A basic question has been hanging over the ongoing economic meltdown on Wall Street: Is the market self-correcting—as conservative economists, bankers, and politicians from Milton Friedman on have aggressively claimed—or does it need to be regulated by the government? On Thursday, September 18, I put that question to Lanny Ebenstein, a former Santa Barbara School Board member and mayoral candidate, currently a visiting professor of economics at UCSB, and Santa Barbara’s most prominent Libertarian. Last year Ebenstein published an admiring, well-received biography of Milton Friedman, the most famous and influential economic Libertarian of the 20th century.
Kornell: Since Bear Stearns went under, the U.S. Treasury has taken on more than a hundred billion dollars in bad debt bailing out Wall Street. [Since this interview, estimates of the amount of bad debt Treasury has taken on have risen to hundreds of billions of dollars.] It also took on $5 trillion in liability from Fannie and Freddie. All of these bailouts are necessary because of terrible financial decisions by bankers on Wall Street, decisions that were made possible by a near total vacuum of government regulation. How should American taxpayers look at this, in light of the fact that they’re picking up the bill?
Ebenstein: I’m not sure if that’s correct. The sub-prime mortgage situation, which was really the cause of all of these problems, started out as a desire to extend the benefits of homeownership to a larger percentage of the American public-
Kornell: That’s not true. It was because bankers on Wall Street wanted to get rich using complex, predatory methods of selling mortgages to people who had no business buying them, and they knew they could do it because there was no government regulation or oversight.

Paul Wellman
Lanny Ebenstein’s recent biography of economist Milton Friedman has garnered significant critical attention.
Ebenstein: Well, right now the underlying question is whether, ultimately, the investments were good investments or bad investments, and over time I think they’ll prove to be good investments. I think interests will come down and values will stabilize.
Kornell: How can you say that? This is bad paper-hundreds of billions of dollars of investments have been lost. I mean, the damage is spreading into money markets, which are supposed to be inviolable. How can you say these are good investments?
Ebenstein: Time will tell. If property values continue to decline you’re absolutely right, all of this paper will be worthless and the taxpayer will be left holding the bag. On the other hand, if property values stabilize, I think there will be an entirely different scenario. The financial superstructure is reorganizing right now, not the real economic basis of the society.
Kornell: Since Ronald Reagan we’ve been constantly told that the market is self-correcting, and that interference in the economy in the form of regulation is bad. And we’ve been told that these brilliant guys on Wall Street know what they’re doing, and all of these incredibly complex financial instruments they use are efficient and ultimately result in broadly shared prosperity. And I think there are a lot of Americans right now who feel like they got sold a bill of goods. All of this stuff-the mortgage-backed securities, the credit default swaps, the short selling, the naked short selling-happened with virtually no government regulation.
Ebenstein: Well, the Republican line on this issue, and I’m not necessarily endorsing it but I’ll repeat it, is that the Bush administration sought regulatory reform in some of these areas, but Democratic Senators like Chris Dodd vehemently opposed it. So it’s not-
Kornell: That’s absurd. They didn’t want regulatory reform, they wanted no regulation. And they got it. They got it in 2000 when Phil Gramm back-doored the Commodities and Futures Modernization Act in an omnibus spending bill, which essentially stripped government oversight from all of these areas. And the Bush administration ran with it, and now we hear that under a McCain administration, Gramm may be the Secretary of the Treasury.
Ebenstein: As I said, that’s the Republican line. Whether it’s accurate or not is another question. The more general point is this: The idea of the market is that government has to establish the rules; it has to be the umpire. So the idea that we don’t have the optimal rules and regulations is completely consistent with a free market position.
Kornell: In response to all of this, John McCain has said he’s going to clean up all of the corruption and greed on Wall Street. Obviously, greed on Wall Street is bad and it’d better if it didn’t happen. But what’s McCain talking about? These bankers have an obligation to make money for their shareholders, and the obligation of the government is to regulate them and make sure they do it in a fair, intelligent way. The issue is regulation, not greed, and McCain has been consistently for deregulation of the financial markets for as long as he’s been in office.
Ebenstein: Well, I’m not sure if it’s the duty of the government to regulate. I think it’s the duty of the government to establish rules within which business and individuals can operate. I think the problem is when the government moves away from establishing a framework of rules within which people can operate, and starts telling people individually what they can do in a particular circumstance.
Kornell: I’m not sure I understand the distinction, but either way it seems like the problem right now is that there was no framework. There was no framework. There was no oversight. There was no regulation.
