Squares. It cannot continue to develop privately and at the same time maintain its authoritarian character politically. It is headed for a clash. Sooner or later, one or the other will give. If they don’t free up the political side, its economic growth will come to an end – while it is still at a very low level. The situation is not all bleak. Personal freedom has grown greatly within China, and that will provoke even more points of conflict between the individual and state. There is a new generation that is educated and travels abroad. It knows firsthand the alternatives out there. So the authoritarian character is softening somewhat. Hong Kong is the bell weather. If the Chinese stick to their agreement to let Hong Kong go on its own path, then China will also go that way. If they don’t, that is a very bad sign. I’m optimistic’.30 Recent events in China on the impact of information technology (that is, mobile phones and accompanying text messaging and the Internet and associated chat lines and blogs) involve criticisms of and demonstrators against (1) reported abducted youth (that is, slave labour) to work in brick kiln factories and (2) environmental hazards in

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Xiamen, a city of 2.3 million people. The bottom-line end results were (1) peaceful demonstrations by the citizenry, (2) recognition by the press of the validity of the claims of the demonstrators and (3) governmental responsiveness and actions to correct the issues. Hu Jintao, the President of China and chief of the Communist Party of China, has acknowledged the need to reform China’s political system. Indeed, President Hu has remarked that political freedom is necessary for the modernisation of China. Interestingly, the Review of Economic Research, a journal controlled by China’s Ministry of Finance, devoted roughly half of a recent issue to a detailed agenda for enhancing political freedom. Even the press has advocated big changes in enhancing political freedom. One of the Communist Party’s leading analytical publications has republished an article, thus entitled,‘Democracy is a good thing’. Hence, the climate for enhancing political freedom building upon economic freedom seems to be quite favourable.31 Thus, Friedman feels that if a country presently has only economic freedom, more often than not, it will lead, in due course, to political freedom. 3. Collectivist advocates (that is, communists and socialists) have foundations that are inherently inconsistent and contradictory with their own recommended economic allocation mechanism. Specifically, their advocated ideas of freedom and organisational market structure and which translate into (1) freedom of individual economic choice and (2) central planning of resource allocation are inherently inconsistent and contradictory. This is because economic freedom requires competitive markets and property rights whereas central planning is premised on the absence of both competitive markets and individual property rights. More specifically, socialism promised a new economic order, which, in essence, was an economic utopia wherein people lived without want. Given socialism’s fundamental flaws and limitations in achieving firm economic resource

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efficiency, it is not surprising that in due course, there was the demise of socialism. Similarly, the demise of communism was also due to its resource allocation failure and negative impact on both the income of the citizenry and the Gross Domestic Product (that is, the value of all the goods and services produced by the economy). Adam Smith felt that there was a definite but limited role for government. Indeed, Smith felt that there were only three appropriate/ legitimate functions of government. They were (1) having a military to protect the country against foreign invasion, (2) the establishment of institutions of law and justice and (3) the implementation and establishment of selected public service functions that individuals cannot justify on an economic basis. However, it is important to note that the government functions (2) and (3) of Adam Smith should be implemented with a focus on individual self-interest and in an environment of market competition.32–34 4. Political freedom without property rights will inevitably lead to the absence of both political and economic freedom. Further, the ownership and control of the production of wealth-assets-future cash flows is, indeed, the control of human life itself. 5. Milton was a fan of privatisation of governmental physical assets and activities, provided the privatisation was a vehicle to put ownership in the hands of all citizens and not simply a mechanism to transfer a governmental monopoly to a private monopoly. Indeed, Milton felt it was a major US governmental policy mistake in Iraq to maintain the status quo with regard to government ownership of the petroleum resources of the country and not to distribute ownership claims to all the citizens (that is, Kurds, Shiites and Sunnis) of Iraq. 6. Milton has indicated that if he was to write a new edition of Capitalism and Freedom,2 he would, at minimum, certainly make one important change. Specifically, he would expand the taxonomy of freedom to include

not only economic and political freedom but also civic freedom (that is, freedom of speech and freedom of religion). He cites Hong Kong as an example, which had very little political freedom but loads of civic freedom and economic freedom. 7. Two powerful triggering forces for additional globalisation are the Internet and e-mail. The ‘perfect’ information parameter of competitive markets is much more descriptive of actual market behaviour cum e-mail and the Internet. This means, due to the Internet and e-mail, equilibrium prices are much more reflective of global supply and global demand. One economic implication is that such market clearing prices, ceteris paribus, penalises (rewards) firms operating in countries having high (low) tax rates. Indeed, Milton Friedman felt that ‘The Internet is the most effective instrument we have for globalization’. The Internet effectively promotes economic freedom because it channels resources to and rewards more efficient firms, independent of country boundaries and simultaneously promotes political freedom because it diffuses and limits governmental power via (1) increasing non-censured and non-monitored communication between individuals, (2) decreasing the importance and extent of governmental resource allocation and (3) decreasing the effectiveness and control of governmental regulation. This is because the Internet opens up tremendous opportunities to broaden their opportunity set to form voluntary associations. In this regard, P. J. O’Rourke states that, ‘The free market is an enormous network of voluntary associations that allows the unfettered exchange of goods, services and ideas through routes that are more complex and unpredictable than MapQuest’s’. The linkage between voluntary associations to competitive markets, to economic, political and civic freedoms is very important. In other words, competitive markets not only have implications for equilibrium market prices but also have

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important implications for economic, political and civil freedoms.This is because ‘Every free market transaction is both an exercise in liberty and an exhibition of respect for the liberty of others’.35 To put the Internet in historical context for promoting freedom, Howard Dean, the present chairman of the Democratic National Committee has stated that ‘the internet is the most significant tool for building democracy since the invention of the printing press. People are now more easily able to create, discover and connect with networks within hours, anywhere around the globe’. As to the future, Howard Dean feels that ‘America can still win the battle for a democratic world. The most important weapon is a free, open, commercially and politically unfettered Internet that empowers ordinary people from across the globe to speak and act in the interests of their communities’.36 8. Friedman in Capitalism and Freedom2 listed 14 government activities in which there as an absence of economic justification. Over the years, this list has grown to 25 or so policy proposals to reduce the size of government and improve market efficiency. A partial tabulated list of these policy proposals to reduce the size of government is as follows: (1) abolish price subsides for agricultural products; (2) eliminate tariffs and other trade restrictions; (3) abolish rent control; (4) eliminate minimum wage rates; (5) abolish mandatory social security; (6) eliminate licensing of professions; (7) abolish public housing; (8) legalise (that is, decriminalised) the use of drugs; (9) eliminate mandatory conscription of armed forces in peacetime; (10) eliminate public ownership and operation of toll roads; 9. A number of Milton Friedman’s suggested reforms have been successfully implemented

