Madrick age of greed; the triumph of finance and the decline of america, 1970 to the present (2011)

To meet its needs, Penn Centralborrowed relentlessly from banks like First National City at low rates.. Rapid consistent earnings growth could turn First National City into afull- edged

THIS IS A BORZOI BOOK PUBLISHED BY ALFRED A KNOPF Copyright © 2011 by Jeff Madrick All rights reserved Published in the United States by Alfred A Knopf, a division of Random House, Inc., New York, and in Canada by Random

House of Canada Limited, Toronto.

www.aaknopf.com

Knopf, Borzoi Books, and the colophon are registered trademarks of Random House, Inc.

Library of Congress Cataloging-in-Publication Data

1 Wealth—Moral and ethical aspects 2 Financial crises—United States—History 3 United States—Politics and government—20th century 4.

United States—Politics and government—21st century I Title HC 79 W 4 M 33 2011 330.9730092’2—dc22 2011003399

Jacket design by David J High, highdzn

v3.1

For Kim

The Making of an Ideology

8 Ted Turner, Sam Walton, and Steve Ross

Size Becomes Strategy

9 Jimmy Carter

Capitulation

10 Howard Jarvis and Jack Kemp

Tapping the Anger

11 Paul Volcker, Jimmy Carter, and Ronald ReaganRevolution Completed

Two

THE NEW GUARD

12 Tom Peters and Jack Welch

15 George Soros and John Meriwether

Fabulous Wealth and Controversial Power

16 Sandy Weill

King of the World

17 Jack Grubman, Frank Quattrone, Ken Lay, and Sandy WeillDecade of Deceit

18 Angelo Mozilo

The American Tragedy

19 Jimmy Cayne, Richard Fuld, Stan O’Neal, and Chuck PrinceCollapse

A Note About the Author

Other Books by This Author

This book starts with a relatively unknown man named Lewis Uhler, a SouthernCalifornian, who, like his father before him, hated the New Deal He and others likehim, who came of age in the 1950s, feared their personal liberty was in constant danger

of being taken away by big government Many of them were sincere, and most wereangry—especially because in the 1950s and 1960s they weren’t being heard But theylaid the foundation for a new age

In those years, most Americans believed the federal government was good for them.Washington created far-reaching nancial, social, and economic reforms in theDepression and managed the massive war e ort in the 1940s In the 1950s it builthighways, set out to send men into space, and subsidized housing In the 1960s, itcreated Medicare, expanded Social Security, adopted regulations to protect consumersand workers, passed long-awaited civil rights guarantees, and developed antipovertyprograms Progressive taxation to pay the bills was widely accepted as just All thewhile, the American economy grew rapidly and wages doubled adjusted for in ation forworkers at every income level

Perhaps more than any other factor, punishingly high in ation in the 1970s changedall of this Americans panicked Well before incomes became highly unequal or thewealthy gained undue political power with outsize campaign contributions and well-nanced lobbying organizations and think tanks, Americans came to believe thatgovernment had gone too far The ideology of the Lewis Uhlers of America, longdormant, began to gain in uence Soon social programs were curtailed Regulationswere eliminated and weakened Uhler among many others participated in a tax revoltthat started slowly but then spread rapidly, well before Ronald Reagan was electedpresident The new persistent refrain was that big government held all Americans back.The narrative came to dominate the public discourse

Greed will always be with us, but it rises and falls with the times Some rebalancingbetween government and business may have been necessary by the 1970s, and somereworking of government programs was needed But the reforms went blindly ahead.Vital purposes of government were rejected An age of greed did not begin in the 2000s

It started decades earlier, and the crisis of 2008 was its culmination, and probably notits end

This book is about how this shift came about, and how profound its in uence hasbeen It contends that the rise of an age of greed since the 1970s was not the result ofthe inevitable forces of history or of a natural swing of a political pendulum The newage was made by people, and how they reacted to crisis and change Much damage wasdone along the way

Part I tells the story of this revolution Presidents, policymakers, and economists are

critical to the history But it is mostly a story of business pioneers who foughtgovernment regulation or, through innovation, escaped government oversight—all thewhile diminishing the power of government and reinforcing the changing nationalattitudes The 1970s set the stage for a different America.

Once government was no longer a counterweight and a new political ideology clearedtheir path, nanciers led the way Wall Street changed radically Part II tells thesestories Debt more than innovation and technological progress became the economy’sdriving force Financial businesses doubled in size compared to the economy and pro tsgrew still faster Hundreds of billions of precious American savings were wasted

The new age started with Walter Wriston, the most innovative, aggressive, andadmired of the nation’s commercial bankers, head in the 1970s of First National CityBank, later Citicorp He was an adamant believer in laissez-faire economics—minimalgovernment intervention He revolutionized banking by circumventing and oftenignoring New Deal regulations Financial deregulation started with him, but three times

in thirty years the bank he built nearly went out of business due to the hundreds ofmillions of dollars of bad loans it made, saved only by federal intervention The story ofCitibank runs through this entire history

Not all those who are the principal focus of a chapter were blatant practitioners ofgreed—some not at all Tom Peters, the famed management consultant, was much theopposite Paul Volcker, the stringent chairman of the Federal Reserve, was mostlyoblivious to nancial gain George Soros, the hedge fund manager, gave much of hisfortune to causes that were detrimental to his personal nancial interest The age’sphilosopher, Milton Friedman, was not intent on getting rich They all contributedimportantly to this history, however

These separate stories are integral parts of a large picture Ultimately, they ttogether Most of the people in this book were not wholly destructive History is never

so simple Some were not destructive at all But most of those discussed here took theeconomy along an unfortunate, tragic path for their own purposes from which it maynot be possible to turn back

REVOLUTION

The post–World War II American economy grew rapidly almost everywhere, butSouthern California and, in particular, Orange County, grew faster still The ood ofmigrants from the Midwest needed new subdivisions of a ordable housing as well asnew cars, appliances, supermarkets, and banks—and new roads, water systems, andsanitation To many citizens of the region, life was good and hard work and talent paid

o beyond expectations Soon, to many of those who did well, prosperity was seen asthe just reward of a determined and diligent populace Government programs—defensecontracts, highways, water works, sanitation projects, primary schools, and high schools

—were accepted as a right, social programs and high taxes an intrusion on themarketplace and personal freedom The seeds of America’s future took root in the soil ofthese counties

Lewis Uhler was born in the Los Angeles area in 1933 and raised as a teenager in one

of its up-and-coming suburbs His father, James, was a successful executive at Sunkist,whose principal suppliers were the politically conservative growers in California andArizona

Lewis Uhler, second from left, with Senator Bob Dole and other members of the National Tax Limitation Committee, opening sacks of mail

addressed to his organization (Illustration credit prl.1)

Lewis carried the conservative message inside him almost as a birthright “My fatherwas a political animal and he hated FDR,” Uhler says “The whole New Deal thing wasanathema to him.” The farmers James Uhler worked for feared nothing more than theunionization of labor, and labor organizing, one of the New Deal’s legacies, was nowspreading throughout the nation

The foundation of American success was not the romanticized dream of nding a pot

of gold Rather, it was the consistent rise in white workers’ compensation, both collar and white-collar, decade after decade, even if one did the same work as, or itscontemporary equivalent of, one’s father Thus, it was not that the son or daughternecessarily got a better job, but that wages after in ation went up for most kinds ofwork Ultimately, the typical white American thirty-year-old male earned signi cantlymore than his father had when he was thirty, a forty-year-old more than his father had

blue-at forty There were poverty and need in Southern California, and bitterness andfutility, as captured especially by some novelists and a handful of lmmakers But thelives of most in Southern California, if not always ideal, improved materially anddependably They participated in the real and reliable American dream of fairlyconstant material improvement

This was true of James Uhler’s life He made a good and generally improving living.Lewis Uhler, learning from his father, came to believe that public social programsinterfered with the virtues of American life, in fact, trampling on Americans’ rights, and,further, that the Founding Fathers fully agreed with him The rise in power of the SovietUnion after World War II stoked a passionate fear that this freedom would be violated.The new superpower was both antireligious and anti-market, in his mind and in those ofhis like-minded friends deeply challenging the values of a free nation In SouthernCalifornia, anticommunism gained rapid popularity Richard Nixon, the fresh-facedcongressman from Whittier when Uhler was a teenager, based much of his earlypolitical career on it, and stoked it further

Franklin Roosevelt was the natural enemy of these believers, his waywardness and

dangerous ways, as they labeled them, frequent dinner conversation for many Hightaxes were justi ed by the war, some conceded, but after Harry Truman’s presidencythese believers feared the spread of progressivism even under his Republican successor,Dwight Eisenhower Desegregating the Little Rock, Arkansas, schools became the symbol

of the misuse of federal power These conservatives also felt that Eisenhower’s program

to build the interstate highways overstepped federal bounds

For a while, the believers lost major elections: Nixon to John F Kennedy in 1960,Barry Goldwater to Lyndon Johnson in 1964 California, a largely Republican state,even elected a Democratic governor, Edmund “Pat” Brown, in 1958 The believerseventually found a unifying voice for their philosophy in the economic writings ofMilton Friedman and the novels of Ayn Rand They found their national politicalleadership in Ronald Reagan They found powerful allies in big business, who wererelative latecomers to their cause, learning in the 1970s to organize themselvespolitically for fear the progressive country was turning against them The views of arelatively small band of believers came, improbably, to dominate the nation

Lewis Uhler was a good student and was accepted to Yale in 1953 He was wary of

enrolling there He believed the future publisher of National Review, William Buckley, when he wrote in his book God and Man at Yale (1952) that the school was disturbingly

liberal, though it was among the more conservative of the Ivy League colleges With the

publication of God and Man at Yale, an undergraduate’s diatribe, if an articulate one,

against Yale professors for their religious agnosticism and support of Keynesiangovernment intervention, the charismatic Buckley had become a household name Thebook became a best seller, evidence that a conservative undertow existed in the UnitedStates despite the nation’s politically liberal direction Buckley, the son of a wealthyoilman, hailed personal freedom, hated the United Nations and the Soviet Union, andcon dently started a new organization, Young Americans for Freedom, which attracted

a large number of disenchanted men and women in the 1950s By the time Uhlerentered Yale, there was a congenial group of friends to be made at Yale who had similarpolitical views about the dangers of big government “We thought of ourselves as thesuccessors to Buckley,” he said

Uhler was outgoing and optimistic and enjoyed himself immensely at Yale He thenwon entrance to Boalt Hall, the law school of the University of California at Berkeley,where he earned his degree in 1960 After his service in the Navy, he joined the o ce ofCongressman John Rousselot from Pasadena Rousselot was proudly, unabashedlyconservative and the only congressman who was an open member of the John BirchSociety, the new right-wing extremist group Robert Welch, a retired candymanufacturer (maker of Sugar Daddys), started the Birch Society in 1958 when he wasnearly sixty, out of his home in Belmont, a handsome Boston suburb north of HarvardSquare The society soon drew tens of thousands of members, many in SouthernCalifornia, where one chapter after another was opened in the early 1960s Welch wrote

a self-published book accusing not only Harry Truman but also Eisenhower and his

secretary of state, John Foster Dulles, of being part of a Soviet conspiracy He had alsodemanded the impeachment of Chief Justice Earl Warren, who wrote the Little Rockdecision desegregating the public schools Rousselot was an early and consistentsupporter, but William Buckley, also an early member of the Birch Society, turnedagainst it as extremist According to Lou Cannon, Ronald Reagan’s biographer, Uhlerjoined the Birchers, but only for six months.