Ebenstein: Well, I agree. In some of those areas there should be new regulation. And I think whoever’s elected president will see that there’s new regulation in those areas.
Kornell:And who’s more likely to accomplish that? The Democratic candidate or the Republican candidate?
Ebenstein: In general, I’m not sure if either party has been more or less inclined to enact tax and regulatory policies that favor one interest over another. I don’t look at this as a Republican-Democrat issue.
Kornell: But at least since Reagan, an explicit selling point of the Republican Party philosophy has been that regulation is bad and markets self-correct. I mean, that’s the Republican platform, is it not?
Ebenstein: Look, in our system, special interests have been able achieve particular benefits that are not in the common interest, and that’s because they lobby politicians in both parties, and the issues are very technical and complex, and people’s ability to follow them is limited except in a crisis, and then, once the crisis passes, they presume the system is working okay, and it’s business as usual again. I do hope that out of the dislocations that have occurred, there will be some regulatory reform. And I think we’ll ride this out.
Comments
"How should American taxpayers look at this, in light of the fact that they're picking up the bill?"
"McCain has been consistently for deregulation of the financial markets for as long as he's been in office."
Does that mean McCain would be for true deregulation, which is to say that if these big business entities end up in the hole the government (i.e., us taxpayers) would not have to bail them out?
billclausen (anonymous profile)
September 19, 2008 at 9:49 p.m. (Suggest removal)
I read Kornell v. Ebenstein right after watching tonite's very interesting and timely episode of Bill Moyer's Journal (financial guests were Kevin Phillips, Gretchen Morgensen, and Floyd Norris) and Washington Week. Subjects of both shows were review and analysis of the unprecedented financial events of the past week.
Based on what I learned from these shows, I give a TKO to Kornell. Its clear that unregulated financial markets don't work and have in large measure created the current dilema we're in. Simply put, it comes down to human nature - greed. Despite conservative chants of "less government", this is one disaster that screams for regulation in hindsight.
Having said that, I don't think the market will get a chance to self-correct in this case. There will be too much collatoral damage to let that happen, and this, for example, is one reason why the behemoth AIG will get government help but the smaller wirehouse Lehman will not. So in a sense, the question of self-correction is sort of moot.
Its clear to me that there are bipartisan contributors to the current crisis (kudos to PBS for showing all the cards) but more blame lies on the conservative side as proponents of minimally-regulated markets who have acted on that (soon to be discredited) philosophy.
EastBeach (anonymous profile)
September 19, 2008 at 10:09 p.m. (Suggest removal)
"Does that mean McCain would be for true deregulation, which is to say that if these big business entities end up in the hole the government (i.e., us taxpayers) would not have to bail them out?"
There was a discussion on tonite's Washington Week about that (plus its been in the news). This weekk, McCain flip-flopped on whether AIG should be bailed out. He initially said AIG should be left alone, then after Secretary Hank Paulson announced the bailout, McCain changed his mind and supported it.
This to me says that McCain doesn't have his economic game on.
EastBeach (anonymous profile)
September 19, 2008 at 10:16 p.m. (Suggest removal)
It's "all" bogus...........the people just don't matter anymore, period...right, left, north, south, is exactly where power wants us. So what do we do? F... them, come out for "CLEAN WATER" at the wharf today11am- 1pm to heal....enjoy nature while we still have some.
lordleadbetter (anonymous profile)
September 20, 2008 at 9:41 a.m. (Suggest removal)
The first statement made by Ebenstein, is the true root of the problem:
"The sub-prime mortgage situation, which was really the cause of all of these problems, started out as a desire to extend the benefits of homeownership to a larger percentage of the American public-" [including illegal immigrants]
Kornell actually supports this by saying:
"It was because bankers on Wall Street wanted to get rich using complex, predatory methods of selling mortgages to people who had no business buying them"
As I understand it, ( I am no expert in this area) it was the regulatory agencies that actually required banks to make these loans, so that they would not appear discriminatory to the borrowers, who were people in poverty of minority status, whether they could afford it or not. Bush was heavily involved in this. There seemed to be this growing idea that owning a house is a "right" and an entitlement.
AShaw (anonymous profile)
September 20, 2008 at 11:36 a.m. (Suggest removal)
Have a look at Bush's little known pet project - the "partnership for prosperity" with Mexico, to find the roots of all of this failure.
http://www.state.gov/p/wha/rls/fs/891...
AShaw (anonymous profile)
September 20, 2008 at 11:49 a.m. (Suggest removal)
From the above link :"in September of 2001, during President Bush's first state visit, President Bush and President Fox took an important step toward realizing that vision. They launched the Partnership for Prosperity, a private-public alliance to harness the power of the private sector to foster an environment in which no Mexican feels compelled to leave his home for lack of jobs or opportunity."