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in varying degrees. These successes include the following: (1) floating the dollar; (2) ending the military draft; (3) repealing interest rate ceilings; (4) treasury innovations such as auctions and inflation indexed bonds; (5) rent control; (6) deregulation in such industries as banking and telecommunications; (7) school vouchers to promote market competition and provide individual choice among multiple alternatives in the parental selection of the primary and secondary schools that their sons and/or daughters would/could attend. 10. Deregulation, privatisation of highways, bridges and so on, and, in particular, school vouchers, are three areas where, although there has been some progress, there are still many, many challenges and opportunities for progress in individual choice, competitive markets and human freedom. Business Week (7 May 2007) reports that a number of public government entities having physical infrastructure assets such as toll highways, airports, water facilities bridges, parking facilities and so on have already been sold or are contemplated being sold. Among the sellers and the entities contemplated being sold are State of New York and the New York State Thruway and the Tappen Zee Bridge; City of Chicago and the Chicago Midway Airport; State of Indiana and Indiana Lottery and the State of New Jersey and the New Jersey Turnpike, Garden State Parkway and the Atlantic City Expressway. Business Week estimates that already completed sales of public physical infrastructure assets in the last 2 years are somewhat less than $7 billion. Likewise, Business Week estimates that the market value of public physical infrastructure assets to be sold in the next 2 years should approximate $100 billion.37,38 These asset sales by government and this

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non-ownership by government of public infrastructure physical assets is, ceteris paribus, regarded as a plus from a public policy standpoint of the appropriate role of government. However, if these sales are simply a mechanism to finance the governmental budgetary deficit and to increase/encourage the expansion of government, then much of its appeal vanishes. Further, these asset sales would be more appealing if the cash proceeds were distributed to the taxpayers. The Friedmans’ proposal for educational vouchers is a variant of the GI education plan for World War II veterans. Namely, the government provides payment for a specified tuition expense, up to a maximum amount, and the student and/or his/her parents have freedom of choice within a broad set of schools. This opportunity set of educational institutions is likely to change over time. This is because entry and exit of schools that meet or do not meet student/parent expectations will inevitably occur. The voucher educational system is likely to turn the present educational system, which is presently a governmental monopoly, into a competitive market where there are a multitude of schools, both private and public, and where there are both educational innovations and entry and exit of schools that meet or do not meet the consumer market test.39,40 Alternatively stated, as Milton Friedman has stated ‘Government ownership and operation of schools alters fundamentally the way the industry is organized. Consumers are free to buy the products of most industries from anyone who offers them for sale at prices mutually agreed on. In the process, consumers determine how much is produced and by whom, and producers have an incentive to satisfy their customers. Competitive private industries are organised from the bottom up. They have been responsible for truly remarkable economic growth, improvements in products and increased efficiency in production’.41

The end result predictably is that ‘though spending per pupil has more than doubled since 1970, after allowing for inflation, students continue to rank low in international comparisons, dropout rates are high, and scores on SATs and the like have fallen and remain flat. Simple literacy, let alone functional literacy, in the United States is almost surely lower at the beginning of the 21st century than it was a century earlier’.42 Indeed, recent international tests show that the United States does not rank in the top 10 nations with regard to the educational productivity of their students.43 The fundamental underlying premise of the advocacy of vouchers is that ‘The voluntary choices of individuals, not the dictates of the state, should be the default mode of human life; government is justified only insofar as it preserves, protects and defends people’s liberty’.44 The end result is that each family has access to educational alternatives independent of their race, beliefs, wealth or heritage.45,46 As indicated, the incumbent public school system is essentially a government monopoly. The empirical evidence of the impacts of increased competition via the voucher system are (1) higher test scores, (2) higher graduation rates, (3) more parental involvement with the schools attended by their children, (4) higher satisfaction with their children’s education, (5) significant tax saving due to decreased education expenditures and (6) improved public schools. There has been slow but some modest progress in implementing freedom of individual school choice.47,48 Specifically, Jon Huntsman, Governor of Utah signed the first state universal school voucher programme in February 2007. Suggested economic policy reform areas of Milton Friedman that were definitely not implemented have included the negative income tax, the constant monetary growth rule, privatisation of social security and privatisation of state colleges and universities.49,50

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11. As Professor Allan Meltzer has stated, Milton and Rose Friedman have ‘had an enormous influence not only on economists and the academic profession but on policies in the United States and large parts of the world. Their efforts to induce societies to foster liberty, individual initiative, and freedom to choice and their successes have few parallels’.51,52 12. Which way is the tide turning regarding (1) collectivism, (2) government expenditures and regulation and (3) individualism?53–56 Is it (1) more collectivism, (2) larger relative government expenditures or (3) greater individual liberties and economic choices? Here are some partial but still murky answers: (1) Since the fall of the Berlin Wall and the demise of the Soviet Union, socialism and communism (that is, government ownership and operation of the productive resources of a country and concomitantly central planning) is dead. (2) The climate of the debate between collectivism versus individualism is presently much more intellectually responsive to arguments pro-individualism than it was in 1945–1946 when collectivism was in vogue. (3) There is more people tolerance in the twenty-first century than in the early to mid-twentieth century. By this, it is meant that there are more positive attitudes between individuals of different groups towards individuals of other groups. Alternatively stated, there are less stereotypes, less bias, less discrimination and less bigotry by individuals of different groups towards individuals of other groups in the twenty-first century. More specifically, there is less anti-Semitism, less prejudice, less discrimination, less stereotype thinking and less bigotry towards African-Americans, Catholics, alternative sexual lifestyles and to relatively recent immigrant groups to America such as Hispanics, Asians, Arabs, Muslims and so on.