In 1958, Governor Pat Brown started raising taxes and establishing ambitiousgovernment programs A native of Northern California, Brown had been a moderateRepublican early in his life He switched parties as a young man and became the stateattorney general as a Democrat, the only Democrat at the time in a prominent statewide

o ce A popular and energetic attorney general, he decided to run for governor againstGoodwin Knight, a moderate Republican governor, and won the statehouse by a widemargin He epitomized the rising national con dence in government Nixon, hoping tolaunch a political comeback after his narrow loss to Kennedy in 1960, challenged Brownfor governor in 1962, but lost badly

With Nixon’s career seemingly over, Uhler now placed his hopes on the moreconservative Barry Goldwater, the Arizona senator who had come to national attentionduring the 1960 Republican National Convention Goldwater published a literate book

that year, Conscience of a Conservative, ghostwritten by William Buckley’s brother-in-law,

L Brent Bozell, a close classmate of Buckley’s at Yale (and a former political liberal) Itbecame a best seller and showed supporters that there was life in conservatism evenafter Kennedy’s victory The book’s central theme was personal freedom, theconservative philosophical warhorse Goldwater advocated a vast reduction ingovernment programs and sharply criticized Social Security, but the popularity of thebook had greatly to do with his tough stance toward the Soviet Union The booksuccessfully bolstered his campaign for the Republican presidential nomination, which

he won in 1964, beating back the moderate Republican governor of New York, NelsonRockefeller

That summer, President Lyndon Johnson was passing the rst important legislation ofhis Great Society, the Civil Rights Act, which made illegal Jim Crow state laws thatauthorized segregation in public places throughout the South Goldwater voted againstthe legislation in the Senate, insisting to widespread scorn his vote was not racist butsimply re ected a desire to preserve the rights of states to make such laws His decisionmay have made him more popular with the rightist diehards, but it reduced his chancesagainst Johnson Goldwater was an impatient candidate of little charm, and given hisbellicose pronouncements about foreign policy, it was easy for his opponent to raiseAmerican fears he might launch a nuclear war in a stare down with the Soviet Union.Goldwater lost in a landslide to Johnson, and the Republican Party looked moribund

There was, however, one shining light for conservatives at the 1964 Republicanconvention Ronald Reagan, the actor and General Electric television host, not yet aprofessional politician, made an especially e ective nationally televised speech thatstrongly supported Goldwater Reagan had been making essentially the same speecharound the nation as a spokesman for GE for several years, and political backers in

California had taken note of a potential new Republican star Reagan gave no ground

to the liberal groundswell In one stroke, he brought himself national recognition as aviable political contender, even as Goldwater lost badly to Johnson Only two yearsafter Goldwater’s resounding defeat, Reagan defeated Governor Brown for theCalifornia statehouse

The governorship was Reagan’s rst elective o ce and he was already fty- ve yearsold Most observers thought his election was a political aberration and that his futurewas limited But to people like Uhler, he was a talented, courageous, and honest “citizenpolitician,” as Reagan called himself, with remarkable verbal skills and deepconvictions He was a former New Dealer who had seen the light, a man who waswilling to exalt individualistic ideals and personal freedom, someone who seemedclearly unafraid to stand up to the Soviets

Edwin Meese, Reagan’s key legal sta er and his future attorney general, had knownUhler at Boalt Hall, and in 1968 invited him to join Reagan’s gubernatorial sta Uhler’srst major assignment was to challenge California Rural Legal Assistance, a nonpro torganization established by Lyndon Johnson as part of the War on Poverty to providelegal aid to the poor, mostly agricultural workers, regarding housing, wages, and healthcare The program was a thorn in the side of Reagan’s backers, and especially thepolitically powerful farm community Uhler wrote a report charging the program’s legalsta with serious improprieties “It was one of those new liberal agencies,” Uhler said,

“where you saw hammer-and-sickle banners drawn on the walls.” Reagan wanted toshut the program down, and he thought Uhler’s denunciatory report gave him thejusti cation to do so But the next year, Nixon, by then president, appointed a federalcommittee of former Supreme Court justices to investigate Uhler’s charges Theinvestigation concluded that the Uhler report was “totally irresponsible” and amisrepresentation of key facts

Nonetheless, Reagan took to Uhler’s youth and enthusiasm and found his ideologicalfaith congenial to his own Uhler had been railing against the progressive income tax—one of Reagan’s favorite themes—and the governor now appointed him to spearhead an

e ort to cut the tax permanently in California “The Founding Fathers never foresawsuch a progressive income tax,” Uhler said time and again He wanted to restrict anyfurther increases in the income tax, but he believed it would require an amendment tothe state constitution Reagan welcomed the idea, despite the objections of some of hissta He had raised taxes in his rst term and, for all his talk about welfare abusers andcoddling the poor, had failed to cut state spending signi cantly If he sought higher

o ce, he felt he would need an unambiguous conservative achievement such as this onwhich to base a campaign Reagan had, with the help of a Democratic state legislature,cut property taxes moderately—house prices had risen so rapidly in the 1960s that thepoor and the elderly were strapped—but this did not seem enough

By 1972, Uhler had laid the groundwork for a statewide referendum on aconstitutional amendment, which would reduce California income taxes and create amaximum level for future taxes They called it Proposition 1 If approved, it could only

be changed by a two-thirds vote of the state legislature

Following Uhler’s advice turned out to be the worst miscalculation of Reagan’s stillevolving political career The amendment, endorsed and supported by a group ofprestigious right-wing economists, including Milton Friedman, who had served asGoldwater’s chief economic adviser, and supported by Reagan in frequent speechesacross the state, was decisively defeated by voters in 1973 Even as Americans began todistrust government, religious, business, and educational institutions—especially duringthe Vietnam War—California and most of the nation were not yet ready for Reagan orthe conservative revolution The campaign for Proposition 1 made him lookirresponsible in the eyes of some California voters, an image the former actor had thusfar ably countered Reagan, characteristically sticking to his views, attributed defeat toother factors, including union opposition He never wanted to appear that he wasbetraying his ideals, though in o ce he compromised pragmatically to maintain hispopularity.

His political future, indisputably bright to that point, was now uncertain, as was theconservative political movement itself Nixon, who became president in 1969, signedlegislation to start the Environmental Protection Agency, the Occupational Safety andHealth Agency, and the Consumer Product Safety Commission, froze prices and wages,provided generous funds to the War on Poverty, aggressively expanded Social Security,and spent federal funds prodigiously to stimulate economic growth Even though hetried to limit civil rights in the South, Nixon was still not the conservative Uhler hadhoped for as the next Republican president But Reagan, like the army of the committed

of which Uhler was a tireless member, kept sowing the truly conservative fields

Uhler never relinquished his vision He started an organization to support similarconstitutional amendments in other states, and he later succeeded beyond his besthopes More than half of America’s state governments eventually adopted such a

constitutional limitation Uhler published a book in 1989 called Setting Limits:

Constitutional Control of Government, and Milton Friedman, who sat on the board of

Uhler’s organization until his death in 2006, wrote an admiring Foreword Uhlerdedicated the book to his father: “To my late father James Carvel Uhler, who urged amid-course correction long before it became clear to others that our Republic had lost itscompass.”

Walter Wriston was born in 1919 in Middletown, Connecticut, his father, Henry, aneminent history professor at the town’s prestigious university, Wesleyan When Walterwas ve, his father was named president of Lawrence College in Appleton, Wisconsin,where Walter grew up until he entered Wesleyan in 1937 Despite the Depression, theWriston family remained comfortable during Walter’s adolescence.

