Global-warming skeptics like to point out the vanity of the idea that human activity can actually change the climate of the planet. If there is a significant change in average temperatures, skeptics argue, it comes from massive and unstoppable natural forces, not human activity. Skeptics also like to point out the inconsistency of climate-change fear-mongers, particularly the widespread fear of global cooling as recently as the late 1970s.

Green activists and global-warming skeptics alike might be surprised to learn that the idea of manmade climate change has been around in the United States since the middle of the nineteenth century. Much like today, this early wave of climate-change fever was vouched for by many prominent scientists and publications, and had many adherents among the general public. Instead of alarm and distress about the danger of climate change, though, in the later 1800s there was excitement and anticipation about what it portended for American agriculture. Although the two episodes differ in this important aspect—whether climate change was to be viewed as a bane or a boon—there is undoubtedly much to learn by examining the nature of nineteenth-century climate-change thinking and its impact on the U.S. economy.

The theories back then held that the high-plains region of the western United States was undergoing a secular increase in rainfall, changing from a semiarid to a humid climate. These theories turned out to be dead wrong and several prominent scientists dismissed them from the beginning. But that did not stop hundreds of thousands of people from making life-altering decisions and undertaking big investments based largely on the mistaken belief that human activity was changing the climate for the better.

The westward drive of American settlers during the 1800s was stunning in its scale, scope, and speed. Within a hundred years adventurous entrepreneurs and hardy pioneers, with some help from the U.S. military, had wrested control of the western frontier and turned it into a well-organized extension of the United States. Settlement proceeded apace, despite the fact that vast swaths of this land had, early in the century, been deemed barren and unfit for agriculture. Major Stephen H. Long, commissioned to explore and map the far western frontier, famously labeled the high plains—extending from roughly the 100th meridian (marking the eastern third of Kansas today) to the base of the Rocky Mountains—the “Great American Desert” in 1823.

Yet the agricultural frontier was approaching the high plains by the 1860s. The 1862 enactment of the Homestead Act, which offered 160 acres to anyone who would farm the land for five years and build a house, encouraged further settlement. Homesteading drew hundreds of thousands of settlers to this “free” land after the Civil War. Although Frederick Jackson Turner declared the frontier closed in 1890, homesteading continued up to the 1920s. Eventually 270 million acres of public domain were claimed.

Homesteading and Climate Change

As many astute commentators of the day noticed, and as thousands of ill-fated “sodbusters” would find out the hard way, 160 acres was far too small a plot of land for a farm to be sustainable and economically viable over the long-term on the high plains. The climate there is officially labeled semiarid, receiving far less rainfall on average than the midwestern states that most of the homesteaders came from. The rain that does come is highly variable. Some years are so wet that corn and wheat crops exceed midwestern yields, but randomly interspersed with these good years are droughts so severe that nothing at all can be grown. Despite this climatic challenge, and observations and reports detailing the difficulty of traditional agricultural methods and crop selections, homesteaders poured onto the high plains confident in the prospects of dryland farming.

The first wave of homesteaders to hit the high plains of western Nebraska and Kansas in the 1870s had lucked out, arriving during an extremely wet phase in the natural climate cycle. The farms did well initially, which prompted further waves of migration. But rather than discount the good years as extraordinary based on the long-term climate experience (going back at least 50 years to Major Long’s expedition and the accumulated knowledge of Plains Indians), settlers were beguiled by the idea of climate change, represented by the common nostrum that “rain follows the plow.” This doctrine held that human activity—in this case, cultivation of large tracts—would lead to a positive climate change in the form of increased rainfall. Economists Gary Libecap and Zeynep Hansen have noted:

[O]n the Kansas frontier, homesteaders relied upon predictions of climate change and increased rainfall due to cultivation. Webb [a Great Plains historian] labeled the notion that precipitation would rise with settlement as a “false hypothesis” that grew out of the intense desire of farmers for more rain. But rainfall initially was high as agriculture moved into the region, and observers lacked any compelling reason to deny its possible link to settlement.

In 1938 Frederic Clements, writing in Scientific Monthly, likewise reported the allure of climate-change theories:

With memories of grasshopper years in mind, pioneer and newcomer alike felt that drought and hard times had passed for good and that the future held nothing but timely rains and bountiful crops. This feeling was capitalized by those with lands to sell or commonwealths to build, and in good faith even men of science gave their support to the myth that the climate had permanently changed for the better as a result of settlement and cultivation.

Theories of increased rainfall attributed its possible causes to all sorts of human activity, from plowing of the soil, to irrigating it, to the planting of trees. Henry Nash Smith, founder of American Studies as an academic discipline, discussed one such theory as advocated by Ferdinand Hayden, a well-known geologist and western explorer:

[I]n 1867 [Hayden] triumphantly advanced a proposal which he believed would increase precipitation on the Plains permanently. Hayden’s scheme was simple: the planting of trees along the eastern edge of the treeless Plains. He believed he had seen experimental proof that trees would thrive there without artificial watering, and that in this fashion “forests may be restored to these almost treeless prairies in a comparatively short period of time.” Forests would bring rain: “The settlement of the country and the increase of the timber,” asserted Hayden, “has already changed for the better the climate of that portion of Nebraska lying along the Missouri, so that within the last twelve or fourteen years the rain has gradually increased in quantity and is more equally distributed through the year. I am confident this change will continue to extend across the dry belt to the foot of the Rocky Mountains as the settlements extend and the forest-trees are planted in proper quantities.”