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(4) History shows ‘that when Britain was at the height of its power when Queen Victoria was celebrating her jubilee at the end of the 19th century, government spending in Britain was 10–12 percent of national income. I noticed in the United States, when the United States was doing well (before the Great Depression) in the 1920s, government spending in the United States at all levels of government, federal, state and local was around 10–12 percent of national income. I noticed that over the millennia the church has always recommended tithing. So somehow I came up with the idea that 10 percent is about right’. However, it should be noted that there is no systematic and rigorous evidence that 10 or 11 or 12 percent is the optimal level of government spending. Or as Milton Friedman has stated, ‘I don’t believe there is any theoretical way of determining the optimal level of governmental spending’.57 (5) It is personally unclear whether there is more (that is, increasing) or less (that is, decreasing) economic, political and civic freedoms in the United States in the twenty-first century. A similar agnostic personalistic assessment is given to the query of whether there is more (that is, increasing) or less (that is, decreasing) economic, political and civic freedoms in the world in general. As to whether there are more or less economic, political and civic freedoms in other geographical areas of the world, the answers are likely to vary from geographical area to geographical area. For example, in Eastern Europe, there are likely more economic, political and civic freedoms in the twenty-first century than there was in the last half of the twentieth century. This is because communism is no longer the dominant mechanism of scarce resource allocation. The breakdown of collectivism (that is, centralised

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government) is also basically descriptive of the economies of mainland China and India. It would not be surprising that by 2030, both China and India, due to the entrepreneurial spirit of their citizenry and the general recognition of the many failures of collectivism, their economy’s resource allocation would be characterised by less centralised planning and a great more competitive capitalism-individualism.58 Also, both countries would have increasing importance in the global product, labour and financial markets. Ad hoc indications of these likelihoods are (1) the $7.8 billion investment by the Chinese government in the IPO of the Blackstone Group, a private equitybuyout firm, (2) the increased prominence of Mittal, an Indian steel company in the international steel markets and (3) Asia having more candidates, 52 900 compared to 45 400 candidates from the United States for the CFA exam. (6) Owing to our (that is, United States’s) present conflicts in Iraq and Afghanistan, questions of trade-offs between security and freedom have and will continue to arise. In this regard, Benjamin Franklin’s view that ‘Those who sacrifice liberty for security will soon find that they have neither’, is a powerful message well worth heeding. It likely has important implications for freedom in the United States in the twenty-first century. A contemporaneous issue for the United States in the early twenty-first century arises from the supposed military threat of terrorism and its implications for wiretaps, visas, immigration and so on. (7) The quest and battle for economic, political and civic freedoms is never won in a finality sense. It is a day-today, meaning an ongoing battle, where new challenges and variations of old arguments and fallacies for collectivism and its policies arise. The particular issue on the battleground for freedom

and its implications for freedom changes over time.

GENESIS OF AND THE PROPOSED GOVERNMENT RESPONSES TO THE SUBPRIME MORTGAGE DEBACLE There have been many reasons offered as to what were the triggering reasons for the subprime mortgage debacle. A major contributing cause was the deterioration of the mortgage lending standards that were induced by (1) increased securitisation and the global increased demand for additional flows of securitised mortgage products and (2) the belief that credit default swaps (CDSs) could reduce significantly the risk associated with the ownership of subprime mortgages.59–62 This resulted in the financial markets not being able to properly price the risk premiums associated with these securitised subprime mortgages. Alternatively stated, the financial innovation in turn resulted in the inability of the financial markets to establish meaningful prices for these risky assets. The corollaries of the absence of meaningful asset prices were: (1) these assets could not be sold, (2) the asset side of the balance sheet could not be accurately valued, (3) borrowing was impossible due to (4) inability to estimate the likelihood (that is, probability) of security and firm insolvency. The primary initial Federal governmental response to the economic instability resulting from the subprime mortgage was detailed in the Emergency Economic Stabilization Act of 2008 signed into law by President George W. Bush on 3 October.This Act initially authorised Secretary of Treasury Henry Paulson to establish the Troubled Asset Relief Program (TARP). The purpose ofTARP is to establish programmes to purchase up to $700 billion of troubled assets of financial institutions. In other words, TARP was a bailout mechanism primarily for mortgage lenders from a variety of financial institutions, who essentially made leveraged risky residential home loans with little or no down payment to

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not particularly credit worthy borrowers. Obviously, in times of downward spiralling residential home prices, the fair market prices-values of these leveraged risky residential home loans decreased significantly. Originally, TARP was a three-page proposal with nearly all relevant specifics, including operational mechanics, to be provided later. Presently, TARP is a 150-page document where there is a great deal of latitude-flexibility as to asset purchase guidelines such as auctions, reverse auctions or Treasury direct purchases through negotiated sales.63,64 However, after only 2 weeks from the date that TARP was enacted with a budget of $700 billion to purchase distressed-toxic securities, the Bush administration backtracked and reversed economic policy directions by adopting a rescue plan that would focus on buying equity stakes in troubled and, perhaps, not so troubled financial institutions.65,66 However, Secretary of Treasury Henry Paulson did not provide the financial and other details as to the relative size of this programme visá-vis the toxic asset purchase programme. As time unfolds and actual transactions take place, more details and a better understanding of this evolving programme will inevitably be provided.

MILTON FRIEDMAN’S LIKELY ASSESSMENT OF THE GOVERNMENT’S ECONOMIC RECOVERY PROGRAMMES Among Milton Friedman’s economic principle that would ceteris paribus constitute the underpinnings of his reasoning are being against (1) economic resources being allocated to special interest groups, (2) government-funded programmes that promote big government and (3) government-funded programmes that are implemented by third parties and (a) do not have an individual choice component and/or (b) do not promote competitive markets. Specifically, my personal assessment of Milton’s likely economic evaluation of the subprime mortgage debacle (perhaps, it should be more accurately described as the credit market disturbance), and the