Henry Wriston’s reputation rose in these years and he was named president of BrownUniversity in 1936, from which perch he was able to preach against FDR and the NewDeal, convinced that the programs would lead to a planned economy His heroesincluded Adam Smith, who, despite the complexities in thinking of the Scottishphilosopher, he saw largely as the father of the invisible hand and laissez-faire economicphilosophy He also deeply admired the British philosopher Herbert Spencer, who acentury after Smith had become popular for what was later called social Darwinism.Spencer, who beginning in the 1850s was philosophically opposed to governmentintervention in markets, was the popular author of the notion that human poverty wasnatural because the “survival of the ttest” (a phrase Charles Darwin borrowed fromhim) was a law of nature

At Wesleyan, Walter Wriston studied history, his father’s

eld He entered the Fletcher School at Tufts University, one of

the nation’s most prestigious schools of diplomacy, just outside

Boston, to pursue a graduate degree in foreign a airs Wriston

was married to a coed he had met at Connecticut College by the

time he graduated in 1942 He was drafted into the Navy in

1944 and sent overseas but did not see combat He returned to

the United States in 1946, one of hundreds of thousands of

other soldiers wondering what to do with their lives—and

whether the economy would slide back into depression

Wriston said he did not want an academic career like his

father’s “I knew I wouldn’t do that because you’d have nothing

but comparisons,” he said “My sister’s an academic and a very

Walter Wriston as First National City CEO, 1971 (Illustration credit 1.1)

good one But I didn’t want any part of that.” Hostility toward

his father surfaced when Henry remarried in 1947, only a year

after his mother’s death, at which point Walter stopped speaking to him

Wriston at rst had “very little” interest in business It was his mother’s doctor whosuggested he go into banking “If I stayed up all night, I couldn’t think of anything morestupid to do,” he said, but the bank “hadn’t hired anyone new since 1933,” and it badlyneeded recruits Moreover, it was willing to pay salaries comparable to those inindustry So in 1946 he took a temporary job in New York with National City Bank, atthat time a diminished version of its pre-Depression glory, when it had been the largestand most visible bank in the nation He fully expected to leave in a year and return tohis planned career in diplomacy

When Wriston joined National City, banking was a stodgy and unimaginative business.Regulations had been imposed in the 1930s to prevent the excesses in nance that had

bu eted America time and again Overaggressive banks had been a serious nationalconcern throughout the nineteenth and early twentieth centuries

To attract savers, deposit-taking banks historically had to make good the promise topay back a depositor’s money at a moment’s notice, which in the 1800s usually meantmaintaining specie (gold and silver coins) against deposits and investing those depositscautiously The essence of banking was dependability The banks redeemed deposits inspecie when requested and some created paper currency they also would redeem inspecie

During good economic times ever more con dent banks o ered higher interest rates

to attract depositors and made riskier loans to farmers and businesses at higher interestrates They kept less in specie as reserves and paid back less in specie for their papercurrencies, and the system of credit expanded rapidly to support speculation inagriculture and livestock, land itself, and countless new businesses Regularly,speculative bubbles were created, then burst, and nancial panic turned into severerecession Banks went out of business by the hundreds, depositors lost money, anddebtors went bankrupt—and, in the early years of the century, often to prison

In its early years, the United States had had a national bank, the principal legacy ofAlexander Hamilton (there had also been an earlier, informal national bank just afterthe Revolution), to restrain overspeculation, but it also tended to restrict lending to elitebusinesses and urban nanciers The bank’s original charter was renewed underPresident James Madison in 1816 for another twenty years But in 1836, PresidentAndrew Jackson’s veto ended the reign of the Second Bank of the United States Jacksonamboyantly sided with the farmers and populists who believed the big Eastern bankerswere corrupt and habitually made credit too scarce or expensive for them

Jackson’s anti-bank policies have been widely criticized by business historians, but thefarmers were correct about often inadequate credit from the national bank for smallerborrowers Looser banking standards did contribute to economic growth and thedemocratization of credit in these years But a balance between adequate credit and

overspeculation could not be reached Big centralized banks favored elites, andoverspeculation at smaller banks almost invariably had painful consequences,contributing to the uneven if occasionally exuberant growth of the nineteenth century.

In the wake of a devastating panic in 1907, the U.S Federal Reserve was created in

1914 to avoid such unstable conditions But the bankers who manned the new youngcentral bank had neither the experience nor the will to do the job properly, and lackedsome of the necessary authority Flagrant abuse in the nancial community wasunchecked in the 1920s and the roaring stock market, supported by highly indebtedspeculators, burst in 1929 The real estate market, also supported by mammoth levels ofdebt, collapsed as well By then, banks were not only making business and consumerloans in excess, but also selling stocks and bonds, running investment managementcompanies, and creating new and highly speculative investment vehicles for individuals

—as well as promoting their own stock prices

Such a credit boom and bust alone may not have resulted in the Depression but itcontributed substantially to its severity Thousands of banks failed in the early 1930s assavers withdrew their funds, fearing that the banks had no assets with which to paythem—a classic bank run By 1932, one fourth of all U.S banks had failed, and stateafter state imposed a moratorium on banking Franklin Roosevelt, on taking o ce aspresident in 1933, declared a bank holiday, closing the deposit and withdrawal windowsaround the country temporarily Roosevelt resisted pleas to nationalize the banks, but

he and his advisers established comprehensive new regulations Under Roosevelt, thefederal government created the Federal Deposit In-surance Corporation (FDIC) to insuresavers’ deposits in case of bank failure, giving the government further oversight ofmember banks The federal government also restrained overly risky investments withinsured deposits by establishing limits on the interest banks could pay savers to attracttheir money (Regulation Q of the new law), and eliminating interest entirely onchecking accounts The fear was that competition for deposits would drive rates up andencourage banks to make more risky investments to earn higher returns

FDR and members of Congress were determined to end the con icts of interest of thenancial institutions If a commercial bank owned equity in a company, it hadincentives to lend money to the company, disregarding the risk of the loans There werenatural incentives to provide biased information to stockbroker clients about companies

in which the banks had investments or to whom they made loans The Glass-Steagall Act

of 1933, named after its congressional sponsors, Senator Carter Glass and CongressmanHenry Bascom Steagall, legally separated commercial banks, which collected depositsand lent money, from investment banks and stockbrokers, who could own parts ofcompanies, raise equity for clients, and advise investors on what investments to make.(The establishment of the FDIC and Regulation Q were parts of the legislation as well.)

Wriston’s bank, National City, was, before the Depression, the largest bank in theworld, and was an aggressive leader in many of the interdependent businesses thateventually caused so much trouble, including stockbrokerage Its high-pro le chairman,Charles Mitchell, was forced to resign in 1933 in the depths of the banking panic, butthe bank survived Under Glass-Steagall, National City, like other major banks, was

required to divest itself of its brokerage and underwriting arms, and do business only as

a commercial bank, accepting deposits and making conservative purchases ofgovernment securities or cautious loans to business The prestigious J.P Morgan bank,run by the most in uential nancier of the age, was also separated from its investmentbanking arm, which took the name Morgan Stanley The investment banks andbrokerage rms were now regulated by the newly created Securities and ExchangeCommission, whose rst chairman was Joseph P Kennedy, an aggressive nancierhimself and the father of a future president The principal demand of the SEC wasdisclosure of far more information by investment banks about the rms for which theyraised money, and other investor protections America thus entered the post–World War

II era with New Deal programs and state government regulations to control interestrates on consumer loans, which in sum regulated banking and the nancial system farmore thoroughly than at any time in its history

The New Deal philosophically infuriated Wriston as much as it had his father When hejoined National City (it changed its name to the First National City Bank of New York in1955), state law restricted it to operate branches in only the ve boroughs of New YorkCity Regulation Q, with its limits on interest rates on savings and checking accounts,particularly frustrated Wriston Since access to new funds was restricted, its lendingpolicies were restrained as a result Wriston felt the company he worked for could neverthrive under the weight of such regulation, and might not even survive

Wriston’s e ort to undo one regulation after another became a personal crusade,driven less perhaps by the desire for pro t than by an almost inchoate anger againstgovernment intrusion The desire to have one’s way can rise to the level of greed, too

“There was something emotional about his drive,” said Albert Wojnilower, a leadingWall Street economist of the time “I felt Wriston wanted simply to dismantle thefinancial system as we knew it.”

Wriston’s early career was characterized by clever innovation, a useful willingness todiscard tradition for its own sake, and considerable intelligence He made small butrapid advances up the ranks at National City, soon becoming a lending o cer A yearinto the job, he was assigned Aristotle Onassis as a client Onassis, in his early forties,was already a wealthy and glamorous Greek shipping entrepreneur, a conspicuousmember of the new international jet set, who had been borrowing at National City foryears After World War II, he saw an opportunity to expand his operations A postwarboom in energy demand, and a surge in oil discovery and production in the Middle East,would mean the world was short of ships to transport adequate petroleum supplies

e ciently Onassis needed substantial nancing to acquire more tankers, andeventually the enormous supertankers that came to dominate trade on the seas WhenWriston’s superiors passed Onassis on to him, Wriston was only twenty-eight

In the past, the cautious banks and insurance companies had made collateralizedshipping loans based only on the asset value—in other words, the resale value—of theship itself But just after World War II, a steep recession made the ships almost

worthless, and undermined con dence they would recover their value Onassis arguedthat growth of energy demand was inevitable, but bankers, who had money on the line,were not as con dent in the future as he claimed to be In his rst encounter withWriston, Onassis told him he was willing to pledge the income from the charter he wasawarded to deliver oil for Texaco as collateral against a loan rather than on the resaleprice of the ship Wriston was convinced, believing that such a loan, if unprecedented atNational City, was less risky than it seemed Wriston won quick approval from his open-minded boss, George Moore Moore, a rare charismatic banker and then head of thelending department, encouraged Wriston’s willingness to take risks and some observerscredited Moore with the new entrepreneurial spirit at the bank, and with some of theinnovations Wriston eventually implemented While Moore alone would not have beenable to accomplish what Wriston did, he gave Wriston the green light time and again,and approved of his aggressive instincts Wriston would not have done it withoutMoore, as he readily acknowledged “The rest as they say was history,” said Wriston.

