Bill Black: Thomas Friedman – Deregulation Makes Banking Safe

Yves here. Bill Black continues with his unsavory task of documenting how Thomas Friedman is urging Hillary Clinton to move hard to the right…or perhaps more accurately, inferring that she intends to go there anyhow and volunteering to provide her with air cover.

By Bill Black, the author of The Best Way to Rob a Bank is to Own One and an associate professor of economics and law at the University of Missouri-Kansas City. Originally published at” rel=”nofollow”>New Economic Perspectives

In this column I focus on Thomas Friedman’s plea that Hillary Clinton embrace deregulation, desupervision, and de facto decriminalization (the three “de’s”) and the Trans-Pacific Partnership (TPP) as a “knock-out” political strategy against Donald Trump and as a means to produce dramatic economic growth and financial stability.  He claims that embracing the three “de’s” and the TPP creates an “open system.”

Friedman presented this advice in two columns he addressed to Hillary to mansplain the economy to her.  His first column was the unintentionally hilarious “Web People vs. Wall People.”  It consists of a surfeit of slogans masquerading for analysis.

Web People understand that in times of rapid change, open systems are always more flexible, resilient and propulsive; they offer the chance to feel and respond first to change.

As I explained in my last column, “open systems” is systems theory jargon for a system that adapts to change by self-organizing.  I explained why social systems, including economics, are not “open systems.”  I showed that “flexible, resilient, and propulsive” were amoral and euphemistic descriptors for what, in the social sphere, would include genocide, mass rape, slavery, and torture.

In this column I apply the “open systems” jargon to Friedman’s endorsement of the three de’s in finance.  In my next column I deal with his support for further eviscerating health and safety regulation through the TPP.  Friedman’s heroes as heads of state were Bill Clinton (he urges Hillary to emulate his economic policies) and Tony Blair.  Blair consciously modeled driving “New Labour’s” economic policies far to the right on the identical strategy that Bill Clinton and his fellow “New Democrats” used to drive the Democratic Party to adopt what had traditionally been (harmful) Republican policies.  The “New Democrats’” structure was the Democratic Leadership Council (DLC), which was funded by Wall Street elites and worked assiduously and slavishly to advance the interests of those elites.

Under Blair, Clinton, Gordon Brown, and George W. Bush the City of London and Wall Street induced their political cronies to engage in a regulatory race to the bottom.  The City “won” that race to the bottom, barely nosing out Wall Street, which is why it became the financial cesspool of the world.

This kind of interactive anti-regulatory competition is not truly an open system for the reasons I have explained, but it is what Friedman incorrectly believes to be an open system.  The regulatory race to the bottom does produce rapid change and rapid “respon[se]” to change.  The UK and the U.S. were the “first” (and second) to change – repeatedly – as they engaged in numerous acts of the three “de’s” that prompted a cascade of competitive responses that eviscerated effective financial regulation and supervision and virtually eliminated prosecutions of financial elites in both nations.  The regulatory race to the bottom evinced “flexibility” in both nations and was “propulsive” – as the competitive dynamic propelled assaults on regulation and supervision that in turn propelled ever more aggressive adoption of the three “de’s.”

Friedman’s paramount idea – financial deregulation – turns out to be a superb means of testing Friedman’s “open systems” slogan.  By examining the financial regulatory race to the bottom for which Friedman was a cheerleader, we can observe that “flexible” and “propulsive” can aptly describe a catastrophic policy failure that literally caused the collapse of much of the financial system until it was bailed out by Friedman’s Great Satan – “socialism.”

That history demonstrates that the three “de’s” did not make finance more “resilient.”  They did the opposite.  They made the financial system perverse, destructive, corrupt, rigged, endemically fraudulent, and fragile.  Friedman observed these facts, particularly in two places, the City and Wall Street, that Friedman worships and often lunches with financial CEOs.