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efficacy of the Federal government’s public policy to ameliorate the economic consequences are as follows:67,68 1. The bells and whistles of the causes and transmission linkages of the Great Depression are different than the bells and whistles of the causes and transmission linkages of the recent subprime mortgage debacle. 2. One major difference was that the Great Depression was triggered by a dramatic contraction in the quantity of money that impacted upon the solvency of the banking system and that led to bank runs. On the other hand, the subprime mortgage debacle was triggered by the deterioration of mortgage lending standards. This leads to the financial market’s limited ability to meaningfully value assets (that is, primarily exotic securities – so-called toxic assets). Hence, it was difficult to determine which financial institutions were solvent.69 3. Although the policy particulars differ, an evaluation of Federal Reserve’s economic monetary policy was that they deserve low marks in both periods.70–73 In the Great Depression, the Fed wrongly did not provide adequate liquidity during the period when depositors withdrew their funds which led to a banking crisis (that is, a run on banks). Additionally, the Fed contracted the quantity of money in the economy. The Fed’s present economic policy for this credit debacle was to provide plenty of liquidity to the financial markets and, in that sense, was fighting the last depression. Instead, they should have been focusing and fixing the root cause of this subprime mortgage debacle, which was the inability of the financial markets to accurately price the risky securitised subprime mortgage products and the mistaken belief that CDSs would adequately hedge their future asset risks. 4. In the subprime mortgage debacle, the original Paulson plan (Paulson I) was to buy toxic assets from financial institutions. Paulson I is a priori, at least, a bit economically appealing

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because it would help establish market prices for toxic assets. Price discovery, of course, is an important and useful function of market. However, it has multiple operational challenges in terms of valuing assets. 5. However, the second Paulson plan (Paulson II), which was to provide capital infusions to poorly performing and now adequately performing financial institutions lacks merit as an economy recovery policy. Specifically, Milton would likely think that Paulson II was a poorly conceived economic recovery plan. It was poorly conceived because (1) it allocates resources, not by the pricing mechanism of competitive markets, but by decisions of a government bureaucracy, (2) it rewards, not penalises, financial institutions that are or near insolvency. In other words, Paulson II rewards financial institutions that wrongly made important asset investment decision. Additionally, Paulson II, because it injects capital into undercapitalised poorly performing and now in its present version interjects capital into adequately performing banks, results in a partial nationalisation (that is, government ownership) of the financial services system. 6. Both government stabilisation programmes (that is, Paulson I and II) in the subprime mortgage debacle lacked a rigorous and system economic justification. Specifically, there were no cost–benefit analyses where the expected benefits were assessed as to whether they were significantly greater than expected costs.These costs included not only the present out-of-pocket costs but also the future implicit costs due to induced future excessive risk taking where firms would expect to be bailed out.74,75 7. There is a complete lack of economic justification for the bailout of individual failing financial institutions.75–77 That is, firms that make poor corporate resource allocation decisions, such as making leveraged loans to not particularly qualified residential mortgage borrowers, should suffer their own self-induced financial insolvency

consequences. Alternatively stated, there should be the absence of a no-loss scenario for firms, wherein heads the firm guesses right in terms of future positive cash flows and the shareholders reap the benefits and tails the firm guesses wrong and negative cash flows result and the Federal government bails them out.78–80 8. The Paulson economic stabilisation programme focusing on the recovery of (1) the financial system is to be preferred to the economic recovery programme aimed at (2) rescuing individual poorly performing financial institutions. 9. In my opinion, Milton Friedman would not have viewed ‘optimal’ regulation as the absence of any regulation. Indeed, Milton conceivably would have viewed regulation that resulted in transparency of relevant investment parameters of CDSs as desirable. This is because individual investors would then be able to have relevant information to value assets in financial markets with the end result that there would have been market prices for both CDSs and firms selling CDSs and hence, better resource allocation. 10. The government rescue efforts (that is, Paulson I of $700 billion and Paulson II of an unnamed amount) will result in an exploding increase in governmental expenditures. This, unfortunately, will lead to an increasing role and increased power of the Federal government in resource allocation. 11. The partial nationalisation of the banking and financial sectors along with the large increase in Federal government expenditures will inevitably lead to a decrease in free trade and a decrease in globalisation. 12. Indeed, the future of capitalism, given the partial nationalisation of the banking sector and the financial system and the growth of Federal government expenditures, is going to have important challenges to capitalism as the predominant resource allocator. To repeat, the challenges to capitalism are a result of (1) there being a larger role for

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the Federal government in the economy and (2) there being partial nationalisation of our banking and financial system. If there is a one word recipe for the US’s economy to prosper in the future, it would not be a surprise that Milton Friedman would say that recipe is ‘capitalism’.81–86 In summary, Milton’s likely economic assessments of the Federal government’s economic recovery programmes were that (1) the monetary policy of the Federal Reserve was aimed at providing liquidity when the financial markets already has loads of liquidity and when the fundamental problem was quite different and was the inability to ascertain a reasonable approximation of the market value of the balance sheets of financial institutions because of the presence of exotic securities and (2) Paulson I and II had important economic limitations as a resource allocator.

CONCLUSIONS In the battle for individual freedom of choice, the promotion of civic, economic and political freedoms and the enhancement of market competition and firm resource efficiency, Adam Smith and Milton Friedman are the two warriors who were and are at the pinnacle of economic ideas, public policy prescriptions and action impact. Milton’s impact on public policy decision makers and debate has been tremendous. His influence on political policy decision makers includes Lady Margaret Thatcher and her chief economic advisor, Sir Alan Walters; US Presidents Richard Nixon and Ronald Reagan; US Senator and 1964 Republican Presidential candidate Barry Goldwater; present California Governor Arnold Schwarzneger; former Chairman of the Federal Reserve System-Board of Governors Alan Greenspan and present Chairman of Federal Reserve System-Board of Governors Ben Bernanke, former US Secretary of State and former US Secretary of Treasury George Shultz, Nobel Laureate in Economic Science Recipient George J. Stigler and legions of others including our own illustrious Michael

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Crew and former SEC General Counsel and present Vice Chairman of Millennium Capital, Simon Lorne. In summary, Milton Friedman, in addition to being a provocative and seminal economic thinker, has had a super terrific public policy impact affecting the wealth and welfare of individuals in a positive manner and ergo the wealth and welfare of nations and increasing the economic, political and civic freedoms of people around the world. His ideas and public policy prescriptions constitute an important economic agenda cum solutions independent of time and space. As the Friedman family has said and accurately so, ‘Dr Friedman will be remembered around the world as one of the 20th century’s greatest champions of freedom’. Milton is truly an individual who has made a significant positive difference on the society or as the Rutgers Magazine stated Milton Friedman was ‘The Nobel Laureate who changed the world’.87,88 Lastly, the grade that Milton likely would give the Federal government, including the Federal Reserve, Treasury and Congress in their economic stimulus programmes to combat the subprime mortgage debacle, would be below average.