National City soon became the largest bank lender to shippers, often in tandem withMetropolitan Life, the insurance company that made the longer-term tankerconstruction loans Since insurance policies had long-term payouts, it made sense forinsurance companies to make long-term loans Banks, in contrast, had to meetwithdrawal requirements from depositors on short notice, so they typically tried to makeshort-term loans, at least if they were managing their funds prudently

Shipping loans based on income rather than asset value became a model for loans tonance trucks, railroad cars, planes, and o ce buildings The other major shippingmagnate of the time, Stavros Niarchos, Onassis’s brother-in-law, o ered Wriston’scounterpart at Metropolitan Life, Walter Saunders, a permanent job directing hisnancing Saunders moved to Monaco, where both Onassis and Niarchos lived Onassisthen o ered Wriston $1 million a year to come with him to Monaco It was too bold forthe modest Wriston, who was then living in Stuyvesant Village in Manhattan, a middle-income housing project, with his wife and daughter Wriston, well paid by bankingstandards, would not earn more than $1 million in a single year until 1982, the rstcommercial banker to do so in the post-Depression era Wriston remained friends withOnassis and his eventual companion, the celebrated opera singer Maria Callas, and laterwith the former first lady, Jacqueline Kennedy, who wed Onassis in 1968

George Moore called Wriston the best employee he ever had Wriston, in turn, bothadmired and feared the often abrasive Moore “One time I brought him a loan,” saidWriston “It was Friday He read the thing and said to me, ‘You’re an idiot An absoluteidiot Idiot Idiot Idiot.’ He said everything three times So I went home despondently to

my wife and asked where else would you like to live? And she said, ‘What did Georgesay to you this time?’ So the next day was Saturday and we had a business gatheringwith clients from around the country George was holding court in the middle of thisgroup and I walked in not feeling too great ‘I want to introduce you to one of myfuture senior lending o cers,’ he said I said to him, ‘That wasn’t what you saidyesterday.’ ‘What’d I say, what’d I say?’ I said, ‘You called me an idiot.’ ‘Oh, if I didn’tthink I could teach you something, I wouldn’t talk to you.’ He would beat up on you one

day and it would completely evaporate by the next He was a teacher and a mentor, and

he had vision.”

There are two sides to the business of banking One is using the funds a bank gathers tolend and invest The other side is to gather the funds from individuals and businesses inorder to increase lending and investing, and thus raise a bank’s pro ts To repeat, theNew Deal regulations restricted both, but Wriston’s desire to nd new funding sourcesdeveloped into an all-consuming passion The most revolutionary of the bank’s newideas was a way to pay interest on something very much like a demand deposit, untilthen strictly forbidden by Regulation Q “We looked at the data and it turned out thatdemand deposits in New York City had not grown for ten years,” Wriston said “Youdidn’t have to be a rocket scientist to know we were going to go out of business.” Thegovernment reported that demand deposits plus currency fell from 29 percent of allfinancial assets in 1946 to 16 percent in 1960

Wriston and his colleagues’ idea was that the bank would allow corporate and foreigncustomers to deposit $100,000 in what they called a “negotiable certi cate of deposit.”This CD would have characteristics of a savings and a checking account Buyers wouldearn a higher interest rate on the negotiable CD like a time deposit (a savings account),but buyers could cash out by selling the CD at any time, as with a demand deposit The

CD would be sold into a secondary or after-market, where the price was technically

“negotiable,” as with any stock or bond There was always the possibility a $100,000 CDwould fetch slightly less when it had to be sold if interest rates rose in the meantime, ormore if interest rates fell, but the company could thus tailor the timing of its cash needswith minimal risk With the secondary market, Wriston was creating a checking accountwith interest for big investors

But to create the secondary market requires someone to “make that market”—buy andsell the CDs—and that requires substantial capital “The problem was that you had tohave a market for it to be successful, and there wasn’t any market,” said Wriston Bythen, 1960, Wriston was executive vice president of the bank, and head of the newlyexpanding international lending operation “George and I went over to see the DiscountCorporation [a government bond dealer] We said, ‘Would you guys make a market inCDs?’ They said, ‘If you lend us $10 million we’d do that.’ We said, ‘We don’t lendunsecured to broker dealers like you.’ They said, ‘Well, in that case we can’t make amarket.’ We went back and had a long conversation with the powers that be and wedecided to lend them the money That was pretty wild and it turned out to be a greatdecision.”

Wriston’s audacity was not fully appreciated in the press Financing the secondarymarket through Discount Corp was almost as if First National City were making its ownmarkets for the CDs they issued, taking a substantial risk, and violating the spirit andperhaps even the letter of the New Deal regulations that prevented conflicts of interest

Another banker would have asked the Fed’s permission to create the negotiable CD,but not Wriston “We had a debate on the CD,” he said “Do we go to the Fed? Well if

we go to the Fed, they will probably say no as a matter of principle while they study it.

So we agreed not to go to the Fed That was a major decision We got a legal decisionfrom our lawyers and we went ahead The Fed was not exactly pleased But at the sametime, the logic of trying to keep the banking system in funds weighed heavily in favor ofthe CD.”

Wriston got away with it In 1961, the Federal Reserve was concerned that bankshave enough funds to prevent an economic slowdown then under way from gettingworse When interest rates rose in an overheating economy—or were raised by the Fed

to forestall in ation—depositors put their money elsewhere because banks could notraise their own rates under Regulation Q This diversion of funds was known asdisintermediation, and the result was a credit crunch as bank lending to businesseswould dry up

Wriston realized that the Fed now feared disintermediation and the economy neededhim as much as he needed the economy But not all his competitors were in favor of thenegotiable CD Unlike Wriston, they feared challenging the Federal Reserve and werealso concerned with a possible rate war, in which banks would keep raising ratescompetitively to attract depositors Why pay for deposits when you get them for free?they wondered Some economists also wondered aloud whether banks would have tomake more risky loans at high rates to pay rising rates to depositors

The negotiable CD was o ered by First National City in early 1961, the FederalReserve looking the other way Within a year, outstanding CDs totaled $1 billion, as allmajor banks joined City in issuing them So-called money center banks, like J.P.Morgan, which had only large depositors, found them especially valuable By the mid-1960s, the volume of these CDs surpassed the volume of commercial paper, the short-term loans to large corporations, to cover immediate business needs usually due touctuations in sales, issued directly to major investors through investment bankers.Now, with CDs, banks could more e ectively compete There were still restrictions onthe rates paid, and the minimum size of a CD was $100,000, but bank credit increasedfar faster than the economy in these years, lending rising from $30 billion to $200billion between 1962 and 1965

By the mid-1960s, new negotiable CDs were not adequate to ward o likelydisintermediation and resulting credit crunches Spending on the Vietnam War waspushing the federal budget into de cit at a time when the economy was growingstrongly, new social programs were under way, and U.S business was booming Thenegotiable CDs actually contributed to higher in ation and interest rates, a fact thatwas not well recognized by either policymakers or economists Even as rates rose,

“banks began to bid for funds aggressively,” wrote Salomon Brothers’ in uential formereconomist Henry Kaufman, “driving open market rates to the maximum allowable underRegulation Q.” In 1966, rates on short-term Treasury bills reached more than 5.5percent from well under 4 percent a year earlier Lending did not dry up as usual “Theyear 1966 was a dress rehearsal for disaster,” according to one history of the period,

re ecting the common view at the time In ation kept rising, doubling in 1966, to 3.5percent

The Federal Reserve, eager to staunch in ation, raised its discount rate sharply tosuppress the ongoing business lending When the banks raised rates to the maximumallowed to be paid even on the negotiable CDs, and market rates went still higher,disintermediation again began and a credit crunch was unavoidable Large depositors

ed the banks, and placed their money in commercial paper or in overseas investments.The volume of CDs shrank rapidly Corporate lending and mortgage underwriting dried

up, and the economy slowed down A recession seemed likely

In the tightening circumstances, Wriston, with Moore’s encouragement, initiatedanother practice to nd the bank more deposits, one that would soon be adoptedindustry-wide When Americans bought products from overseas, or traveled there, theU.S dollar payments accumulated in overseas banks These deposits were calledEurodollars, and they were mostly free of American banking regulations—the mostimportant of which was the Fed’s requirement to keep reserves against domesticallymade loans The deposits reached an enormous volume, as Americans bought moreforeign goods Facing the loss of funds in the United States, Wriston had his Londonbranch issue certi cates of deposit in Eurodollars to overseas buyers Other banksfollowed Wriston’s lead The banks in turn lent the Eurodollar deposits at attractiveinterest rates to U.S international subsidiaries, overseas borrowers, or foreigncompanies, the loans soon contributing handsomely to profits

As U.S bank lending nevertheless slowed, and the economy weakened, the FederalReserve under William McChesney Martin, Jr., in uenced by President Johnson’sexhortations, eased monetary policy and pushed rates down in general Funds owedback into the banks as rates fell, but Wriston’s Eurodollar deposits and loans became aprofitable staple for American banks

In 1967, Stillman Rockefeller, the staid chairman of First National City, frequentlyannoyed by Moore’s energy, aggressiveness, and ebullient personality, appointed Moorechairman but did not name him the chief executive officer of the bank “Moore never gotalong with Stillman,” said Wriston Instead, the lower-keyed Wriston, at forty- ve, wasnamed president, which gave him more authority than Moore had

The negotiable CD and the Eurodollar CD were major victories for Wriston, and hewanted more The strong economy of the late 1960s was making men wealthy on WallStreet and across the nation, stock prices hitting record levels The Standard & Poor’s

500 had soared by ve times since the early 1950s The stock market awarded thosecompanies whose pro ts grew fastest with the highest price-earnings multiples—thestock price as a multiple of a company’s earnings per share (P-E multiples are theconventional way to measure a stock’s value.) The average price-earnings ratios rosefrom 12 or 13 in the 1950s to 17 or 18 in the bull markets of the late 1960s By the end

of the 1960s, some companies were selling at multiples of 100 and 200 times earningsper share The high prices led to a new wave of high- ying conglomerates, such as Ling-Temco-Vought, Litton Industries, ITT, and Gulf + Western, whose business objectivewas acquisition of other companies by exchanging high-priced stock for them Highstock prices were also the path to great wealth for the executives in these companies,who owned shares or options to buy shares Wriston felt left out

In 1968, after considerable internal debate, First National City decided to form a bank holding company (known formally as First National City Corp.), which could serve

one-as an umbrella to acquire subsidiaries, not all related directly to banking As a holdingcompany, First National City could also apply for listing on the New York StockExchange, with the possibility that First National City might become a Wall Streetfavorite

Wriston had one dream above all—for his bank to become a one-stop nancial centerfor consumers, supplying them with not only traditional banking products like savingsaccounts and mortgages, but also credit cards, mutual funds, insurance, brokerage, andother investment services Consumers were where the money was, he gured One of hisrst acquisition targets as a bank holding company was the large insurance companyChubb Corporation, but the Nixon antitrust authorities, despite their sympathies towardbusiness, believed the potential con icts of interest violated the antitrust laws, and FirstNational City abandoned the idea Wriston’s other attempts to make First National City

a one-stop nancial institution were also largely foiled by government regulators: hehad to give up plans to sell mutual funds, and his decision to join the Master Card (thencalled Master Charge) group to sell credit cards also faced difficult legal obstacles