So seven years have passed and they're still leaving in droves. It's amazing how they look us right in the eye and sell their package of goods and the unwashed masses still buy it.
What would happen if the Minuteman and La Raza contingents realized who the the TRUE enemy was and came together in soldedarity and took out their frustrations in the voting booth?
billclausen (anonymous profile)
September 20, 2008 at 7:01 p.m. (Suggest removal)
Ashaw wrote:
"As I understand it, ( I am no expert in this area) it was the regulatory agencies that actually required banks to make these loans, so that they would not appear discriminatory to the borrowers ..."
Having followed this for quite some time with guidance from my professional finance acquaintences, I have not heard such a far-fetched and dubious claim. It comes down to pure greed allowed to run rampant by inadequate regulation. Yes, consumers (of all ethnic backgrounds) are partly to blame, but only to an extent. Its too complicated to explain in a blog, but if you want a humorous and fairly accurate assesment of the Subprime aspect of the problem (which is only a portion of the big picture), see this popular slide show:
http://www.businesspundit.com/sub-prime/
You'll see why loosely regulated financial markets (pushed by both sides of the aisle, but mostly by conservatives) from the mortgage makers to the loan repackagers to the ratings firms to the hedge funds are largely to blame (and by inference the politicians and regulatory agencies that allowed this situation to occur).
There are other inflammatory aspects as well, such as Alan Greenspan's loose monetary policy that allowed bubbles to develop and the devaluation of the dollar:
http://www.washingtonpost.com/wp-dyn/...
This is a bitter pill for conservatives who are proponents of free markets and "less government".
For more info, check out the Bill Moyer and Washington Week transcripts and videos for this past week's episodes at pbs.org. Other financial websites like The Economist and The Financial Times all have info about this. Steve Pearlstein at the Washington Post has a few columns on the matter as well.
EastBeach (anonymous profile)
September 20, 2008 at 10:47 p.m. (Suggest removal)
Oh, Oh Eastbeach! some people don't want facts, facts can get in the way
JohnMcKnight (anonymous profile)
September 22, 2008 at 8:51 a.m. (Suggest removal)
I have two words:
La Raza
http://www.nclr.org/content/programs/...
AShaw (anonymous profile)
September 22, 2008 at 10:36 p.m. (Suggest removal)
Any of your professional finance acquaintances ever heard of an ITIN?
http://michellemalkin.com/immigration...
AShaw (anonymous profile)
September 22, 2008 at 10:45 p.m. (Suggest removal)
Here's some fun reading:
http://undocumentedblogger.blogspot.c...
AShaw (anonymous profile)
September 22, 2008 at 10:49 p.m. (Suggest removal)
Thank you, by the way, East Beach that was quite educational. I told you I was no expert in this area, but at least I was right about one thing according to the info you provided - the first part of the problem is loans were given to those who could ill afford the payments, including (and don't deny it) illegal immigrants. What is so far fetched and dubious about that?
AShaw (anonymous profile)
September 22, 2008 at 11:02 p.m. (Suggest removal)
Even worse than loaning to illegal immigrants, do I interpret Bush's "Partnership for Prosperity to mean that we actually pushed lenders to loan for mortgages in Mexico?
AShaw (anonymous profile)
September 22, 2008 at 11:07 p.m. (Suggest removal)
Glad you enjoyed the stick figure cartoon Ashaw, its to the point and amusing at the same time.
I don't deny that some illegal immigrants have defaulted on their mortgages. I would be surprised if there were none! However, based on the info I've seen, I disagree with any claim that mortgage defaults by illegal immigrants have been any kind of major driver to this crisis.
Reference this story by the Wall Street Journal entitled, "Solid Bets: Illegal Immigrants Exception to Mortgage Meltdown":
http://www.tucsoncitizen.com/daily/lo...
So I believe mortgage defaults by illegal immigrants are ancillary to any focused discussion regarding how we got into this financial mess, what exactly is the mess, who is responsible, and what the solutions should be.
Now, if there was no intent to imply that illegal immigrant mortgage defaults are a major driver, then why bring it into the discussion at all? That would be tantamount to demonizing illegal immigrants. For example, one might say, "There are murderers in LA, including illegal immigrants", or "There are rapists in LA, including illegal immigrants". That's one of the oldest dirty debate tricks in the book.
EastBeach (anonymous profile)
September 24, 2008 at 1:37 a.m. (Suggest removal)