REFERENCES AND NOTES 1

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The announcement of the Royal Swedish Academy of Sciences award of the 1976 Prize in Economic Sciences in memory of Alfred Nobel to Milton Friedman is contained in the Everiges Riksbank Prize in Economic Sciences in memory of Alfred Nobel 1976, 14 October 1976. Friedman, M. (1962) Capitalism and Freedom. Chicago, IL: University of Chicago Press. Milton Friedman met Rose Director at the University of Chicago during the 1932–1933 academic year where they were both first-year graduate students in economics. They met in a course entitled ‘Price and distribution theory’ taught by Jacob Viner, a prominent economist. They were married in June 1938. When Milton passed away in November 2006, Rose and Milton had been married for over 68 years.

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Free to Choose was not only a book but also a 10-part television series which was privately funded.5 It was televised starting in January 1980 on 196 PBS stations which was 72 per cent of the total PBS stations in the United States. The series consisted of 10 televised broadcasts which were (1) The power of the market, (2) The tyranny of control, (3) The anatomy of crisis, (4) Cradle to grave, (5) Created equal, (6) What’s wrong with our schools?, (7) Who protects the consumer, (8) Who protects the worker, (9) How to cure inflation and (10) Milton Friedman’s overview comments. SeeFriedman, M. and Friedman, R. (1980) Free to Choose: A Personal Statement. New York: Hartcourt Brace Janovich. For a sample of public policy articles authored or co-authored by Milton Friedman, see Friedman.7–15 Friedman, M. (1997) Public schools: Make them private. Education Economics 5(3): 3414. Friedman, M. (1990) The suicidal impulse of the business community. The Adam Smith address. Business Economics 25(1): 5–9. Friedman, M. (1967) Why Not a Voluntary Army. In: Tax 5 (ed.) The Draft: A Handbook of Facts and Alternatives Tax. Chicago, IL: University of Chicago Press. Friedman, M. (1989) Using the market for social development. Cato Journal 8: 567–579. Friedman, M. (1981) Market Mechanisms and Central Economic Planning. Washington DC: American Enterprise Institute. Friedman, M. (1976) Adam Smith’s Relevance for 1976. Paper presented to the Mont Pelerin Society, St. Andrew, United Kingdom. Friedman, M. (1967) The Negro in America. Newsweek, December. Friedman, M. (1993) Why Government is the Problem. Palo Alto, CA: Hoover Institution, Stanford University Press. Friedman, M. and Stigler, G. (1946) Roofs or Ceilings? The Current Housing Problem. In:Popular Essays on Current Problems, Vol. 1(2). Irvington-On-Hudson, NY: Foundation for Economic Education. A self-interested individual decision maker is homo economicus, which means the person is an expected utility maximiser. As Friedman notes, ‘The great virtue of a free market is that it enables people who hate each other,

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or who are from vastly different religious or ethnic backgrounds, to cooperate economically. Government intervention can’t do that. Politics exacerbates and magnifies differences’. See Nathan Gardels.17 Gardels, N. (2007) Interview of Milton Friedman. In: L. Ebenstein (ed.) Milton Friedman: A Biography. New York: Palgrave Macmillan. Smith, A. (1776) Wealth of Nations, Book 7, Chapter 11. New York: Appleton-CenturyCrofts Inc., New York. In an earlier draft of this paper, the typist was unable to read my handwritten notes. Instead of ‘invisible’ hand, her typed draft read ‘invincible’ hand. Both alternative phrases are descriptive of Adam Smith’s competitive market mechanism or/and the economic impact of competition/competitive markets. Merton Miller, 1990 co-recipient of the Nobel Prize in Economic Science, has made essentially the same point in a different economic context (that is, corporate governance) when he stated ‘Let me begin my defense of US corporate governance by emphasizing that managerial concern with shareholder value is merely one specific application of the more general proposition that in American society the individual is king. Not the nation, not the government, not the producers, not the merchants, but the individual – and especially the individual consumer – is sovereign’. Certainly that has not been the accepted view of ultimate economic sovereignty here in Japan, though the first signs of change are beginning to appear. The connection between consumer sovereignty and corporate governance lies not just in the benefits that customers derive from the firm’s own output. The customers are not the only consumers that the firm serves. The shareholders, the investors, the owners – however one chooses to call them – are also consumers and their consumption actual and potential is what drives the shareholder – value principle. See Merton H. Miller21 Miller, M. (1994) Is American corporate governance fatally flawed? Journal of Applied Corporate Finance 6(4): 32–39. As an aside, Milton Friedman detested the terms microeconomics and macroeconomics. He preferred as being more descriptive ‘price theory’ rather than microeconomics and

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‘aggregate economics’ rather than macroeconomics. In those market scenarios (that is, non-competitive markets) where resource allocations are non-efficient, there may be an appropriate but limited role for government. These noncompetitive market scenarios are sometimes referred to as market failures. Alternatively stated, market failures are an appropriate justification for a limited role of government. One important market failure is negative externalities such as environmental pollution resulting from the production of carbon dioxide when coal or oil is burned. Friedman recognises there is, under certain circumstances, more to the analyses than simply ‘free or competitive markets’. Specifically, Friedman has stated that ‘Free markets’ is a very general term. There are all sorts of problems that can emerge. Free markets work best when the transaction between two individuals affects only those individuals. But that isn’t always the case. The fact is that, most often, a transaction between you and me affects a third party. That is the source of all problems and the justification of an ‘appropriate’ role for government. For example, it is the source of pollution problems and of the inequality problem. There are some good economists like Gary Becker and Bob Lucas who are working on these issues. This reality ensures the end of history will never come. Thus, Friedman recognises the usefulness and veracity of Stiglitz’s market failure rationale for a legitimate expanded role for government. An externality occurs when the cash flow consequences of a firm’s decisions impact on parties other than the firm. Specifically, if the cash flow consequences are benefits (that is, costs) to other parties, it is called positive (negative) externalities. Baumol–Litan–Schramm (BLS) in a challenging book argues that capitalism is not monolithic. Indeed, for BLS, the etymology of capitalism is (1) entrepreneurial, (2) bigfirm, (3) state-directed and (4) oligarchic. BLS maintains that ‘good capitalism’ is a mix of entrepreneurial capitalism and big-firm capitalism. According to BLS ‘the precise mix will vary from country to country, depending on a combination of cultural and historical characteristics that we hope others will help clarify in