But First National City was thriving Wriston had expanded its lending operationsboldly to include international clients He was hiring MBAs from the best schools to runlending programs, encouraging them to develop new ideas for growth, and paying themwell, if not Wall Street salaries His foray into negotiable CDs turned out to be a gusher

“The negotiable CD was number one for us,” said Wriston, “but commercial paper wasnumber two.” Banks and other corporations were also typically the buyers of theseloans Because they were issued only by major corporations, they were generallythought riskless in the 1960s That would change

In 1969 and 1970, another credit crunch descended on the nancial community as theeconomy again overheated sending interest rates up The amount of commercial paperoutstanding more than doubled between 1968 and 1970 to some $38 billion The FederalReserve, still under William McChesney Martin, pushed rates up in 1969 to ght risinginflation, and soon the nation was sinking into recession Stock prices had fallen sharplysince early 1969 In 1970, the Federal Reserve, now under a new chairman, theeconomist Arthur Burns, and President Nixon’s close friend and adviser, was being tested

by the strained conditions Then, in June 1970, the Penn Central, a major borrower inthe commercial paper market, led for bankruptcy because of the higher interest rates.The expansion of the highways and air travel had long been undermining the health ofthe nation’s once essential railroads The Grand Central Railroad and the PennsylvaniaRailroad, the two lines that terminated in Manhattan, had merged in 1967 to reducecosts, but signi cant savings were hard to nd To meet its needs, Penn Centralborrowed relentlessly from banks like First National City at low rates The railroad hadbeen given a high rating by Dun & Bradstreet, a leading ratings agency at the time.Characteristically, the aggressive First National City loan o cer, more poorly informedthan Wriston realized about Penn Central’s scal a airs, and trusting the ratingsagencies too well, had lent more to the railroad than anyone else Wriston was about to

take his biggest loss ever Overall, Penn Central defaulted on $80 million of commercialpaper Wriston blamed Penn Central management, not his own loan o cers, fordisguising its problems, and demanded that the railroad’s CEO resign.

The Penn Central announcement so roiled investors that they stopped buying thecommercial issues, creating an unprecedented crisis Businesses often simply rolled overcommercial paper—they paid o one set of loans with another Now they might not beable to pay back their creditors Wriston, the free market evangelist, implored the Nixonadministration to make an emergency loan to save Penn Central before it wentbankrupt, but help was refused Wriston then got on the phone to beg Federal Reserve

o cials—it is not clear whether he spoke directly to the chairman—to urge them tokeep their discount window open over the weekend, an unusual practice, enablingbanks to borrow reserves to nance their business clients (banks can borrow reservesfrom the Fed at the discount window, paying an interest rate, known as the discountrate) Without access to commercial paper, clients needed a lot of money quickly,Wriston made clear Many companies were in jeopardy of not paying their bills,meeting their payrolls, or paying back their loans If workers weren’t paid, they wouldstop buying goods, which could throw the economy into a more severe recession If bankloans were not paid, some might not survive Burns, sensitive to the dangers, kept thediscount window open that weekend, and continued to supply substantial reserves tobanks the next week Under pressure, Burns also eliminated the Regulation Q restriction

on the low rate banks could pay on CDs of less than three months’ duration It was therst crack in Regulation Q The government had saved the day Money partially owedback into the banks as they paid rates in line with other rates in the market

The crisis passed without spreading to other borrowers, but another milestone wasreached, as Wriston made a further serious dent in Regulation Q Wriston was bailed out

by the government on his reckless loans to Penn Central, and also won the ability toraise money on CDs with the change in Regulation Q “It was the beginning of the end,”said one banker, meaning the demise of Regulation Q

The nancial economists Henry Kaufman and Albert Wojnilower argued that theessential nature of nance had now changed as long-standing capital controls onlending were dismantled by Burns or circumvented through the negotiable CDs andEurodollar deposits The rationing of credit would be determined by rising and fallinginterest rates, not explicit nancial controls Unlike free market advocates like Wriston,both Kaufman and Wojnilower were skeptical that the level of interest rates alone couldregulate and stabilize the system Businesses in robust times were eager to borrow even

as rates rose, and especially if in ation was raising the prices at which they could selltheir goods and services But the quality of the loans—their creditworthiness—woulddecline Wriston, more reliant on the economic philosophy espoused by MiltonFriedman, thought Kaufman and Wojnilower were dead wrong, and said so

Kaufman and Wojnilower, who followed the credit markets closely at their respectiveinstitutions, Salomon Brothers and First Boston, believed interest rates would rise higherwithout slowing borrowing due to the weaker nancial controls The two economistsgained legendary reputations by anticipating the rise in rates while traditional

economists kept forecasting that these high and rising rates would slow economicgrowth and soon fall themselves “Spread banking” had begun by 1970, said Kaufman,and both he and Wojnilower believed it would create in ationary conditions Mosteconomists, including academic economists, neglected this Spread banking meant theprice of credit was e ectively indexed to in ation and credit would largely be available

no matter how high interest rates and in ation went Thus, demand for goods andservices would not be slowed

Eventually, Wriston published a book called Risk and Other Four-Letter Words,

criticizing those who would limit the initiative of bankers Wriston also started aneconomics department in his bank based on Friedman’s economics, which produced anewsletter and gave advice to traders and investors Looking back to 1961, Kaufmanwrote, Wriston’s negotiable CD was the “key development” that started it all “Thesenew money market instruments fundamentally altered the structure of nancialmarkets, for they allowed the banks to bid for [funds] in the open market for the rsttime Whereas before a bank depended on the wealth of its local community, now itcould buy deposits [anywhere in the world] in order to increase its loans andinvestments, and thereby enlarge its role as a nancial intermediary.” There were stillsome regulations on interest rates, however, and Wriston was determined to eliminatethem

In 1970, Moore retired and Wriston was named chairman, more an honor than a newjob, since he was already CEO Once the Penn Central debacle was digested, with thehelp of the Fed, First National City was triumphant in the early 1970s In deposits, itwas larger than its old rival Chase Manhattan Its stock was now trading as if it were anindustrial or services growth company, earning a high price-earnings ratio due to therapid growth of earnings—if not high enough for Wriston And Wriston was the bestpaid banker in the country He lived in the glamorous United Nations Plaza, home ofJohnny Carson and Alan Greenspan, the future Federal Reserve chairman, who wassomething of a man about town and a prosperous Republican consultant Wriston hadmarried a lawyer twenty years his junior two years after his wife died in 1965, and wasfamously driving a red sports car—famous because it seemed out of character for theman

In 1971, Wriston announced to Wall Street analysts that the bank’s objective would be

to increase earnings by 15 percent a year on average This was unheard of for a bank,and many inside First National City thought it an impossible goal By then Wristonbelieved in the impossible, however, and he knew it was exactly what Wall Streetwanted to hear Rapid consistent earnings growth could turn First National City into afull- edged growth company, like Xerox, Johnson & Johnson, and IBM He wantednothing more And a high stock price would enable him to acquire other companies forfewer shares in an exchange of stock

But Arthur Burns worried that such goals would encourage Wriston’s bank to takeunwarranted risks, and he said so publicly and told Wriston himself Burns knew that

Wriston always had the government to bail him out, unlike non nancial companies,and Wriston surely knew it, too, though he preached otherwise.

Wriston was unfazed by the Fed chairman’s chastisement He increasingly cited freemarket economic theories to justify his aggressive ways Increasingly, there were nobounds on how much banks could raise and lend, and Wriston’s ambitions encompassednew territory By 1980, Wojnilower concluded, the old economic rules no longerapplied Only a credit crunch truly slowed economic growth and dampened in ation, hewrote in an academic paper, and these were being eliminated as bank regulations wereloosened and more sources of funds were being found High in ation was partly theresult of deregulation and the new spread banking, he said This conclusion was much

di erent than the one drawn by economists like Friedman, who blamed in ationentirely on a rapidly growing money supply In more vernacular terms, Wojnilowersaid, “I thought the old regulations protected the market from runaway speculation Butthe reduction in the regulations ultimately fed in ation People did not realize theheight interest rates now needed to go to slow the economy and inflation.”

Wriston’s ambitions, stock market gold in his sights, encouraged him to makeexpensive and risky bets on borrowers First National City became a favorite of WallStreet and the press, and Wriston became the most admired banker in the world He wasproviding needed funds, the lifeblood of business, to deserving companies, andeventually funds to undeserving companies—and nations—as well Up to 1970 or so, hisaggressiveness was partly justi able He provided a service to a growing economy Butthen the light in his eye turned to a blaze

The expansion of debt, facilitated by the commercial banks and then the entire WallStreet community, became the fulcrum on which the economy was levered for the nextforty years Nothing turned out to be as important to economic growth, including thenew computer technologies, as the expanding capacity to lend and borrow Personaland business debt rose more than two and a half times as fast as total income over thecourse of this history Debt payments as a percentage of the nation’s income grewaccordingly Wriston multiplied the risks of nancial collapse of the entire nancialsystem as he pursued his ambition to build his bank Banking was simply not like anyother business

Financial institutions, including banks, brokers, and insurance companies, ultimatelygained power not known to them since the 1920s, and set the stage for furtherexpansion The nancial industry, which borrowed and lent money, and invested it aswell, accounted for one in two and a half to three dollars of business pro ts in the 2000scompared to one in eight in earlier years

Finance had rarely been the source of greatest personal wealth in American historyuntil this new era Traditionally it was handmaiden to the great industrial,transportation, chemical, communications, and retailing fortunes Now this changed Bythe 1990s and 2000s, nancial companies provided the fastest path to fabulous wealthfor individuals, directly producing 20 percent of America’s nearly ve hundred

billionaires and having a central part in the wealth creation of most of the others.Moreover, corporate executives, once adversaries as customers of banks, wereincreasingly now aligned with Wall Street as their pay was dominated by the companystock, and their focus therefore turned mostly to short-term profits.