Friedman appears to be unaware that there were economic claims that the financial regulatory race to the bottom was inherently stabilizing for the economy.  Ben Bernanke made famous the claim that deregulation was part of the reason for the “Great Moderation.”  Alan Greenspan explicitly endorsed the regulatory “competition in laxity,” claiming that unregulated financial derivatives inherently made the financial system far more resilient and stable because they would diffuse risk and ensure that the firms taking financial risks were the ideal firms for holding such risks.  Greenspan asserted that regulation was unnecessary and harmful because unregulated financial markets would automatically exclude fraud.  Each of these claims proved not simply incorrect; the opposite was proven true in the real world.  Friedman, of course, ignores Minsky.

Friedman’s unsupported assertion that open systems always “respond first to change” is also dubious.  I’ll repeat the caution that there is no “open” economic system and cannot be.  But let us test Friedman’s claim using what appears to be his (incorrect) view that the three “de’s” produce an economic system that is an “open system.”  Was the supposed economic “open system” actually the “first” to “respond” to “change?”

That turns out to be a trick question.  I’ll explain with the aid of three examples from finance.  In late 1983, one year after the onset of the second phase of the savings and loan debacle, made possible by the aggressive and dogmatic adoption of the three “de’s” and a regulatory race to the bottom between the federal and state governments, 300 fraudulent CEOs controlling savings and loans were growing at an annual rate of at least 50 percent.  Plainly, these CEOs responded rapidly to the change (the adoption of the three “de’s) that made the S&L industry the most criminogenic industry in the Nation by entering the S&L industry and locating overwhelmingly in the states that “won” the regulatory race to the bottom.

Those fraudulent S&L owners did not simply “respond” to “change,” they used the economic and political power of the firms they controlled to cause radical “change” in a host of settings.  They crafted their hiring, promotion, and compensation systems to create powerful, perverse incentives among their officers, employees, auditors, attorneys, and appraisers.  They deliberately generated a series of “Gresham’s” dynamics in which bad ethics drives good ethics from the markets and professions as a means of suborning these “controls” into (not remotely) “independent professionals” that would aid and abet the CEO’s looting of “his” S&L by massively inflating the reported value of the assets and hiding real losses.  They grew extremely rapidly and employed massive leverage.  Many employees, officers, and appraisers responded rapidly to these changes crafted to the CEOs and became the CEOs’ most valuable fraud allies.

What Friedman was presumably trying to claim, however, was the opposite – that the valiant “Web People” of the private sector banded together to end the S&L debacle.  How many of the 300 S&L “accounting control frauds” were shut down by “private market discipline?”  Zero.  They never responded to the change of the entry of the frauds by stopping the frauds.  They often responded by praising and aiding the fraudulent CEOs.

The S&L regulators began to reregulate the industry one year after the key federal deregulatory legislation and only a few months after the regulatory agency had a new leader – Edwin Gray.  Gray continued to respond for years to the changes (the three “de’s”) that created the criminogenic environment that created the epidemic of accounting control fraud that drove the second phase of the S&L debacle.  What was the response of what Friedman incorrectly claims to be the “open [S&L] system” created by the three “de’s?”  That system ridiculed, attacked, and sought to destroy Gray and his removal of the three “de’s.”  Had those opponents succeeded in destroying Gray’s removal of the three “de’s” the cost of the debacle would have grown by trillions of dollars.

The second example began in 1989 in Orange County, California – where all top U.S. financial frauds begin.  The overall S&L debacle was raging.  California and Texas tied in the regulatory race to the bottom, so California was an epicenter of the debacle.  Our examiners in the Office of Thrift Supervision (West Region) were overwhelmed dealing with the paramount epidemic of accounting control fraud – commercial real estate.  A new type of home loan began to become material in 1989.  At that time, it was call a “low documentation” loan.  These were loans made without verifying the borrower’s income.

Our examiners had been trained to understand the fraud “recipe” for a lender.  Our examiners understood that it was essential for a lender following the recipe to gut its underwriting system.  Gutting your underwriting is the great “tell” that allows examiners who understand fraud schemes to identify these frauds while they are still reporting record profits and minimal losses.  Failing to verify the borrower’s income is an obvious invitation to inflate the borrower’s income, which optimizes the fraud recipe and which no honest lender would do.  Our examiners recognized this immediately and called the likely fraud to the attention of the OTS-West’s leadership.