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the years ahead’. Although BLS praises the virtues of competition, as in the section entitled ‘Competition and innovation: Keeping winners on their toes’, it is likely that the market structure of big firms is not in competitive but in some quasi-monopolistic market structure. If it is a competitive market structure, then BLS’s analyses are consistent with Friedman’s analyses. See W.J. Baumol et al26 Baumol, W. J., Litan, R. and Schramm, C. (2007) Good Capitalism, Bad Capitalism and the Economics of Growth and Prosperity. New Haven, CT: Yale University Press. Adam Smith offered an alternative to mercantilism for the organisation of the resource allocation of the economy. Smith emphasised the individual and his/her welfare and ergo societal welfare. One of several economic policy implications of Smith’s analysis is that trade without restrictions/barriers would result in lower prices because of more competitive financial, labour and product markets. This would benefit both individuals and society at large. Mercantilism was the reigning economic framework in the European countries between 1500 and 1800. The focus of mercantilism was to build a country’s wealth and power by generally restricting imports except for gold and silver. It was thought that gains (increases) in national power were a result primarily of international trade with particular emphasis on the accumulation of precious metals. Similarly, around this time period, guilds were quite powerful in several parts of Europe. Guilds were economic organisations of producers awarded by government decree. They had the authority to set the quantity to be produced, market transaction prices and so on. As an aside, Hong Kong was perhaps Milton and Rose’s favourite country outside of the United States owing to its entrepreneurial citizenry and free markets economy. See Gardel N., Ref. 17. See Economist. (2007) Democracy? Hu needs it: Ahead of its congress later this year, the Chinese communist party is tolerating a surprisingly wide-ranging debate about political reform, 30 June 2007, 535: 47–48. John Stuart Mill was also an advocate of laisser faire. Indeed, John Stuart Mill’s view on the

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limited role of government is ‘Laisser faire, in short, should be the general practice; every departure from it, unless required by some greater good, is a certain evil’. Mill’s analytical criticism of government was two-edged. First, he felt, like Adam Smith, that an individual would know what constitutes his/her wellbeing/self-interest better than government and second, government was a bureaucracy and its growth was a potential impediment to continued democracy. In essence, John Stuart Mill felt there was a limited role to government and it was to prevent some people from doing harm to other people. Mill’s viewpoint contrasted with Plato’s point of view that certain individuals (so-called ‘philosopher kings’) should decide what actions are in the best interests of the citizenry. The rhetorical question is what makes an individual or small set of individuals so gifted that they know what constitutes the best economic choices for the citizenry.That is, why are Mary, Paul and Joe so gifted that they know some critical components of the optimal spending/consumption choices for tens of millions of other individuals?33 Mill, J. On Liberty, Chapter 3. 1859, reprinted in John Stuart Mill: A selection of his works New York 1966. Interestingly, Milton Friedman, while objecting to anything other than individual/consumer sovereignty, if posed with the Hobson’s choice of whether meritocracy or aristocracy would constitute the lesser of two evils, Milton would answer aristocracy. The reasons are that there would be general recognition that aristocrats are aristocrats only because of the chance event of birth and that aristocrats would likely be less arrogant than individuals who feel they are members of the meritocracy. O’Rourke, P. (2007) Adam Smith: Web junkie: He may not have imagined Amazon and Google, but the old boy anticipated and everyone would depend on freedom. Forbes, 7 May 2007. Dean, H. (2007) Wikiportia: How the web is restoring democracy to politics. Forbes, 7 May 2007. Thornton, E. (2007) Hey buddy, You wanna buy a bridge? Why investors are clamoring to take over American roads, bridges and airports – And why the public should be nervous. Business Week, 7 May 2007.

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Mike Lammers of UBS Global Asset Management provides an excellent overview of the risk-return, industry characteristics such as revenue-business drivers, barriers to entry, operating margins, revenue inflation adjustments and portfolio diversification of a number of infrastructure assets such as toll roads, airports rail, shipping facilities and so on. See Mike Lammers, UBS Global Asset Management, ‘An Introduction to Infrastructure Investing’, Paper presented at Rutgers Business School, Newark, New Jersey, 9 July 9 2007. The Milton and Rose D. Friedman Foundation, founded in 1996, focuses solely on promoting educational choice in primary and secondary schools. Indeed, it was the first national foundation whose sole purpose was to promote parental choice in elementary and secondary education. The Friedman Foundation emphasises educational choice where the parents have (1) the ‘Freedom to choose a school that matches your child’s needs … not everyone else’s’, and (2) the ‘Freedom to choose a school that meets your standards … not the governments’’, and (3) the ‘Freedom to choose a school based on its quality … not your address. This is freedom. This is school choice’. A compendium of their research is found on their zip drive, which can be obtained by writing to Robert C. Enlow, Executive Director, One American Square, Suite 2420, Indianapolis, IN 46282. A useful starting point of the economic perspectives as to why the voucher system (that is, competitive markets) is to be preferred to the present governmental monopoly of school system, see Friedman and Friedman.40 Friedman, M. and Friedman, R. (2005) Liberty and Education:The Collected Works on the Voucher Idea; 1955–2005. Indianapolis, IN: Milton and Rose D. Friedman Foundation. Friedman, M. (2006) Prologue: A Personal Perspective. In: R. Enlow and L. Waly (eds.) Liberty and Learning: Milton Friedman’s Voucher Idea at Fifty. Washington DC: Cato Institute. See Friedman, M., Ref. 41. Economist. (2007) Education reform: Top of the class, 28 June 2008, 387: 65–66. St Angelo, G. (2007) An enormous loss for us all. The School Choice Advocate, June 2007. Friedman, M. (2002) Interview on the school voucher. The Free Radical, June 2002.