Climate-Change Theories Published

Lending to their credibility, official government reports and major scientific journals published climate-change theories like Hayden’s. As Smith further pointed out,

[D]uring the decade 1865–1875 the idea of a permanent increase in rainfall gained much wider currency and was treated with respect by scientists of unquestioned professional standing. A communication setting forth theories of this type was, for example, accepted by Joseph Henry for publication in the Reports of the Smithsonian Institution; and similar ideas were discussed favorably at a meeting of the American Association for the Advancement of Science.

All the “rain follows the plow” believers were eventually disappointed by the cycles of severe drought normal for semiarid zones. But the early climate-change optimism, combined with terribly inadequate government land policies, set the stage for tremendous malinvestment, economic waste, and often a tragic and painful dislocation of population. In the journal Agricultural History (1977) Gilbert Fite gave details of the dislocations prompted by an 1890s drought:

Thousands of broke and starving settlers fled the region. Between 1890 and 1900 the population of western Kansas and Nebraska dropped sharply. There were 15,284 less people in the counties west of the 100th meridian in Nebraska in 1900 than a decade earlier and 6,018 fewer farms. Sixteen of South Dakota’s counties, mostly between the James and Missouri Rivers, lost population in that discouraging decade. Depopulation in the countryside also brought decline in the towns and villages and punctured the speculative plans of promoters and town-site boosters.

Clements likewise noted the massive depopulation brought on by the drought and the shaking of climate-change views: “Such beliefs [‘rain follows the plow’] were disturbed by the drought of 1889 and shattered for a generation by that of 1893–95, when the exodus from the parched regions sent a half million settlers across the Missouri River and back to their homes in the East.”

Similar waves of farm failure and farmer flight recurred after a region-wide drought in the early 1920s. Libecap and Hansen have noted that in eastern Montana, for instance, one-fifth of the homestead farms failed in the early 1920s, with 60,000 farmers packing up and leaving. Henry Smith reported contemporary observations of the economic hardship:

The seasoned plainsman, General William B. Hazen, asserted in 1875 that “dreadful suffering and almost starvation” had resulted from agricultural occupation of inadequately watered areas in Kansas under the influence of “the very popular theory” that the rainfall was undergoing a permanent increase. Fifteen years later the distinguished British geologist John W. Gregory, who had been conducting a study of artesian wells in the Dakotas for the United States Department of Agriculture, wrote in the Century magazine that large portions of the Plains had been thrice occupied by overconfident settlers and then abandoned because of drought. And as late as 1901 Willard D. Johnson of the United States Geological Survey pointed to the “vexing problem” created by “fruitless and demoralizing movements of population” into subhumid portions of the Plains under the mistaken belief that “a radical change of climate” was taking place.

The net result of a well-intentioned though terribly misguided government land policy, combined with a pseudo-scientific popular belief in climate change, was wasteful malinvestment in high plains farming on a grand scale. The 160-acre plots allowed by the original Homestead Act turned out to be far too small to support a dryland farm family over the long haul. Although the homestead size was doubled in 1909, 320-acre plots still proved inadequate; by the early 1980s, when most of the failed and marginal farmers had long since fled, average farm sizes had reached into the 1,200–2,500 acre range, according to Libecap and Hansen. Widely held and supposedly “scientific” ideas of climate change magnified the eventual problems. Indeed, the idea of a permanent increase in rainfall in the Great American Desert, though patently absurd from our vantage point, was nothing but a confirmation-biased rationalization of existing government policy and popular ideas about American development.

I don’t have the scientific knowledge or training to cast an authoritative judgment on the possibility of manmade global warming nor the efficacy of geoengineering. What I do know, however, is that most grandiose schemes to drastically remake the world, whether based on science or morality, have been tried before in some form or another and found wanting, sometimes with utterly disastrous consequences. More than a century ago, people were fooled by an unlucky coincidence of bad science and good weather into thinking that man could change earth’s climate. Today, we are again facing a string of weird weather coupled with highly dubious science proclaiming that man has it in his power to change—in our case, to wreck—the climate of the planet. Will we learn a lesson in patient skepticism in the face of “scientific” alarmists, or let them in their hubris lead us down a path of improvident and ultimately wasteful investments? I’m skeptical, not just about the very idea of manmade climate change, but also that we’ll be able to take the alarmist-crusaders’ calls for action with the grain of salt they deserve.

Related posts:

1. President Set Back on Climate-Change Deal
2. Troubles Confront Senate Climate-Change Bill
3. Climate Change: What if They’re Right?

Despite ample lip-service for “hope” and “change,” the Obama administration’s cynical response to the escalating drug prohibition-related violence around the Mexican border epitomizes Einstein’s oft-quoted observation.

Since 2008 more than 7,000 people—over 1,000 last January alone, including Mexican civilians, journalists, police, and public officials—have been killed in clashes with warring drug traffickers. Wire-service reports estimate that Mexico’s drug lords employ over 100,000 soldiers—approximately as many as the Mexican army—and that the cartels’ wealth, intimidation, and influence extend to the highest echelons of law enforcement and government. Where do the cartels get their unprecedented wealth and power? By trafficking in illicit drugs—primarily marijuana—over the border into the United States.

The U.S. Office of Drug Control Policy (more commonly known as the drug czar’s office) says more than 60 percent of the profits reaped by Mexican drug lords are derived from the exportation and sale of cannabis to the American market. To anyone who has studied the marijuana issue, this figure should come as no surprise. An estimated 100 million Americans age 12 or older—or about 43 percent of the country—admit to having tried pot, a higher percentage, according to the World Health Organization, than any other country on the planet. Twenty-five million Americans admit (on government surveys, no less) to smoking marijuana during the past year, and 15 million say that they indulge regularly. This high demand, combined with the drug’s artificially inflated black-market value (pot possession has been illegal under federal law since 1937), now makes cannabis America’s top cash crop.