Despite being engulfed by the epidemic of commercial real estate frauds, we concluded that it was critical to prevent a second fraud epidemic from arising.  We decided to drive these fraudulent loans out of the industry before that second epidemic could develop.  The biggest and worst of the low doc lenders, Long Beach Savings, eventually gave up its federal deposit insurance and its charter as a savings and loan for the sole purpose of escaping our regulatory jurisdiction.

Long Beach converted to a virtually unregulated mortgage bank.  It’s controlling owner changed its name to Ameriquest.  It continued its frauds and increasingly specialized in defrauding blacks and Latino borrowers.  There was no “private market discipline” restraining Ameriquest’s endemic frauds and discrimination.  The largest investment banks eagerly provided the loans to help Ameriquest dramatically increase the size of its frauds.  Ameriquest was largest specialist making low doc loans for decade.  Everyone involved on the lender’s side of the table knew that the loans were endemically fraudulent and that the massive inflation of the borrowers’ income helped the lenders sell the fraudulently originated loans at a premium price to the secondary market.

By early 2006, the Mortgage Bankers Association’s own fraud experts, MARI, warned the entire lending industry in writing:

  1. The incidence of inflated income in such loans is 90%
  2. The loans are an open invitation to fraud
  3. The loans deserve the term the industry now uses to describe them: “liar’s” loans
  4. The industry seems to have forgotten that these loans caused hundreds of millions of dollars in losses in the early 1990s [as we were driving them out of the S&L industry]
  5. Even the Bush administration anti-regulators are warning against making the loans

From 2003-2006, liar’s loans increased by over 500 percent.  By 2006, liar’s loans represented 40% of all the loans made that year, and half the loans called “subprime” were also liar’s loans.  Liar’s loans were the loans that hyper-inflated the real estate bubbles.  Far from being a pariah, Washington Mutual (WaMu) and Citigroup eagerly acquired Ameriquest’s endemically fraudulent operations and personnel.  The finance industry behaved in the opposite manner of providing “private market discipline.”

Greenspan and his successor Bernanke refused to use the Fed’s unique statutory authority (HOEPA) to ban all liar’s loans because of their anti-regulatory ideologies and because the industry fought bitterly to prevent any effective regulation of liar’s loans.  Liar’s loans were the single most destructive financial fraud scheme in world history.

Under Friedman’s (false) claim that the three “de’s” make the economic system an “open system,” none of this should have happened.  Books and movies celebrate the supposed genius of John Paulson for realizing in 2006 that he should short liar’s loans, but our examiners figured that out in 1989.  The first differences are that our examiners figured it out when such loans were brand new and had minimal losses and that when our examiners learned of the problem they immediately raised the alarm so that we could act to prevent a financial catastrophe.  Paulson had all the benefit of our examiners figuring it out 17 years before he did, MARI’s warnings, and the enormous increase in defaults on liar’s loans.  By 2006, liar’s loans had vastly increased default risk compared to 1989, because of a host of other loan characteristics.

The second difference between our examiners and Paulson is that instead of preventing a crisis by promptly issuing a warning, Paulson did everything he could to keep the news from getting out so that he could become personally wealthy by “shorting” liar’s loans.  Our examiners were evil “socialist” “Wall People” under Friedman’s rubric because not a single one of them was sufficiently “capitalist” to resign and get rich shorting lenders making liar’s loans.  Friedman must think that perverse incentives, a global financial collapse, and a Great Recession are the hallmarks of an “open system.”

The regulators responded first and effectively to liar’s loans as a new fraud “ammunition.”  We responded many years before the industry began calling these fraudulent loans “liar’s” loans.

The third example is appraisal fraud.  It was common during the S&L debacle, particularly because it is far more difficult to accurately appraise “spec” commercial real estate, particularly acquisition, development, and construction (ADC) loans.  ADC loans, unsurprisingly, were the S&L fraudsters “ammunition of choice.”  As S&L regulators, we worked closely with the appraisers’ associations in an effort to block the Gresham’s dynamic that the CEOs looting “their” S&Ls deliberately created to extort appraisers to inflate appraised values.  No honest lender, of course, would inflate appraised values because the collateral should be the great protection against loss.