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Economist. (2007) Education vouchers: Free to choose and learn. 5–17 May 2002. The slow progress in adopting school vouchers has been primarily a result of lobbying; this would include campaigning for the election of candidates who support the monopoly of public schools or/and increasing government expenditures significantly for public schools. See the American Federation of Teachers.48 American Federation of Teachers. (2008) Let’s Keep a Friend Representing Us in Washington. Washington DC: American Federation of Teachers. Although Milton Friedman’s constant monetary growth rule has not been formally and technically implemented, it has had significant impact upon monetary theory, policy and practice. For example, Ben S. Bernanke, the present Chairman of the Federal Reserve System-Board of Governors has stated ‘one can hardly overstate the influence of Friedman’s monetary framework on contemporary monetary theory and practice. He identified the key empirical facts and provided us with broad policy recommendations, notably the emphasis on nominal stability that has served us well. For these contributions, both policy makers and the public owe Milton Friedman an enormous debt’. See Ben S. Bernanke.50 Bernanke, B. (2003) Friedman’s Monetary Framework: Some Lessons. In: M. Friedman and R. Friedman (eds.) The Legacy of Milton and Rose Friedman: Free to Chose, A conference hosted by the Federal Reserve Bank of Dallas, Dallas, TX, 23–24 October 2003. Allan Metzler has offered an interesting tabulation of the successes and failures of Milton and Rose Friedman’s economic policy prescriptions. See Allan H. Metzler.52 Metzler, A. (2003) Choosing Freely: The Friedman’s Influence on Economic and Social Policy. In: M. Friedman and R. Friedman (eds.) The Legacy of Milton and Rose Friedman: Free to Choose, A conference hosted by the Federal Reserve Bank of Dallas, Dallas, TX, 23–24 October 2003. Schumpeter’s54 view in Capitalism, Socialism, and Democracy was that capitalism will not survive. Socialism will replace capitalism, which will not survive as the economic order to allocate scarce resources. Schumpeter’s view

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of the demise of capitalism is perplexing. This is because Schumpeter had indicated that an important characteristic of capitalism is the process of creative destruction where less efficient firms are replaced by more efficient firms. Thus, in my assessment, creative destruction is an important positive characteristic of competitive markets because it leads to enhanced firm resource efficiency, higher growth for the economy and more civic economic and political freedom. Creative destruction and its results are triggered by entrepreneurs who have positive incentives to maximise their gains from the ownership of property rights and that existing dominant firms are not entrenched and cannot rest on their laurels. Schumpeter, J. (1950) Capitalism, Socialism and Democracy. New York: Harper & Brothers Publishers. Alfred Marshall offered an interesting observation in 1907 about the attitudes of economists concerning the proper role of government. Marshall stated that ‘Economists generally desire increased intensity of State activities for social amelioration that are not fully within the range of private effort: but they are opposed to the vast extension of State activities which is desired by Collectivists’. My own assessment is that Marshall’s observation about government is descriptive of the views of many present day economists in 2008. See Marshall.56 SeeMarshall, A. (1907) The social possibilities of economic chivalry. Economic Journal 17: 7–29. Friedman, M. (2003) Session 3 Q&A. In: The Legacy of Milton and Rose Friedman’s Free to Choose, Federal Reserve Bank of Dallas, Dallas, TX, 23–24 October 2003. Of course, central planning and competitive capitalism-individualism are flip sides of the same coin meaning that they are alternative and different ways for allocating a society’s scarce resources. Credit derivative swaps (CDSs) are private negotiated insurance contracts, between two parties. These contracts provide, in essence, insurance protection where, for example, a lender gets paid if a borrower defaults. This means that they provide credit protection to the buyer from a counter party by paying a premium. CDSs are an off-balance sheet item.

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They are completely unregulated. This makes them opaque to investors regarding the magnitude of the liability structure of the seller and impossible to estimate a rigorous probability of default by the seller. The corollary of this proposition is that there is an absence, a hope of deriving a rigorous and systematic estimate of the fair market value of a CDS. Perhaps, this is why Warren Buffet views these securities as ‘financial instruments of mass destruction’. In recognition that CDSs can be instruments of mass financial destruction, Darrell Duffie – a professor of finance at Stanford University’s Graduate School of Business – recommends carefully crafted regulation wherein there is transparency of the information parameter required to meaningfully ascertain major financial institutions to have sizeable risk exposure to CDSs or other exotic derivative securities. See Duffie.60 Duffie, D. (2008) Derivatives and mass financial destruction. The Wall Street Journal, 22 October. The increasing demand for securitised mortgage products was met, in large part, by decreasing lending standards to, in some cases, minimal levels. Indeed, ad hoc anecdotal evidence suggests that some financial institutions emphasised high mortgage loan production regardless of whether the customer had sufficient financial assets-labour market income to justify and pay back the mortgage loan. For example, Washington Mutual (that is, WaMu), particularly under Kerry K. Killinger, who was the CEO until he was relieved of his duties in mid-September 2008, put emphasis on mortgage loan production. Thus, mortgage loans that had high probabilities of defaulting were regularly approved. Illustrative of the decline in mortgage lending standards and the pressure to approve mortgage loan applications of non-qualified applicants are the stories of Ms Cooper, an individual whose responsibilities included approving or disapproving mortgage loans. See Morgenson.62 Morgenson, G. (2008) Was there a loan it didn’t like. The New York Times Sunday Business, 2 November. Further, the US Federal Government in September and October 2008 announced several other efforts to alleviate crises in the financial markets. They include (1) the Treasury

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purchasing stakes in US banks, (2) the Federal Deposit Insurance Corp. (FDIC) providing for 3 years guarantees on corporate debt of banks, (3) the Federal Reserve providing banks having asset-backed securities lending opportunities, (4) the FDIC increasing their insurance on interest bearing bank accounts from $100 000 to $250 000 and providing unlimited insurance on zero interest bank accounts, (5) the Federal government agreeing to provide $250 billion of capital to various financial institutions of the United States and (6) the Fed financing $540 billion to purchase short-term debt of the money market mutual funds. However, it must be clearly stated that because these programmes are in a state of flux so that an accurately described programme at one point in time is an inaccurately described programme at a later point of time. The US Treasury has agreed to purchase $330 million of non-voting cumulative senior preferred stock with warrants of Valley National Bank. This senior preferred stock will pay 5 per cent cash dividends per year for the first 5 years and 90 per cent cash dividends per year. Valley National Bank is a regional commercial bank with $14 billion of assets. It presently has approximately $14 billion of assets and is the largest commercial bank headquartered in New Jersey. This purchase by the US Treasury is part of their $250 billion Capital Purchase Programme which, in turn, is part of the $700 billion TARP that was established by the Emergency Economic Stabilization Act of 2008. Among the other banks participating are Capital One Financial Corp and Sun Trust Bank which are selling $1.55 and 65 billion, respectively, worth of preferred stock to the Treasury Department. Other regional banks participating in the programme are KeyCorp, Fifth Third Bancorp and Commercial Inc. A revealing sidebar to the subprime mortgage debacle is present Secretary of Treasury Henry Paulson’s comment that ‘I could have seen the subprime problem coming earlier’. This is interesting because Professor Allan Meltzer of Carnegie Mellon University had insightfully commented that ‘If the central bank is going to be able to identify bubbles, why aren’t there people, who are speculating and can make money on doing that, able to

