Adam Smith and Financial Regulation

Here’s a letter that I sent yesterday to the New York Times Book Review:

Paul Barrett’s review of two books on today’s financial crisis is a verbal bubble inflated by its author’s irrational exuberance for naïve conventional wisdom and his greedy reliance upon morality-play explanations (“Rational Irrationality,” Nov. 15).

The review never mentions any of the many decidedly anti-laissez-faire interventions leading up to the crisis, such as Uncle Sam’s creation and backing of Fannie and Freddie; or politicians pressuring lenders to make mortgages “more affordable”; or the Fed’s 1998 intervention to save Long Term Capital Management (and the dangerous signal that this intervention sent to Wall Street); or the Fed’s loose monetary policies leading up to the crash.

This latter omission is especially egregious given Mr. Barrett’s favorable reference to John Cassidy’s claim that Adam Smith himself allegedly supported heavy regulation of financial markets.  The quotation from the Wealth of Nations that convinces Mr. Cassidy and Mr. Barrett that Adam Smith was a proto-Barney Frank on matters of financial regulation appears in Smith’s discussion of paper money.  In this quotation Smith endorses restrictions on banks’ issuance of paper money to the general public.  Paper money, Smith believed, is appropriate only for “dealers.”  Regardless of the merit of Smith’s argument here, it is clearly not an endorsement by Smith of widespread regulation of financial markets.

Sincerely,

Donald J. Boudreaux

And my colleague Larry White points out this other passage from Smith, also from Book II, Chapter II of Wealth of Nations:

If bankers are restrained from issuing any circulating bank notes, or notes payable to the bearer, for less than a certain sum; and if they are subjected to the obligation of an immediate and unconditional payment of such bank notes as soon as presented, their trade may, with safety to the publick, be rendered in all other respects perfectly free. The late multiplication of banking companies in both parts of the United Kingdom, an event by which many people have been much alarmed, instead of diminishing, increases the security of the publick. It obliges all of them to be more circumspect in their conduct, and, by not extending their currency beyond its due proportion to their cash, to guard themselves against those malicious runs, which the rivalship of so many competitors is always ready to bring upon them.

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