In fact, according to a 2007 analysis by George Mason University professor Jon Gettman, the annual retail value of the U.S. marijuana market is some $113 billion.

How much of this goes directly to Mexican cartels is difficult to quantify, but no doubt the percentage is significant. Government officials estimate that approximately half the marijuana consumed in the United States originates from outside its borders, and they have identified Mexico as far and away America’s largest pot provider. Because Mexican-grown marijuana tends to fetch lower prices on the black market than domestically grown weed (a result attributed largely to lower production costs—the Mexican variety tends to be grown outdoors, while an increasing percentage of American-grown pot is produced hydroponically indoors), it remains consistently popular among U.S. consumers, particularly in a down economy. As a result, U.S. law officials now report that some Mexican cartels are moving to the United States to set up shop permanently. A Congressional Research Service report says low-level cartel members are now establishing clandestine growing operations inside the United States (thus eliminating the need to cross the border), as well as partnering with domestic gangs and other criminal enterprises. A March 23 New York Times story speculated that Mexican drug gangs or their affiliates are now active in some 230 U.S. cities, extending from Tucson, Arizona, to Anchorage, Alaska.

In short, America’s multibillion-dollar demand for pot is fueling the Mexican drug trade and much of the turf battles and carnage associated with it.

Same Old “Solutions”

So what are the administration’s plans to quell the cartels’ growing influence and surging violence? Troublingly, the White House appears intent on recycling the very strategies that gave rise to Mexico’s infamous drug lords in the first place.

In March the administration requested $700 million from Congress to “bolster existing efforts by Washington and Mexican President Felipe Calderón’s administration to fight violent trafficking in drugs . . . into the United States.” These efforts, as described by the Los Angeles Times, include: “vowing to send U.S. money, manpower, and technology to the southwestern border” and “reducing illegal flows (of drugs) in both directions across the border.” The administration also announced that it intends to clamp down on the U.S. demand for illicit drugs by increasing funding for drug treatment and drug courts.

There are three primary problems with this strategy.

First, marijuana production is a lucrative business that attracts criminal entrepreneurs precisely because it is a black-market (and highly sought after) commodity. As long as pot remains federally prohibited its retail price to the consumer will remain artificially high, and its production and distribution will attract criminal enterprises willing to turn to violence (rather than the judicial system) to maintain their slice of the multi-billion-dollar pie.

Second, the United States is already spending more money on illicit-drug law enforcement, drug treatment, and drug courts than at any time in our history. FBI data show that domestic marijuana arrests have increased from under 300,000 annually in 1991 to over 800,000 today. Police seizures of marijuana have also risen dramatically in recent years, as has the amount of taxpayer dollars federal officials have spent on so-called “educational efforts” to discourage the drug’s use. (For example, since the late 1990s Congress has appropriated well over a billion dollars in anti-pot public service announcements alone.) Yet despite these combined efforts to discourage demand, Americans use more pot than anyone else in the world.

Third, law enforcement’s recent attempts to crack down on the cartels’ marijuana distribution rings, particularly new efforts launched by the Calderón administration in Mexico, are driving the unprecedented wave in Mexican violence—not abating it. The New York Times states: “A crackdown begun more than two years ago by President Felipe Calderón, coupled with feuds over turf and control of the organizations, has set off an unprecedented wave of killings in Mexico. . . . Many of the victims were tortured. Beheadings have become common.” Because of this escalating violence, Mexico now ranks behind only Pakistan and Iran as the administration’s top international security concern.

Despite the rising death toll, drug war hawks at the U.S. Drug Enforcement Administration (DEA) remain adamant that the United States’ and Mexico’s “supply side” strategies are in fact successful. “Our view is that the violence we have been seeing is a signpost of the success our very courageous Mexican counterparts are having,” acting DEA administrator Michele Lionhart said recently. “The cartels are acting out like caged animals, because they are caged animals.” President Obama also appears to share this view. After visiting with the Calderón government in April, he told CNN he intended to “beef up” security on the border. When asked whether the administration would consider alternative strategies, such as potentially liberalizing pot’s criminal classification, Homeland Security Secretary Janet Napolitano replied that such an option “is not on the table.”

A New Remedy

By contrast the Calderón administration appears open to the idea of legalizing marijuana—or at least reducing criminal sanctions on the possession of small quantities of drugs—as a way to stem the tide of violence. Last spring Mexican lawmakers made the possession of personal-use quantities of cannabis and other illicit substances a noncriminal offense. And in April Mexico’s ambassador to the United States, Arturo Sarukhan, told CBS’s Face the Nation that legalizing the marijuana trade was a legitimate option for both the Mexican and U.S. governments. “[T]hose who would suggest that some of these measures [legalization] be looked at understand the dynamics of the drug trade,” Sarukhan said.

Former Mexican President Vicente Fox recently echoed Sarukhan’s remarks, as did a commission of former Latin American presidents. “I believe it’s time to open the debate over legalizing drugs,” Fox told CNN in May. “It can’t be that the only way [to try to control illicit drug use] is for the state to use force.”

Writing recently on CNN.com, Harvard economist and Freeman contributor Jeffrey Miron said that ending drug prohibition—on both sides of the border—is the only realistic and viable way to put a permanent stop to the rising power and violence associated with Mexico’s drug traffickers. “Prohibition creates violence because it drives the drug market underground,” he wrote. “This means buyers and sellers cannot resolve their disputes with lawsuits, arbitration or advertising, so they resort to violence instead. . . . The only way to reduce violence, therefore, is to legalize drugs.”