Flash forward a decade to 1998, late in the Clinton administration.   In that year the rival professional associations of appraisers begin meeting to find a common strategy to repel the return of the fraudulent lenders extorting appraisers to inflate market values of homes pledged as collateral on real estate loans.  By 2000, they had reached agreement on the common strategy and implemented it.  They create an on-line petition, written in plain English, that eventually had 11,000 signatories of professional appraisers.  The petition, sent to the relevant regulatory agencies, pulled no punches.  It informed the regulators that lenders were extorting appraisers to inflate values by blackballing appraisers who refused to help them commit fraud.  I have been unable to find any meaningful action taken by any regulator or any lender in response to this warning.

In this third example, it was not regulators, but honest appraisers who responded first.  They responded brilliantly in a way that should have been totally persuasive.  They should, along with the OTS-West examiners of 1998, be the heroes who prevented the two most destructive epidemics of financial fraud in history, prevented the hyper-inflation of the bubble, and prevented the Great Recession.  The “capitalist” entities that Friedman valorizes did the opposite.  They responded to the fraudulent “changes” by feeding the frauds and profiting from them and then collapsed under the weight of the fraud epidemics until they were bailed out by “socialism.”

These three examples make clear that the obviously more important question than who responds most quickly to change is how the financial system “respond[s]” to the “change.”  Friedman is so clueless that he simply assumes that the “respon[se]” of an unregulated financial system to “change” will be desirable rather than disastrous.  This is one of the “tells” that demonstrates that Friedman has no understanding of systems theory, economics, finance, regulation, fraud, or logic.  The three examples I provided show that the response of the putatively “open” financial system was perverse – it massively increased the problem.  The response of the government regulators and the non-profit professional appraisers’ associations (both closed systems) was often prompt and highly desirable.  The regulatory response saved trillions of dollars during the S&L debacle and, had it been mirrored in response to the current crisis it would have saved even more trillions of dollars.

Similarly, Friedman provides no content on what “change” he is referring to.  The way he uses the word suggests he thing “change” is generic.  George Akerlof’s point in coining the term “Gresham’s” dynamic in his classic 1970 article on markets for “lemons” was that when the change is fraud by sellers, the “market” can become perverse and drive honest firms and high quality goods and services out of the markets.  Even if you have never studied systems theory, any rigorous thought about the concept would lead you to the realization that the nature of the “change” can be enormously important to how a “system” will respond.

“Open systems” is simply part of a stream of slogans for Friedman.  It is not a mode of analysis; it is a means of pronouncing that “open systems” are “always” superior, defining (incorrectly) his ideas as producing an “open system,” and declaring that his ideas are irrefutably correct because “open systems” are “always” superior.  He has no understanding of how the financial system is rigged by elite CEOs and their political allies.

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  1. Otis B Driftwood

    One can only wonder what people like Liz Warren are thinking when she reads Black (and I’m sure she does) and reflects on her support of the Clinton neoliberal enterprise and Friedman’s fronting for what’s to come after the charade of this political season is over. Friedman is a tool, but Warren ought to know better.

    I don’t expect Black’s pantsing of Friedman will shut him up (he’s too self-important and impressed by himself to do that), but maybe others will take notice. Maybe the editors of the NYT?


    In fact, it’s a testament to just how degenerate our system has become that people like Friedman and Summers still get wide exposure to their discredited and destructive views while others, like Black, are deliberately and conspicuously muted.

    1. pretzelattack

      tools can be self aware, too. what they tell themselves? “oh boy oh boy oh boy, i can leverage an influential job in the clinton administration into big private sector bucks!”

  2. hemeantwell

    Likely someone has already said this, but if you’re looking for an example of zombie economics, Friedman’s proposals are a current epitome.

    I can’t believe he expects to be taken seriously, but I wonder if he’s making this noise to literally add mass to the antiregulatory dike that will be challenged when the next crash hits us. To shift metaphors, watching the Times in action this election cycle has made me appreciate more than ever how much political combat is carried out by establishing climates of opinion that reduce criticism to passing squalls.