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identify these things at least as well as a central bank’? So, there is reason to doubt that central banks can in fact identify bubbles accurately without making as many type 2 errors as type 1 errors. Professor Metzler’s point on lack of forecasting superiority of financial panic on the part of government officials was right on target. See Meltzer.66 Meltzer, A. (2007) General Discussion: Housing and Monetary Policy. In: Housing, Housing Finance and Monetary Policy, A symposium sponsored by the Federal Reserve Bank of Kansas City, Jackson Hole, Wyoming, 30 August–1 September. My personal assessment of Milton’s likely economic evaluations of the subprime mortgage debacle are based on Milton’s economic writings and a recent interview by the Wall Street Journal of Anna Schwartz. See Carney.68 Carney, B. (2008) The weekend interview with Anna Schwartz: Bernanke is fighting the last war. The Wall Street Journal, 13–15 October. An interesting and insightful compendium of insights into financial manias is contained in Kindleberger. Many of Friedman’s rationales for the importance of the stock of money and the mismanagement of monetary supply by the Federal Reserve are a result of the Friedman–Schwartz findings that ‘the statistical evidence on the role of money in business cycles … demonstrates beyond reasonable doubt that the stock of money displays a systematic cyclical behavior. The rate of change in the money stock regularly reaches a peak before the reference peak and a trough before the reference trough, though the lead is rather variable. The amplitude of the cyclical movement in money is closely correlated with the amplitude of the cyclical movement in general business and is about half as large as the amplitude of cyclical movements in money income’. Further, Friedman–Schwartz maintains that ‘the stock of money is much more closely and systematically related to income over business cycles than is investment or autonomous expenditures’. See Friedman and Schwartz.71 Friedman, M. and Schwartz, A. (1963) Money and business cycles. Review of Economics and Statistics, February, 45(1, Part 2 Supplement): 32–64.

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Friedman and Schwartz also find ‘that leaving monetary and banking arrangements to the market would have produced a more satisfactory outcome than was actually achieved through government involvement’. See Friedman and Schwartz.73 Friedman, M. and Schwartz, A. (1986) Has government any role in money. Journal of Monetary Economics, January, 383: 47–48. Feldstein captures the essence of the reasoning of many economists when he states that ‘It is widely agreed that neither the Federal Reserve nor the government should bail out individual borrowers or lenders whose past mistakes have created losses. Doing so would simply encourage more reckless behavior in the future. But it would be a mistake to permit a serious economic downturn just in order to avoid helping those market participants’. See Feldstein.75 Feldstein, M. (2007) Concluding Remarks. In: Housing, Housing Finance and Monetary Policy, A symposium sponsored by the Federal Reserve Bank of Kansas City, Jackson Hole, Wyoming, 30 August–1 September. For some of the subtleties and complexities of integrating individual preferences into a social welfare function and its linkage to economic policy, see Kenneth J. Arrow.77 Arrow, K. (1963) Social Choices and Individual Values, 2nd edn. New Haven, CT: Yale University Press. Chairman Bernanke of the Federal Reserve Board of Governors is correct in recognising the important challenges that the TBTF doctrine has for potential future bailouts of sectors other than commercial banking. For example, insurance companies such as Metropolitan Life Insurance Company, New York Life Insurance Company and Prudential Financial are said to be interested in equity infusions/investment by the Treasury Department. Likewise, the auto industry, particularly for the GM and Chrysler proposed combo, are discussing with the Federal government a $5 billion low cost loan. In short, an important challenge of the present bailout is whether it is essentially an advertisement to future failing companies/industries that they can and should expect future financial rescue packages.

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The importance of recent events, such as the Federal Reserve taking actions to ensure that Bear Stearns would not default, has implications for the future of the TBTF doctrine. Chairman Ben S. Bernanke of the Federal Reserve System – Board of Governors is keenly aware of this challenge when he states ‘if no countervailing actions are taken, what would be perceived as an implicit expansion of the safety net could exacerbate the problem of ‘too big to fail’, possibly resulting in excessive risk-taking and yet greater systemic risk in the future. Mitigating that problem is one of the design challenges that we face as we consider the future evolution of our system’. See Ben S. Bernanke.80 Bernanke, B. (2008) Reducing Systemic Risk. Speech given at the Federal Reserve Bank of Kansas City’s Annual Economic Symposium, Jackson Hole, Wyoming, 22 August. This one-word recipe for America’s future economic prosperity in the opinion of Steve Forbes,82 capitalism. Forbes’ specific prescriptions to stimulate economic growth in the United States is to avoid (1) loan guarantees to the automakers of Detroit, (2) the legislation of higher emission curb standards, (3) legislation of mandatory expansive health care coverage, (4) the abolishment of the up-tick rule of shorting a stock and (5) having Fannie Mae and Freddie Mac survive with quasi-government support (see Steve Forbes).83,84 Forbes, S. (2008) How capitalism will save us. Forbes, 10 November.

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Interestingly, Chairman Ben Bernanke of the Federal Reserve Board of Governors, at least on 15 October 2002, appears to agree with Friedman and Schwartz’s view that it would neither be desirable nor feasible for the Fed to be an ‘arbiter of security speculation or values’. Further, Chairman Bernanke never mentions asset auction sales as an appropriate monetary or public policy tool for correcting the effects of an asset bubble. See Bernanke.84 Bernanke, B. (2002) Asset-price ‘bubbles’ and monetary policy. Speech given to the New York Chapter of the National Association for Business Economics. New York, 15 October. Michael E. Porter makes several economic recommendations that parallels Friedman’s ideas of increasing economic freedom by advocating (1) more freedom (that is, less barriers) to capital flows, (2) lower trader barriers, (3) reducing economic distortions due to both taxes and subsidies and (4) improving dramatically our inefficient public school system. See Porter.86 Porter, M. (2008) Why America needs an economic strategy. Business Week, 10 November. This citation is from the cover page of the Rutgers Magazine, fall 2006.88 Ward, J. (2006) The view from up there: Economist Milton Friedman, RC 32 reflects on a long life as a contrarian. Rutgers Magazine 83(3).

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