Growing Support

Americans’ support for legalizing the regulated production and sale of cannabis—an option that would not likely rid the world of cartels, but would arguably reduce their primary source of income—is at all an all-time high. In May a national Zogby telephone poll of 3,937 voters by the Republican-leaning O’Leary Report discovered, for the first time ever, that a slight majority (52 percent) of Americans “favor the legalization of marijuana.” A separate Zogby poll reported even stronger support (58 percent) among west-coast voters.

Predictably, critics of marijuana legalization claim that such a strategy would do little to undermine drug traffickers’ profit margins because cartels would simply supplement their revenues by selling greater quantities of other illicit drugs. Although this scenario sounds plausible in theory, it appears to be far less likely in practice.

As noted, Mexican drug lords derive an estimated 60 to 70 percent of their illicit income from pot sales. (By comparison, only about 28 percent of their profits are derived from the distribution of cocaine, and less than 1 percent comes from trafficking methamphetamine.) It is unrealistic to think that cartels could feasibly replace this void by stepping up their sales of cocaine, methamphetamine or heroin—all of which remain far less popular among U.S. drug consumers anyway. Just how much less? U.S. Department of Health and Human Services survey data show that roughly two million Americans use cocaine, compared to 15 million for pot. Fewer than 600,000 use methamphetamine, and fewer than 155,000 use heroin. In short, this is hardly the sort of demand that would keep Mexico’s drug barons in the lucrative lifestyle to which they’ve become accustomed.

Of course, it’s unrealistic to think that pot legalization would wipe out prohibition-inspired violence altogether. After all, ending alcohol prohibition in America didn’t single-handedly put the Mafia out of business (though it greatly reduced its power and influence). And it’s always possible that Mexico’s drug cartels would continue to engage in violent acts toward one another as competing factions fought over the crumbs of America’s drastically shrunken illicit-drug market.

That said, it’s equally unrealistic, if not more so, to think that continuing our same failed drug war policies will do anything but exponentially increase the catastrophe they’ve spawned, both in Mexico and at home. It’s time to engage in a different strategy. It’s time to seriously consider legalizing marijuana and other drugs.

Related posts:

1. What The Drug Warriors Have Given Us
2. The War Against Drug-Speech
3. Book Review ~ Why Our Drug Laws Have Failed and What We Can Do About It

In contrast, many Austrian economists reject both forms of intervention. They argue that the free market would respond in the most efficient manner possible after a major disruption (such as the 1929 stock market crash or the housing bubble in our own times). As we shall see, the U.S. experience during the 1920–1921 depression—one that the reader has probably never heard of—is almost a laboratory experiment showcasing the flaws of both the Keynesian and monetarist prescriptions.

The 1929–1933 Great Contraction

Despite what many readers undoubtedly “learned” in their history classes as children, Herbert Hoover behaved like a textbook Keynesian following the 1929 stock market crash. In conjunction with Treasury Secretary Andrew Mellon, Hoover achieved an across-the-board one percentage point reduction in income tax rates applicable to the 1929 tax year.

Hoover didn’t stop with tax cuts to bolster “aggregate demand”—though analysts at that time would not have used the term. He also signed into law massive increases in the federal budget, with fiscal year (FY) 1932 spending rising 42 percent above 1930 levels. Hoover ran unprecedented peacetime deficits, which stood in sharp contrast to his predecessor Calvin Coolidge, who had run a budget surplus every year of his presidency. In fact, in the 1932 election FDR campaigned on a balanced budget and excoriated the reckless spending record of the Republican incumbent.

It wasn’t merely that Hoover spent a bunch of money. He spent it on just the types of things that we associate today with Roosevelt’s New Deal. For example, he signed off on numerous public-works projects, including the Hoover Dam. Of particular relevance today is the Reconstruction Finance Corporation (RFC) established under Hoover, which quickly injected more than $1 billion to prop up troubled banks that had made bad loans during the boom years of the late 1920s—and this was when $1 billion really meant something.

It is true that Hoover eventually blinked and raised taxes in 1932, in an effort to reduce the federal budget deficit. Today’s Keynesians point to this move as proof that reducing deficits is a bad idea in the middle of a depression. Yet an equally valid interpretation is that it’s horrible to hike tax rates in the middle of an economic disaster. After the bold tax cuts pushed through by Andrew Mellon in the 1920s, the top marginal income-tax rate in 1932 stood at 25 percent. The next year, because of Hoover’s desire to close the budget hole, the top income tax rate was 63 percent. Given this extraordinary single-year rate hike, it is no wonder that 1933 was the single worst year in U.S. economic history. (For what it’s worth, the FY 1933 budget deficit was still huge, coming in at 4.5 percent of GDP. Despite the huge rate hikes, federal tax revenues only increased 3.8 percent from FY 1932 to FY 1933.)

So we see that the standard Keynesian story, which paints Herbert Hoover as a do-nothing liquidationist, is completely false. Yet Milton Friedman’s explanation for the Great Depression is almost as dubious. Following the stock market crash, the New York Federal Reserve Bank immediately slashed its discount rate—how much it charged on loans—in an attempt to provide relief to the beleaguered financial system. The New York Fed continued to slash its discount rate over the next two years, pushing it down to 1.5 percent by May 1931. At that time, this was the lowest discount rate the New York Fed had ever charged since the establishment of the Federal Reserve System in 1913.

It wasn’t merely that the Fed (along with other central banks around the world) was charging an unusually low rate on loans it advanced from its discount window. The entire mentality of central bankers was different during the early years of the Great Depression. Writing in 1934, Lionel Robbins first noted that during previous crises, the solution had been for central banks to charge a high discount rate to separate the wheat from the chaff. Those firms that were truly solvent but illiquid would be willing to pay the high interest rates on central-bank loans to get them through the storm. Firms that were simply insolvent, on the other hand, would know the jig was up because they couldn’t afford the high rates. Yet this tough love was not administered after the 1929 crash, as Robbins explained: “In the present depression we have changed all that. We eschew the sharp purge. We prefer the lingering disease. Everywhere, in the money market, in the commodity markets and in the broad field of company finance and public indebtedness, the efforts of Central Banks and Governments have been directed to propping up bad business positions.”