  3. washunate

    I agree with Black in so far as that matters, however, the optics of stuff like this is that people like Friedman aren’t being intellectually honest. So treating their positions as legitimate, paradoxically, legitimizes them in the general discourse.

    Rather, I think it’s far more fun to take their ideas to their natural conclusion. Call the BS assumptions underlying their superficial argument. I’m all for deregulating banking, for example. It’s the neocons (in both political parties, as if they aren’t working together) who favor state support.

    FDIC insurance? $10,000 limit sounds good. If a big bank wants big customers, pony up for the full cost of the insurance. Boom, deregulated. What normal person has more than that at risk in a bank, anyway?

    Home mortgage interest deduction? Goodbye. Boom, deregulated.

    Qualified dividends? Gone. Carried interest? Gone. Special tax rates for capital gains, including complete exclusions on some things like profit on selling your home? Gone. De-reg-u-late.

    The drug war and all the money laundering that entails? Ciao.

    Federal Reserve balance sheet? Sell, Mortimor, Sell. Boom, deregulated.

    On and on, the large US banks are not deregulated, and the neocons aren’t pushing deregulation. The large US banks are government sponsored entities carrying out public policy, policy choices supported by the bipartisan leadership consensus going on for decades now.

    It’s not even unique to the financial system. Some of the biggest government initiated predation happens in the US healthcare system, a medical system that coincidentally has the most waste and the most inequality in the known universe. And there’s the tech world – those Web People Friedman invents – which depends heavily upon government protection, as well. They’re relatively more competitive than finance and healthcare since just about anything is in comparison, but just try and violate the Sacred IP of a Microsoft or a Google or an Amazon and see how far you get. Or try hacking a corporate entity helping the government hack your own info. The two-tiered justice system will come to greet you. Very speedily and most decidedly un-deregulatedly.

    1. templar555510

      I had something to put on here and then I read your comment and realised mine would be superfluous because you have said it all ( and better ) so well done .

      1. washunate

        Ha, thanks, I appreciate it. The small government meme is one of my favorite punching bags. No one in power supports actual deregulation in the sense of reducing government power over people’s lives and subsidies to connected insiders.

  4. Watt4Bob

    Due to lack of adequate regulation we currently have what amounts to a two-tiered system in our stock markets, one is an ‘open system’ in which HFT folks do what ever they want, and the other is a ‘closed system’ where the rest of us are effectively corralled by the collusion of those who own the trading system, and the folks in the first tier.

    Open system for me, straight-jacket for you.

    I’ll keep saying it, Friedman’s a really stupid guy, sincerely stupid, but that’s the worst kind of stupid.

    What you might call a useful idiot.

  5. Punxsutawney

    More drivel from Friedman. Has he been right about anything the last 20 years? Maybe we should call him “Failed Friedman, Wall Street Shill”.

    Unfortunately he’s part of the elite consensus so his voice will get way more exposure than it merits.

    Whenever banking has been deregulated (rigged to use Black’s term) it has ended up in a crisis of some proportion. Thanks to Bill Black for documenting recent examples of this nicely.

  6. Vatch

    Oh my. Tom Friedman has really jumped the shark. Here are some howlers from the “Web People vs. Wall People” article that Bill Black linked to:

    Having been secretary of state, Clinton has been touching the world.

    Yes, she’s been touching the world for donations, via her family foundation.

    To her credit, though, she chose a great running mate, Senator Tim Kaine, a Web Person with a soul.

    I honestly don’t know how to comment on this one. Tim Kaine has soul.

    …Bernie Sanders, who promises to stop the winds by ending our big global trade deals and by taking down “The Man” — the millionaires, billionaires and big banks. I don’t see how the country could afford either man’s plans,…

    I don’t know how the country will be able to afford to ignore Sanders’s plans.

    Friedman is really quite a piece of work.

    1. Watt4Bob

      Having been secretary of state, Clinton has been touching the world.

      For some reason I fell compelled to fix his framing.

      Having been secretary of state, Clinton has been putting the touch on the world.

    2. DanB

      I’d say Hillary was torching the world as S o S.