Wriston relished his role in diminishing the federal government’s traditional role asoverseer and regulator of nance, knocking down barriers through audacity andattracting competitors to join him in his freewheeling ways, and thus turning his bankinto the biggest in the world He was at the center of every nancial storm in the nationduring his tenure Over these years there were many For decades, First National Cityunder Wriston walked an edge of illiquidity and even at times insolvency, makingenormous pro ts and occasionally fantastic losses But the health of the giant banksbecame so critical to the nation’s nancial system that Wriston learned to use it aspolitical leverage, while, given his intense laissez-faire philosophy, denying hisdependence on government all the time This advantage he played like a maestro Whilepreaching the values of competition and unfettered markets, he created a bank that wastoo big for government to allow it to fail, and Citibank, its successor, needed rescuingseveral more times, most urgently in 1982 when its loans to developing nations wentbad Aggressive business gave way to vanity and greed

Friedman did not think he had the power to provoke crisis deliberately, but crisis iswhat brought Friedman’s ideas to the foreground and made them popular Highunemployment of 9 percent and consumer in ation, which reached 12 percent in 1974and rose even faster at the end of the decade, seemed to discredit prevailing economictheories and created demand for new explanations and policies.

Friedman had warned persistently about both in ation and government spendingthroughout his academic career, which began in the 1940s Attempts to stimulateeconomic growth usually failed, he argued, often resulting in in ation—a conventionalconservative argument based on the classical economics that prevailed before the GreatDepression Friedman revived the precepts of that economic theory, and turned theminto an easily understandable theory known as monetarism In ation could only becreated by the Federal Reserve’s allowing the money supply to grow too rapidly, hesaid, and it could only be controlled by reducing money’s rate of growth, but nogovernment interventions could increase the long-term rate of growth of the nation’sannual income itself—its Gross Domestic Product, including wages and pro ts Crisisserved him well When in ation did rear its head in the 1970s as federal budget de citsincreased, Friedman’s views seemed correct and he got credit for his foresight Hisrelatively simple solution was also easy to communicate—stop money from growing—and he denied that tightening the grip on money would mean a serious and prolongedrecession—that is, reduced investment, lost jobs, and widespread bankruptcy Receivingthe Nobel Prize in economics in 1976, awarded in the midst of rising in ation, gainedhim international credibility

Milton Friedman, second from left, and Arthur Burns, his former professor, flanking President Richard Nixon (Illustration credit 2.1)

His broader philosophical view was that government social programs and regulations,

in ationary spending aside, were almost always damaging interference with the

e cient workings of an economy They undermined opportunity, social justice, andabove all personal freedom, he felt His economic views were indistinguishable fromtraditional libertarian political philosophies whose overriding concern was personalliberty He sought to eliminate one social policy after another, including Social Security,unemployment insurance, the minimum wage, and a wide range of regulationsgoverning labor organizing, pharmaceuticals, consumer safety, and job safety.Friedman, in e ect, provided the intellectual map for a reversal of the progressiveevolution of the nation

He insisted he was not ideological, and adamantly claimed he based his theories onfacts In this, he exaggerated greatly His public policy essays and speeches were wellwritten and often ingenious but overly simple assertions of free market claims based on

a straightforward interpretation of Adam Smith, disregarding Smith’s many caveats andphilosophical and psychological writings Friedman’s social policies as opposed to hiswork on monetary policy were rarely substantiated by empirical research or evenhistorical examples His academic research, sometimes usefully provocative, wascontroversial and usually not adequate to justify his many claims

Throughout his career, one of his major goals was to undermine the rising reputation

of John Maynard Keynes, who since 1936 had strongly advocated government spending

as a way to support rapid growth, rising wages, and low unemployment Keyneselaborately argued that increases in public spending could ease recession and increasethe long-term rate of growth Friedman’s constant critiques of Keynes became a personalcalling, as he devoted much of his more vigorous research to attempts at disproving theKeynesian models

Friedman’s ingenuity, persistence, and articulateness were the sources of hisattractiveness In the 1970s, there was no other intellectual force comparable to him onAmerica’s right This son of working-class Jewish immigrants became an extreme

political conservative at a time when those brought up like him were mostly liberals Hismain competitor for conservative attention, Ayn Rand, a Russian-Jewish immigrant,was more romantic than analytical—her reputation depended on her novels far morethan her philosophical essays Friedman’s popularity also eased the path towardacceptability for complex analyses made by some of his controversial rightist economistcolleagues, such as James Buchanan and Ronald Coase, who also advocated minimalgovernment regulation and oversight.

Friedman remained the avatar of the conservative cause, however He embarked on

an intellectual adventure, doing seemingly fearless battle in academia and the halls ofpolitical power with the best minds of his time Without him, the nation’s newly harshattitudes toward government would not have become nearly as respectable or aspopular

Milton Friedman’s parents were born in the Hungarian part of Austro-Hungary andemigrated as teenagers to Brooklyn in the mid-1890s They met there, married, and hadthree girls before a son arrived in the summer of 1912, a little more than six monthsafter Ronald Reagan was born and a year before Richard Nixon When Friedman wasone year old, his parents bought a building on Main Street in Rahway, New Jersey, nearthe railroad tracks, where they would live and run a clothing factory and dry goodsstore Before that, his mother worked as a seamstress in a garment factory—asweatshop, as he later called it, about which, he proudly wrote, she never complained.Friedman was unclear about the success of his parents’ early business ventures “Moneywas always a concern,” said Friedman Yet the family was able to buy a Model T by

1918 when few others as yet could

Friedman recalled being “fanatically religious” as a boy, abiding faithfully, forexample, by the dietary requirements of Orthodox Judaism He once ran away from hisBoy Scout camp because the boys were cooking hot dogs containing pork, which wasforbidden to him But as a teenager, Friedman turned against Judaism with as muchdetermination as he had once embraced it, pronouncing himself an agnostic He wasattracted to rule-based systems, and even as a youth demanded intellectual consistency

in himself His resoluteness and commitment to purity of thought were hints of his futureabsolutist nature

His religious agnosticism was tested when his father died Friedman, then fteen andthe only son, was required by Jewish law to attend a synagogue and say Kaddish, aprayer of mourning, every Saturday for a year He hesitated to do it, but at lastrelented, traveling by bus for well over an hour to a synagogue every Saturdaymorning He was a dutiful son, but remembered it as a violation of principle

His father died in the midst of the Roaring Twenties, before the progressive politics ofthe Depression If his father had any political in uence on him, he did not recall it, andhis mother, he said, was more consumed with raising her family than with politics

Friedman went to public schools in Rahway and was an excellent student He won ascholarship to Rutgers, a dozen miles away in New Brunswick, New Jersey, and

participated in school activities Despite his bookish ways, he was naturally a able,served on the school newspaper, and started several business ventures, including atutoring service for struggling high school students Anyone who met the adult Friedmanwas immediately struck by his articulateness and the force of his unhesitant voice, indistinct contrast to his diminutive stature; he stood about ve feet tall If his sizebothered him, it hardly made him hold back, and probably propelled him In later years,

he wore his fame casually, but to those who had known him as a younger man, hisambition was everywhere evident

His original college major was math, and he planned to become an actuary, but hemet two persuasive economists in college who turned him toward his future interest Therst was Arthur Burns, the traditionally conservative economist, who would later head

t h e National Bureau of Economic Research, teach at Columbia University, andeventually serve as President Eisenhower’s chairman of the Council of EconomicAdvisers, the three-person council created in 1946 to provide economic information andguidance to the president, before serving as Nixon’s Fed chairman

Burns was never as conservatively doctrinaire as Friedman became, allowing greaterroom in his economic philosophy for government policy and regulation Friedman,despite serious open disagreements with Burns about monetary policy in the early1970s, remained devoted to him “Save for my parents and my wife, no one has

in uenced my life more than Arthur—as my teacher, mentor, colleague, and friend,”Friedman said in his eulogy for Burns on his death in 1987

When Burns was doing his doctoral work at Rutgers, he asked Friedman and a fellowstudent to go over his dissertation line by line for accuracy Burns’s statistically orienteddissertation was called “Production Trends in the United States.” “That seminar,” saidFriedman in the eulogy, “imparted standards of scholarship—attention to detail,concern with scrupulous accuracy, checking of sources, and, above all, openness tocriticism—that a ected the whole of my subsequent work.” Burns also introduced him to

the main work of the British economist Alfred Marshall, author of Principles of Economics,

published in 1890, and a teacher of Keynes at Cambridge University in England WithFriedman’s bent toward mathematics, he readily took to Marshall, who, among otherpioneering contributions, helped develop more clearly the idea that the price of goodsand services will change until the supply and demand for goods are equalized at a pointeconomists call “equilibrium.” A higher price will encourage more to be supplied andless to be demanded, and conversely, a lower price less to be supplied and more to bedemanded The maximum number of producers and consumers are satis ed atequilibrium

Marshall’s innovative supply and demand curves are a foundation of every economicstextbook, and lend themselves to the sort of clarity of analysis that appealed toFriedman He was especially attracted to the seeming stability of markets in Marshall’sanalysis—equilibrium could be achieved and it was ideal The Cambridge University donbelieved his version was an abstracted model, and not itself a complete representation

of the real world Friedman thought Marshall’s model, if not the real world, a closeenough approximation to be taken more literally Prices to Friedman were wondrous

carriers of information that set the supply and demand for goods, services, jobs, andcapital as e ciently as possible as long as they were left unfettered by governmentregulation or control For Friedman, then, prices (including interest rates and wages, ifset freely) were the key to competition and functioning markets In this, he was asuccessor to an earlier school of Austrian economists led by Ludwig von Mises and ayounger disciple of that school, Friedrich von Hayek.