We therefore see an eerie pattern. When it came to both fiscal and monetary policy during the early 1930s, the governments and central banks implemented the same strategies that the sophisticated experts recommend today for our present crisis. Of course, today’s Keynesians and monetarists have a ready retort: They will tell us that their prescribed medicines (deficits and monetary injections, respectively) were not administered in large enough doses. It was the timidity of Hoover’s deficits (for the Keynesians) or the Fed’s injections of liquidity (for the monetarists) that caused the Great Depression.

The 1920–1921 Depression

This context highlights the importance of the 1920–1921 depression. Here the government and Fed did the exact opposite of what the experts now recommend. We have just about the closest thing to a controlled experiment in macroeconomics that one could desire. To repeat, it’s not that the government boosted the budget at a slower rate, or that the Fed provided a tad less liquidity. On the contrary, the government slashed its budget tremendously, and the Fed hiked rates to record highs. We thus have a fairly clear-cut experiment to test the efficacy of the Keynesian and monetarist remedies.

At the conclusion of World War I, U.S. officials found themselves in a bleak position. The federal debt had exploded because of wartime expenditures, and annual consumer price inflation rates had jumped well above 20 percent by the end of the war.

To restore fiscal and price sanity, the authorities implemented what today strikes us as incredibly “merciless” policies. From FY 1919 to 1920, federal spending was slashed from $18.5 billion to $6.4 billion—a 65 percent reduction in one year. The budget was pushed down the next two years as well, to $3.3 billion in FY 1922.

On the monetary side, the New York Fed raised its discount rate to a record high 7 percent by June 1920. Now the reader might think that this nominal rate was actually “looser” than the 1.5 percent discount rate charged in 1931 because of the changes in inflation rates. But on the contrary, the price deflation of the 1920–1921 depression was more severe. From its peak in June 1920 the Consumer Price Index fell 15.8 percent over the next 12 months. In contrast, year-over-year price deflation never even reached 11 percent at any point during the Great Depression. Whether we look at nominal interest rates or “real” (inflation-adjusted) interest rates, the Fed was very “tight” during the 1920–1921 depression and very “loose” during the onset of the Great Depression.

Now some modern economists will point out that our story leaves out an important element. Even though the Fed slashed its discount rate to record lows during the onset of the Great Depression, the total stock of money held by the public collapsed by roughly a third from 1929 to 1933. This is why Milton Friedman blamed the Fed for not doing enough to avert the Great Depression. By flooding the banking system with newly created reserves (part of the “monetary base”), the Fed could have offset the massive cash withdrawals of the panicked public and kept the overall money stock constant.

But even this nuanced argument fails to demonstrate why the 1929–1933 downturn should have been more severe than the 1920–1921 depression. The collapse in the monetary base (directly controlled by the Fed) during 1920–1921 was the largest in U.S. history, and it dwarfed the fall during the early Hoover years. So we hit the same problem: The standard monetarist explanation for the Great Depression applies all the more so to the 1920–1921 depression.

The Results

If the Keynesians are right about the Great Depression, then the depression of 1920–1921 should have been far worse. The same holds for the monetarists; things should have been awful in the 1920s if their theory of the 1930s is correct.

To be sure, the 1920–1921 depression was painful. The unemployment rate peaked at 11.7 percent in 1921. But it had dropped to 6.7 percent by the following year, and was down to 2.4 percent by 1923. After the depression the United States proceeded to enjoy the “Roaring Twenties,” arguably the most prosperous decade in the country’s history. Some of this prosperity was illusory—itself the result of subsequent Fed inflation—but nonetheless the 1920–1921 depression “purged the rottenness out of the system” and provided a solid framework for sustainable growth.

As we know, things turned out decidedly differently in the 1930s. Despite the easy fiscal and monetary policies of the Hoover administration and the Federal Reserve—which today’s experts say are necessary to avoid the “mistakes of the Great Depression”—the unemployment rate kept going higher and higher, averaging an astounding 25 percent in 1933. And of course, after the “great contraction” the U.S. proceeded to stagnate in the Great Depression of the 1930s, which was easily the least prosperous decade in the country’s history.

The conclusion seems obvious to anyone whose mind is not firmly locked into the Keynesian or monetarist framework: The free market works. Even in the face of massive shocks requiring large structural adjustments, the best thing the government can do is cut its own budget and return more resources to the private sector. For its part, the Federal Reserve doesn’t help matters by flooding the shell-shocked credit markets with green pieces of paper. Prices can adjust to clear labor and other markets soon enough, in light of the new fundamentals, if only the politicians and central bankers would get out of the way.

Related posts:

1. The Great Depression According to Milton Friedman
2. The Great Depression and World War II
3. The Great Depression

To be sure, financial firms leveraged up—that is, they did a lot of business with borrowed money. That juiced up revenues and bonuses in the boom—and exacerbated losses in the downturn. Selling notes based on questionable mortgages as collateral was one method for tapping into the money sloshing around.

Without abundant credit, it would not have been possible to borrow so much and in so many different ways. Banks create credit but are subject to myriad controls by the Federal Reserve System. Money was plentiful because of Fed policy.