      Re: “Tim Kaine has [a] soul.” This is one of the talking points about him the DC pundits keep repeating to make it seem true, just like they keep saying Hillary is the most qualified person ever to be president.

      1. John Wright

        As I’ve mentioned before, I see Hillary Clinton as more of a malevolent female Forrest Gump, always there when bad stuff happened as FL, Senator, SOS.

        Simply “being there” moves her in to the most qualified category in some people’s minds.

        If only she appeared to be able to learn from failure…

  7. Alejandro

    The self-proclaimed spokesman for souls ensnared in a “Web” of deception and sophistry, hiding behind a “Wall” of privilege, having not learned himself, has nothing to teach…the “mustache of understanding” gets pruned, by a great teacher with real understanding.

  8. Ken Ward

    While rightly lambasting Friedman, Black shows his own ignorance in calling Blair ‘head of state’. Why is it so hard for Americans to understand that in many political systems heads of government are not at the same time heads of state?

  9. Robert NYC

    Friedman is a pop intellectual and neoliberal fool. Nobody who really understands things takes him seriously. Unfortunately he seems to have a pretty big following amongst the masses but even they seem to be waking up. It really reflects poorly on the NYT to give a guy like this a platform to spew forth his ignorance, but then again it’s the NYT so it’s to be expected.

    As much as I dislike Friedman I thought his book from Beirut to Jerusalem was very good but that was a long time ago and maybe I was wrong.

  10. Sue

    Here is a question: Are we sure that Friedman is ignorant, or is it possible that he is simply paid to share opinions that come straight from his lunch mates – fraudulent CEOs and financiers who want to go on extracting rent from the economy? Jargon is usually a way to look like you are speaking intelligently when your real intention is to obscure the fallacy of your statements. Isn’t it possible that Friedman regards the three “de’s” as successful economic policies because they make the people he believes deserve it rich? Does he even think the Great Recession was a bad thing, since the 1% are richer than ever before and people who don’t share in the wealth are obviously undeserving folks who simply don’t have a place in the new world order?

    He might regard the Great Recession as simply capitalist Churn that separates the weak from the strong….

  11. phichibe

    Friedman reminds me of no one so much as George Gilder, who after writing some Reagan era screeds on the evil of welfare then re-invented himself in the 90s as a tech guru/evangelist and wrote of the coming era of bandwidth so plentiful it would be free. Gilder’s mistake (apart from woeful ignorance and invincible arrogance) was that he became so greedy that he tried to cash in on his new-found status as a visionary by starting a newsletter and investment fund, which promptly went pear-shaped when the tech bubble burst. If Gilder ever resurfaced I never noticed it.

    Friedman has been shielded from the folly of his words by virtue of the fact that his wife’s family money kept him from trying to double down and also by the NY Times’ policy restrictions that prevent their staff from cashing in on their positions. The thing that is so amazing about TF is that he is *completely* unfazed and unapologetic about his past errors and omissions. When he and reality find themselves on alternate paths (which is frequent) it is always reality that is error, not Friedman. The worse thing is that when he hangs up his position at the Times, I predict he is going to join Kleiner Perkins as a “venture capitalist” and make pile of money by talking his book. Oh well.


  12. NYPaul

    On Charlie Rose, 2003:

    “We needed to go over there, basically, and take out a very big stick right in the heart of that world and burst that bubble.… What they needed to see was American boys and girls going house to house from Basra to Baghdad and basically saying “Which part of this sentence don’t you understand? You don’t think we care about our open society? You think this bubble fantasy, we’re just going to let it grow? Well, suck on this!” That, Charlie, is what this war was about.”

    If ever there was a Pulitzer category, “Pathological idiocy”…..N.Y.T……You’ve got the man.

  13. animalogic

    People like Friedman always raise this perennial question: are they knave or gull ? ( are they a cynical, calculating bastard or a greedy idiot ?) Or can you be both ? Does someone like TF knowingly continue sprouting his toxic nonsense for so long he comes to actually believe it ? Or does he and his CEO mates, between courses, laugh their guts up at the stupidity of the average NYT reader ?
    I suspect the later, but the man has such a tone of the “true believer” that greedy idiot also fits….

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