Friedman eventually virtually ignored the power of business to raise prices in amarket with limited competition or set a wage unrelated to the demands of workers Healso largely ignored the e ects of speculation in nancial markets, which may drive thevalue of stocks, or the willingness to borrow to unjusti ed and damaging extremes,claiming such distortions were in fact rare He took little account of how consumerscould be deceived in markets for complex products, from used cars to health care Whatdid bother him was when labor organized to negotiate for higher wages, which hebelieved was a distorting and unfair market intrusion Burns remained more sensitive toinstitutional power and irrational market decisions

The other persuasive conservative teacher Friedman met was Homer Jones Jones hadbeen a student of a brilliantly original, conservative economist, Frank Knight, of theUniversity of Iowa, who later taught at the University of Chicago Knight, aMidwesterner, was, as Friedman said, committed to the American ideal of self-reliance.The free market, unencumbered by government intervention, was consistent with thisvision “Like his mentor, Frank Knight, [Jones] put major stress,” wrote Friedman, “onindividual freedom, was cynical and skeptical about attempts to interfere with theexercise of individual freedom in the name of social planning or collective values, yet hewas by no means a nihilist.” Jones was the reason Friedman ultimately went to theUniversity of Chicago for his graduate studies, turning down a scholarship o er in mathfrom Brown

The economy was in the steepest slide of the Great Depression when Friedmanentered graduate school in 1932 The university faculty proudly represented a variety ofintellectual views, but the prevailing philosophy of the economics department, led byKnight, and the other illustrious Chicago economics professors of that era, includingJacob Viner, Henry Simons, and Lloyd Mints, was unreservedly liberal in thenineteenth-century meaning of the word (that is, conservative in the modern Americansense) It emphasized, as Simons put it, a traditional liberal political philosophy, “ofdispersion of economic power and of political decentralization.” This approach in a timewhen progressive ideas were ascending, wrote Simons, was “almost unrepresentedamong great universities, save for Chicago.”

According to Friedman, the Chicago economists also believed that the Depression wasthe consequence of mistaken government policies, not the nancial speculation of the1920s or any other inherent weakness of free markets “My teachers regarded thedepression as largely the product of misguided policy,” Friedman wrote “They blamedthe monetary and scal authorities for permitting banks to fail and the quantity ofdeposits to decline.”

But what became known as the Chicago School was originally not, contrary to

conventional wisdom, as pure a free market institution as it became when Friedmanwas its leading member in the 1950s “Simons for example did not equate the idealmarket with the actual market in this country,” wrote one economist The older guardalso believed that short-term government spending could be necessary in somecircumstances to support a falling economy and that monetary policy itself wasinadequate at times—ideas that were anathema to Friedman “Once a de ation hasgotten under way, in a large modern economy,” wrote Simons, “there is no signi cantlimit which the decline in prices and employment cannot exceed, if the centralgovernment fails to use its scal powers generously and deliberately to stop thedecline.” Knight, the most prestigious member of the faculty, was in particular notinvolved with the evolution of the Chicago School in the early 1950s A di erent sort ofeconomics then evolved, contrary to the conventional views of Friedman himself and hisacolytes It was more purely devoted to laissez-faire, more re exively antagonistic togovernment, and generally justi ed big business and monopoly far moreenthusiastically than did the early Chicago economists.

Friedman completed his graduate studies at Columbia, where he polished his skills instatistics Then in 1935, he took a research job with the Roosevelt government.Friedman later said he was not opposed to government social programs at that time Hewas, in fact, a mild proponent of the New Deal His future brother-in-law, AaronDirector, later an in uential professor at the University of Chicago law school andeventual head of the economics research program, teased his younger sister and Milton’sfuture wife, Rose, that Milton was too much of a New Dealer for him

Friedman met Rose in a class they were taking at Chicago Her brother, Aaron, adozen years older, encouraged her to attend school at Chicago and she adopted Aaron’snewfound conservative views She and Milton began dating in 1932 and were married

in 1938 After a di cult year as a young associate at the University of Wisconsinembroiled in faculty politics, Friedman returned to Washington to work for the Treasury

in the early years of World War II He helped develop the nation’s tax withholdingsystem, which made possible the rapid growth of government that he ultimatelydeplored There is no greater irony in American economic history He later said hisexperience in government reinforced his doubts about its efficiency

Friedman received his Ph.D from Columbia in 1945 His doctoral thesis alreadycontained conservative claims Written with the future Nobelist Simon Kuznets, it wastitled “Income from Independent Professional Practice,” and argued that statelimitations on the number of entrants, even if the desire is to maintain a high standard,into professions like medicine, dentistry, and law raised fees arti cially and reduced theaccessibility of the professional services With his degree at last in hand, Friedmansought a teaching position at a good university Aside from the aborted Wisconsin o er

a few years earlier, few invitations came his way until he was at last o ered a position

at the University of Minnesota

There, he joined his fellow Chicago graduate George Stigler, already a professor, andtogether in 1946 they co-authored a stinging, ideological article criticizing rent control.The central thesis was that rent control restricted the supply of new housing and

arti cially kept the price (the rent) down The article, like his graduate thesis, focused

on the dangers that arise when government sets prices The piece was based on skimpydata regarding rents in a single month in San Francisco after the 1906 earthquake (fortyyears earlier) Moreover, it was published by an advocacy organization called theFoundation for Economic Education, which was dedicated to “the explanation of themeaning of free private competitive enterprise It seeks to demonstrate the di erencebetween voluntary enterprise and coercion; between individualism and collectivism;between limited and unlimited government.” One conservative sta er referred to thefoundation as the “granddaddy of all libertarian organizations.” The publication was aclear announcement of Friedman’s conservative philosophy, which seemed to be formedsometime in the 1940s, perhaps not long after he married his libertarian wife

In addition to his new views, Friedman already had a reputation as a highlycompetent economics statistician When Stigler turned down an o er from theUniversity of Chicago in 1947, Friedman, known to the faculty, connected by marriage

to Director, and a credentialed conservative, was o ered the job, which he accepted.The University of Chicago would become his intellectual home

Rose’s brother, Aaron, himself had converted from early left-wing views to style conservatism He had emigrated in his early teens from Eastern Europe with hisfamily and entered Yale, where he was a politically active left-wing undergraduate andco-edited the school newspaper with the future Abstract Expressionist Mark Rothko(then Marcus Rothkowitz) After stints as a migrant farmworker and a textile factoryemployee, among other jobs, he went on to study for his doctorate in economics atChicago in the 1920s There, partly under the in uence of Henry Simons and theespecially persuasive Jacob Viner, he changed his political views The newlyconservative Director took jobs teaching at various economics departments, includingChicago, and also worked for the government during World War II Aaron found hisway to London where Simons had made an introduction for him to his good friendFriedrich von Hayek, the Austrian economist, who was teaching at the London School ofEconomics Director, like many others, became a devotee

Chicago-When Director returned to Chicago, he convinced the University of Chicago Press to

publish the American edition of Hayek’s new British best seller, The Road to Serfdom, for

which Director wrote a favorable review for a journal Hayek, a serious academic,

turned The Road to Serfdom into a fear-inspiring polemic Its central message was that a

growing welfare state in Europe would inevitably lead to totalitarianism, the rise ofNazi Germany fresh in the public’s mind The welfare state would also weaken thenation’s economy by undermining markets, which were the only means by which tosend signals to producers about the quantities and quality of goods and services Thiswas accomplished through the “discovery” of the e cient price for goods and services,

or in the case of credit, for the interest rate As noted, this sanctity of freely set priceswas a key part of Friedman’s thinking

Hayek wanted to establish an international cadre of in uential intellectuals with minded ideas He succeeded in finding the financing and attracted a formidable group ofthinkers, including the Chicago economists Knight, Simons, Director, and the Friedmans,

like-as well like-as the philosopher Karl Popper and the chemist and philosopher MichaelPolanyi They named the group after the small Swiss town in which they convened,Mont Pelerin, near Vevey, Switzerland.

The formation of the Mont Pelerin Society was nanced by Europeans and a highlyconservative tax-exempt American foundation, the William Volker Charitable Fund ofKansas City, founded by prosperous right-wing local businessmen The fund also helpednance the Foundation for Economic Education, which published the Friedman-Sigler

paper on rent control After the remarkable success of The Road to Serfdom, the Volker

Fund attempted to bring Hayek from London to an American university The fund’spresident, Harold Luhnow, was determined to underwrite an Americanized version ofthe Hayek book—though there was already a condensed version of it published by

Reader’s Digest But nding a suitable university position for Hayek turned out to be

difficult, and he was not interested in rewriting his book for an American audience

Hayek convinced Luhnow and the Volker Fund to support an economics programstudy at Chicago, to be headed by Director The Volker Fund, with Hayek as its guidinghand, had a strong in uence over the new direction to be followed by the Chicagoeconomics department as well as the law school where Director taught Hayek wrote theproposal for the new program, to be called the Free Market Study: “The free market [is]the most e cient organizer of economic activity—[the study will] emphasize andexplain that the free market is systemic, rational, not chaotic or disorderly—, show howthe free market performs some of the more di cult functions, such as allocatingresources to their best use and distributing consumption through time.”