Politicians, pundits, and the Obama administration want to impose new regulation on the financial system, giving wider powers to government agencies. Depending on how and to what extent they implement that agenda, the Federal Reserve—alongside other agencies like the Securities and Exchange Commission—stands to gain greater authority. Hence the Fed’s track record is a timely and pertinent subject.

Although the institution now commands unquestioning acceptance, its inception was controversial. Richard Timberlake, in his history of monetary policy in the United States, quotes a congressman shortly after the 1913 passage of the law that created the Federal Reserve System: “This act establishes the most gigantic trust on earth, such as the Sherman Antitrust Act would dissolve if Congress did not by this Act expressly create what by that Act it prohibited.”

That gigantic trust has correspondingly gigantic effects on the economy, through multiple roles and powers. As overseer of ordinary banks the Fed makes sure they play by the rules. As lender of last resort it can keep banks going through cash-flow problems. Beyond its supervision of individual banks the Fed pursues economy-wide goals.

It operates various levers that reduce or expand the supply of money and credit. In what is generically called monetary policy, the Fed uses the levers to boost a drooping economy—as is happening at present—or cool down an overheated one. In theory those efforts benefit society at large.

In reality—well, let’s take a look at the 1930s and our own time to understand the Fed’s role in the two most dramatic financial crises of living memory.

Stability Found and Lost

Two seminal insights emerged from the path-breaking A Monetary History of the United States, 1867–1960 (1963) by Milton Friedman and Anna Schwartz. They argued that the Federal Reserve worsened the banking collapse of the 1930s and probably killed off a potential recovery by tightening money. In reaction to a drain on U.S. gold reserves, the Fed clamped down on an already shrinking money supply, thereby turning an ordinary recession into what came to be known as the Great Depression.

Current Fed Chairman Ben Bernanke agrees with that conclusion and is certainly not repeating the mistake. He has eased money in every way it can be eased.

But Friedman and Schwartz offered a broader lesson as well. They showed that the stock of money became subject to greater fluctuations after the Fed took over the control of money from the gold standard system. “The blind, un-designed, and quasi-automatic working of the gold standard turned out to produce a greater measure of predictability and regularity—perhaps because its discipline was impersonal and inescapable—than did deliberate and conscious control exercised within institutional arrangements intended to promote monetary stability,” Friedman and Schwartz wrote.

By the late twentieth century it looked as though central bankers had taken this criticism to heart. They had reason to congratulate themselves on what was called the Great Moderation. Since the mid-1980s both prices and output growth had been reassuringly stable. In a 2004 speech Bernanke argued that this was primarily due to improved monetary policy, although economic change and plain old luck also may have played a role, too.

At that time Bernanke was not yet Fed chairman, but he was a member of the board of governors, a position he held from 2002 to 2005. Current Treasury Secretary Tim Geithner was president of the New York Federal Reserve Bank from 2003 until this year. These facts are worth recalling because there is a tendency to concentrate the blame on former chairman Alan Greenspan. But whatever one thinks of Greenspan, the officials who currently make policy were there with him as the Fed sowed the seeds of financial crisis.

In retrospect those seeds were already discernible in the late 1990s. The steep rise in housing prices had started, encouraged by a stock bubble that created the illusion of wealth. In 1998 the Fed eased interest rates several times in response to panic after Russia defaulted on its bonds and the related near-failure of a large hedge fund, Long-Term Capital Management. This policy reassured investors, who subsequently bid up share prices to the stratosphere in 1999 even as the Fed reversed course.

The stock bubble burst in early 2000, and the economy stalled. Interest-rate cuts are prescribed and expected in a recession, so it is no surprise that the Fed took that course. But even after the economy recovered, rates stayed exceptionally low in comparison to what they would have been by the standard of the Great Moderation.

Stanford University economist John Taylor has used a measure known as the Taylor Rule to demonstrate that monetary excess lasted several years, into 2006. The title of Taylor’s new book says it all: Getting Off Track: How Government Actions and Interventions Caused, Prolonged, and Worsened the Financial Crisis.

Not everybody agrees that monetary policy was loose during the Greenspan era. David Henderson and Jeffrey Rogers Hummel argued in the March issue of The Freeman that monetary policy was not expansionist from 2001 to 2006 as measured by the declining growth of monetary aggregates. The Taylor Rule, however, allows the comparison of two periods—and the federal funds rate was lower in the 2000s than in the 1980s.

Another explanation of the monetary excess, endorsed by Bernanke and Greenspan, is that there was a global glut of savings. But Taylor shows that worldwide there was no such glut because the surplus savings in Asia and the Middle East were offset by a savings gap in other countries, in particular the United States.

It is fair to say that most of us partook of the Fed’s generous punch, whether by running up credit-card debt, buying houses beyond our means, trading with borrowed money, or making 30 percent on exotic debt instruments. Monetary excess meant that borrowing was easy; mortgages were to be had for a song. Housing prices rose at amazing rates year after year. With the hazard of price declines out of sight and out of mind, homeowners, developers, and banks overextended themselves.

It was an extraordinary boom; hence the following bust was also extraordinary. In effect, the stability of the 1980s Great Moderation was over by the time Bernanke credited monetary policy for fostering that stability.

What Failed

The bubble-and-collapse sequence is now attributed to a failure of capitalism, to use the title of a new book by Richard Posner, a judge and prolific author. According to a widely held view, the private financial system is intrinsically unstable, with leverage a central element in its penchant for self-destruction. Had the system been properly regulated and restrained, it would not have gone haywire. Hence whatever is not sufficiently regulated should be nailed down to avoid similar disasters in the future. Much of the media reflects that view.

And yet the Fed and the Securities and Exchange Commission (SEC) between them already have massive regulatory powers over banks and broker-dealers, including investment banks. What is more, they and other agencies were part of the President’s Working Group on Financial Markets, set up after the crisis of 1998 to deal with systemic risk—the kind of danger that came up so frequently in 2007–2008.

Despite all the regulatory powers, a crisis broke out. Posner may represent current conventional wisdom when he writes that the government’s myopia, passivity, and blunders played a critical role in allowing the recession to balloon, but there would have been a crisis anyway regardless of those shortcomings.

The alternative view, represented by Taylor (following in the footsteps of Ms. Schwartz and the late Mr. Friedman), is that monetary policy turned what might have been mild cyclical fluctuations into a big bubble, inevitably leading to a big collapse. No easy money, no crisis.

Regarding the central bank’s multiple functions, its stance in the supervision of individual banks appears to have been of a piece with its broader policy. The Fed as overseer of banks could have demanded that they reduce their use of leverage, but the Fed as maker of monetary policy was providing the wherewithal for that leverage.

Hence the let-them-leverage regulatory stance was not accidental or myopic; it was consistent with deliberate monetary policy. If policymakers were concerned about the galloping credit expansion, they should not have let money go loose in 2003–2006. Lacking such concern, the Fed had no reason to get banks to reduce their risk. The whole institution took this track, not just Alan Greenspan.

Controlling or Creating Risk?

There’s no question private action results in economic cycles, largely because human beings have mental biases that keep them focused on the near term. The key point, though, is that even the largest private actor does not have the impact of the gigantic banking trust. Monetary policy is system-wide; policy mistakes have ramifications across the economy.

So the Fed by itself can create systemic risk, even as people call for expanding its powers to control the systemic risk posed by market participants like banks and hedge funds.

The Fed actively implemented measures that destabilized the system in the 1930s and again in the 2000s, albeit in different ways. The mistake was different—back then the Fed tightened in a downturn; this time it kept money too loose in an upturn. But there was the same fundamental consequence of financial and economic instability.

Timberlake thus summarized the Federal Reserve’s track record: “It comes across as a prototypical governmental institution operating under the rule of men rather than the rule of law.” To prevent misguided monetary interventions, the discretion of the people who run the institution should be limited.

Friedman argued for rule-based monetary policy, specifically that the Fed should follow a rule to keep the money supply growing steadily at a fixed rate of 3 to 5 percent a year. This turned out to be difficult to implement, given that the money supply and its relation to the economy are complicated.

This is where the Taylor rule, which describes actual policy during the Great Moderation, comes in. Taking that policy as a template, the Fed can set the short-term interest rate in accordance with a constant formula based on inflation and output.

Compared to Friedman’s fixed rate, the formula is more flexible.  But it keeps interest-rate policy predictable and transparent. If followed consistently, rule-bound monetary policy, combined with proper enforcement of existing regulations for banks and broker-dealers, would prevent the excesses seen in recent years.

Government Intelligence and the Nirvana Fallacy

Instead, what’s being advocated is broader activity by policymakers. Posner, for instance, draws the conclusion that “we need a more active and intelligent government to keep our model of a capitalist economy from running off the rails.” It is interesting that he sees a need not just for more-active government but more intelligent government. If government action has not been intelligent in the past, why expect it to be intelligent in the future?

We’re talking about institutions with overarching powers that have caused a variety of harms, from deliberate Fed policies that created instability to the SEC’s inability to detect fraud even after being told about it, misleading investors into believing that all was well with Bernard Madoff. (See my May Freeman article on the Madoff case) If there is more government activity of this sort, there will be even worse disasters.

One way to prevent another round of government-made debacles would be to replace the central bank with market-based money, thereby imposing an impersonal discipline—to use the words of Friedman and Schwartz. But following the Taylor Rule is a more likely solution, since it serves the goal Fed officials themselves say they want to pursue, namely, more predictable and transparent policy.

Those calling for greater interventionism tend not to engage the issue of what the government does in reality. There is a presumption that regulation is the cure-all, even as we live through the effects of a systemic policy failure. Economist Robert Solow, in a review of Posner’s book, writes that Panglossian ideas about “free markets” encouraged lax or no regulation of a potentially unstable financial apparatus.

When you consider the actual role of the Federal Reserve in crises, it is the notion of government activism as the solution to financial uncertainty and fluctuations that comes across as Panglossian.

Related posts:

1. Interest Rates and the Federal Reserve
2. The Federal Reserve System
3. Banking Before the Federal Reserve: The U.S. and Canada Compared

Her colleagues at Indiana University describe Ostrom as “humble and hardworking,” and another Nobel Prize winner, Vernon Smith, calls her a “remarkable scholar” with a passionate drive to understand human societies in all their variety. A former president of the Public Choice Society and the American Association of Political Science, Ostrom is also one of the most beloved teachers in academia. The Workshop in Political Theory and Policy Analysis at Indiana University that she co-directed with her husband, Vincent, is perhaps the ideal model for a research and graduate education center.

But what do we learn from her studies? I would argue that we learn at least three major points of style and substance. First, much of the last century of political and economic discourse has been dominated by a debate between advocates of perfect markets and perfect central planners. The latter strove to demonstrate market failure, then would insist that government would provide the necessary corrective. Ostrom was one of the core thinkers in the social sciences to say, “Hold on. Markets may fail, but government solutions also might not work.” One must always remember that Elinor and Vincent Ostrom are foundational contributors to the theory of Public Choice. But the Ostroms went further than simply demonstrating the possibility of government failure.