Simons, Hayek’s long-standing friend, was the original choice to lead the newprogram But his less than extremist conservative views did not truly suit the VolkerFund executives He had written in 1948, for example, “The great enemy of democracy

is monopoly, in all its forms: gigantic corporations, trade associations and otheragencies for price control, trade-unions—or, in general, organization and concentration

of power within functional classes.… A monopolist is an implicit thief … because hispossession of market power leads to the exchange of commodities at prices that do not

re ect underlying social scarcities.” This was a conventional argument in classicaleconomics, which held that monopoly market power wielded by business as well asother institutions could distort prices (or wages or interest rates) by keeping themarti cially high for more pro t or keeping them low to drive o potential competitors.But the men who ran the Volker Charitable Fund were put o by any views critical ofbig business and it is possible that Hayek was dubious himself of Simons, having writtenthat public regulation was more dangerous than private monopoly Simons, forexample, was also opposed to “squandering” money on advertising and marketing

Simons died suddenly, possibly a suicide Had he become the program’s director, theChicago School of economics would have had a signi cantly di erent outlook—conservative but less doctrinaire and absolutist Aaron Director, on the law schoolfaculty, was appointed to run the study Director was an acolyte of Simons anddevastated by his death, but where Director often agreed with Simons in the past, hewas now reorienting his views The most marked shift regarded monopoly, which like

Simons he once thought destructive A few years later, he clearly no longer believed that

it was the problem Simons and others once thought it to be In 1950, he wrote thatcompetition would often naturally undermine monopoly By 1951, Milton Friedman hadalso shifted his views of the dangers of powerful monopolies, claiming that monopolywas not even widely present in the U.S economy The power to set prices and wages ofmonopoly corporations, he wrote, was “considerably exaggerated.” Director andFriedman argued that a monopolist in one market still had to respond to thecompetition from a company in a seemingly di erent market Airlines compete withtrains, for example, or in a more contemporary example, the Web competes withnewspapers With such a rationale, an economic theory could be devised that was farmore tolerant of power waged by a single or a small group of large companies over a

particular market This claim was easily taken to extremes In Capitalism and Freedom,

written as noted in the 1950s but not published until 1962, Friedman said that in mostcases he preferred private monopoly to government regulation, much as Hayek hadsuggested a few years earlier It was also a view highly congenial to the executives ofthe Volker Fund

As a member of the law school faculty, Director helped found the Chicago School ofthought on antitrust law, which claimed the American application of antitrust laws tobreak up large companies was often misguided and restrained economic growth, andthese ideas became the foundation of Ronald Reagan’s weakened antitrust enforcement

in the 1980s Director’s students at the Chicago law school included future outspokenfederal judges Robert Bork and Richard Posner, whose conservative views later had wideinfluence

Hayek was ultimately given a position on the university’s Committee for SocialThought, not in its economics department It is possible that the economics faculty, fullyunderstanding how in uential he was in redirecting their theoretical work, did not want

to acknowledge him

But the more extremist and overtly political turn the Chicago economics departmenthad taken under Director and Friedman’s in uence disturbed the old guard, whomFriedman nevertheless ever after cited as his admired mentors Frank Knight, the mosthighly regarded of the original group, was signi cantly more skeptical of laissez-faireeconomics than Hayek or Friedman and was concerned that some of Friedman’s publicpolicy proposals were doctrinaire and oversimpli ed In private conversation, he told afriend that Friedman’s criticism of government-run public schools was “foolish.” Knightwas also more sympathetic to the progressive writings of John Kenneth Galbraith thanhis younger associates “Colleagues spoof at [Galbraith], but I nd some truth in what

he says, perhaps as much as in their position,” he wrote to the British economist LionelRobbins, referring in particular to Friedman As economic historians Rob Van Horn andPhilip Mirowski make clear, claims that the “neo-liberalism” of Friedman was a pureoutgrowth of the highly respected Chicago pioneers like Knight and Simons weremisleading

Once securely at the University of Chicago, Friedman became a proli c researcher andwriter, much of his work based on a Marshallian framework Economists refer to this aspartial equilibrium analysis—partial because it is focused on one market at a time, forautos or stockbrokers, for example, and not on how each of these markets interacts inthe entire economy.

As noted, Friedman applied much of his energy toward pushing Keynes o the

in uential pedestal on which he had been recently placed by young Americaneconomists Keynes had been a student of Marshall’s when he was an undergraduate atCambridge, and until the Depression largely a classical economist himself But thiseconomic theory, Keynes felt, could not make sense of the worldwide catastrophe of the1930s Depression In the United States, the nation’s income fell by 25 percent, industrialproduction by half, and unemployment rose to 25 percent by 1933 Partial recovery inthe mid-1930s was followed by a new recession Keynes was at this point an exaltedgure in British life, having rst become internationally known when in 1919, as a

junior British Treasury o cial, he published an angry, eloquent polemic, The Economic

Consequences of the Peace, against the American, British, and French demands for

reparations from Germany that were part of the Treaty of Versailles ending World War

I He wrote highly regarded economic treatises on money and related subjects in lateryears, mostly oriented along the lines of classical theory, and many in uential politicalessays and journalistic pieces

During the Depression, however, Keynes believed, as he once put it, that ideas had tochange In 1936, after struggling for years with his new concepts, Keynes published a

complex theoretical book, The General Theory of Employment, Interest, and Money, which

altered thinking about economic growth and employment more than any other work inthe century

Classical theory held that economies were self-adjusting An overheated economy maylead to recession but when interest rates, prices for equipment and inventory, andwages fall far enough, business will start investing and hiring again Through suchadjustment, the ideal quantity of goods and services is produced, incomes generally rise

as much as possible, and the maximum number of jobs is created—that is,unemployment falls to its lowest possible level

But Keynes argued that economies could stabilize at much less than ideal levels ofcapital investment, incomes, and employment, and that this was precisely what hadhappened in the Depression The central idea was a radical innovation in thought, andKeynes went a long way toward demonstrating it Even if interest rates and prices fall,business may not invest, not for lack of access to bank loans, but because of lack ofdemand for their goods and services as consumers hold on to their money In otherwords, businesses may not borrow because they have nothing to invest in pro tably.Therefore, a nation’s central bank could try to reduce interest rates and increase thesupply of money, but these actions would often have little or no impact during deeprecessions Business would not invest without customers’ buying their products And,most revolutionary, the economy could stabilize inde nitely at this reduced level of

activity—a direct refutation of the classical self-adjustment process In economic terms,equilibrium could be reached at far less than ideal levels of employment and capitalinvestment.

Roosevelt and President Herbert Hoover before him sought to balance the federalbudget because, as classical economists argued, budget de cits reduced the savingsavailable to be invested Keynes argued this was exactly the wrong approach because,

by cutting the de cit, the nation also reduced demand for goods and services, and couldundermine capital investment, deepening any recession

The solution, by contrast, was to increase government spending—“ scal stimulus”—tocreate demand for goods and services and therefore the desire to invest by business Inother words, even as de cits may rise in recession, it made sense temporarily to create abigger de cit Keynes stood conventional economics on its head with these views andalso became the most compelling target for the Chicago free market school (Even theleast ideological old-guard Chicago professors argued that any scal stimulus should be

at most a stopgap, removed as soon as possible.)

Many American economists, who up to the Great Depression and even World War IIwere mostly avowed classical theorists, now quickly converted to Keynesianism Theconverts included Alvin Hansen, an in uential Harvard professor, who had earlierargued that the nation’s technological advances were simply petering out, and alsoyoung newcomers to the profession like Paul Samuelson and John Kenneth Galbraith

To Friedman, any views that promoted government spending as a way to stabilizeeconomies and promote prosperity were not merely wrongheaded but seen as pandering

to the majority by promising more social programs Moreover, government itself had itsown greedy expansionist motives, he believed “Ever since the New Deal,” as Friedmanput it, “a primary excuse for the expansion of government activity at the federal levelhas been the supposed necessity for government spending to eliminate unemployment.”

In the late 1940s and early 1950s, Friedman regularly wrote academic piecescriticizing Keynesian policies, international currency rates xed by governmentagreement, and progressive income taxes Friedman’s early e orts typically met theacademic standards required for publication in professional journals, and his originalityand impressive statistical abilities won him a coveted award in 1951 from the AmericanEconomics Association, the John Bates Clark medal, as the most accomplished economistunder forty

To reinvigorate classical economics and show that Keynes was wrong, Friedmanupdated a theory about the quantity of money in an economy dating back to theseventeenth-century philosopher David Hume and in even simpler versions still earlier,one that had also more recently been re ned by other economists, notably Yaleprofessor Irving Fisher The theory held that the quantity of goods and services aneconomy produced was equal to the size of the money supply and how rapidly themoney was circulated, known as the velocity of money Money circulation was held to

be stable (or at least predictable); therefore, money was the only variable that couldaffect the economy

This contention was a direct refutation of Keynes’s main argument that government

spending could a ect the rate of growth Keynes’s budget de cit would be e ective only

if the central bank increased the money supply to compensate for Treasury’s additionalborrowing, claimed Friedman, but the increase would result in more in ation, not realeconomic growth—the bene t of any gains in income from more spending would bewiped out by the higher prices If the central bank, in turn, did not expand the moneysupply to provide funds for government borrowing, the new Treasury debt would

“crowd out” valuable private borrowing and growth would be unchanged—or, overtime, even reduced

To make his key point, what Friedman needed to demonstrate was that changes in themoney supply caused GDP to rise and fall His rst e orts at documenting this were notpromising So, in 1948, with Anna Schwartz, a highly competent, dedicated researcherfrom Columbia University, he started an ambitious research project under the auspices

of the National Bureau of Economic Research He and Schwartz would reconstructmoney supply data in the United States since the Civil War and compare it to changes inGDP, Schwartz compiling the data, a monumental task, and Friedman overseeing theproject

Friedman tried to marshal other evidence against Keynes The success of Keynesianpolicies depended on how much of the money earned due to stimulative governmentspending programs, such as unemployment insurance, was spent More money spentwould mean more revenue for business, which in turn would mean more hiring andinvestment, and still more money spent The round-robin of increased spending raisedthe level of GDP by a “multiple” of the original government spending This “multiplier”was central to Keynesian analysis and policies

Friedman gathered evidence to show that people did not spend as much of theirincreases in annual income as Keynes assumed He reasoned that people based spendingdecisions on their expected earnings over time and would not increase spendingsigni cantly from a onetime boost in income Thus, a government stimulus would notnecessarily result in all the spending Keynes said it would It was probably Friedman’smost e ective use of statistical evidence against Keynes But it only dented the surface

of the Keynesian edi ce Friedman showed that the multiplier was somewhat less thanKeynes proposed, not that there was no multiplier And Friedman’s conclusionsoverstated the ability of people to foresee their future income accurately Such allegedconsumer prescience—his theories typically depended on prescience on the part ofbusiness and workers as well—became a hallmark of Friedman’s thinking, and one of itsweakest links

In the 1950s, before Schwartz fully gathered the evidence, Friedman, sometimes withcollaborators, promoted his new monetarist theories based on partial statistical analyses

in a variety of academic essays He had not yet come up with a de nitive statisticalfoundation for the endorsement of the theory He also began to write journalistic essaysand make speeches about public policy mostly paid for by the Volker Charitable Fund

With Rose’s considerable editing help, he organized these essays into Capitalism and

Freedom, which when published in 1962 received little national attention.

The clarity of writing and breadth of subject matter made Capitalism and Freedom a