Rules In Use

This leads to the second point. In the history of political and economic thought the source of social order has been attributed either to the invisible hand of market coordination (Adam Smith) or the heavy hand of state control (Hobbes). Perhaps one of the best ways to understand Elinor Ostrom’s work is to see it as working out a Hobbesian problem by way of a Smithian solution. That is perhaps a bit of a stretch but not by much. Her work on local public economies and common-pool resources focuses on actual “rules in use” (as opposed to the “rules in form”) that decentralized individuals and groups rely on to make decisions and to coordinate their behavior in order to overcome social dilemmas. It yields an optimistic message about the power of self-governance to succeed even in difficult situations. As my colleague Alex Tabarrok put it, Ostrom sees how, through various voluntary associations, groups transform the common-pool resource situation from a “tragedy of the commons” to an “opportunity of the commons.”

Traditional economic theory argues that public goods cannot be provided through the market. Traditional Public Choice theory argues that government often fails to provide solutions. Ostrom shows that decentralized groups can develop various rule systems that enable social cooperation to emerge through voluntary association.

A point that sometimes trips up readers is that Ostrom often focuses on situations where the technology of parceling property into private plots does not exist. In these situations she studies collective, but non-State decision-making over common-pool resources. While private-property solutions are not employed in such cases, the “rules in use” that do operate accomplish what private property would have accomplished. We find rules that limit access and that make individuals in the group accountable for their misuse of the resource. We also find enforcement of those rules. In short, the analyst must be willing to look at both the form and function of rules in a variety of social situations.

Local Solutions for Local Problems

Diverse institutions at work in different societies promote voluntary cooperation. As social scientists, we have to be able to understand them. There are rules that are in use, rules that are stated but not in use, rules that go by one name but that in practice do something else, and rules that tightly fit use, form, and function. Ostrom has insisted that social scientists must understand the rules that govern human behavior—both the way we interact with one another and the way we interact with nature. Some rules systems promote human betterment through the promotion of peaceful social cooperation and wealth creation; others thwart human progress by ensuring violence and poverty. It is actually that simple, and that profound.

The foundation of the social order of a free people is self-governance, not governmental authority and centralized power. Decentralized decision making that drills deep into the local social dilemmas real people face, that mobilizes incentives within a local rule structure, and that utilizes local knowledge is how the process of institutional development assures that self-governance is effective governance, enabling fallible human beings to reasonably manage scarce resources and the relationships among themselves.

The final point I want to stress concerning Ostrom’s research comes as a methodological message. Her work is humanistic and scientific. She is trying to understand human societies in all their variety. To do so she had to get up close and personal: from local government in California to irrigation systems in Nepal—and everything in between. Her field work in economics and political economy is guided by the logic of human choice. She describes her research program as “a behavioral approach to the rational choice theory of collective action.” If you take away the academic language, it translates into a research program that begins with human beings and their purposes and plans, and ends with their stumbling and groping to find voluntary solutions to difficult social dilemmas through norms, conventions, and rules.

A Message of Hope

Let me conclude by bringing this back to my title: Why should people who care about liberty rejoice in this choice for the prize? There is an ideological importance to the work of Elinor Ostrom. She has not stressed it in her work, but Vincent has ventured into the field of social philosophy. My favorite book of his is The Meaning of Democracy and the Vulnerabilities of Democracies (1997). In that work Vincent inquires into the preconditions for a self-governing citizenry. A self-governing society, he says, must be composed of citizens fully capable of embracing the “cares of thinking and the troubles of living.” Unfortunately, the machinations of democratic politics—with interest-group manipulation, logrolling, rent-seeking, and the vote motive—tend to undermine the capacity for self-governance among a people.

Nothing in this should be interpreted as deterministically pessimistic. The message is that hope is to be found not in the State but in the people. A society of free and responsible individuals who are able to form voluntary associations will solve the social dilemmas they confront through various means of self-governance.

A Diverse World of Associations

Nobody has done more than Elinor Ostrom, both in her research and in her teaching/mentor capacity at the Workshop in Political Philosophy and Policy Analysis, to help us understand the self-governing rules and institutions that work to elicit cooperation in a wide variety of societies. And nobody has done more to alert us to the damage governments can do when they attempt to impose alien rules on local peoples from afar—especially when their own systems are already addressing social dilemmas in their own way. Elinor demands that we understand and respect institutional diversity in our world, to see the ingenuity and wisdom in local solutions and in the entrepreneurial creativity and resourcefulness of individuals throughout the developed and less-developed world. Transcending the older debates in social science and public policy, Elinor Ostrom’s work emphasizes the richness of the institutional environment and the creative solutions that arise when individuals are free to form associations and work within a network of informal rules that promote individual responsibility and collective accountability.

Supporters of FEE and readers of The Freeman are attracted to the vision of a society of free and responsible individuals. Elinor Ostrom’s research gives us a window into the diverse world of associations that do not fit neatly into the categories of “market” or “State” but nevertheless are essential to peaceful and prosperous social cooperation.

Related posts:

1. Elinor Ostrom’s Nobel Prize in Economics
2. Who Deserved the Nobel Prize?
3. The 1975 Nobel Memorial Prize in Economics: Some Uncomfortable Reflections

“Nudged” by federal policy, the previous owners accepted a handsome payment from the rest of us for ridding the nation of older, more heavily carbon-emitting vehicles and replacing them with shiny new machines that required a lot of energy to produce but would, on average, yield lower carbon exhaust and greater fuel efficiency. The clunker statute gave consumers $3,500 vouchers if they purchased vehicles that yielded a four- to nine-miles-per-gallon (MPG) improvement in fuel economy, and $4,500 if the yield was ten or more MPG.

In all, according to Bloomberg, some $2.88 billion in tax money helped buy some 700,000 vehicles made up of the popular Ford Focus, Toyota Corolla, Camry, and Prius, along with some Hummers and Ford F-150 and F-250 trucks. These and a wide variety of other cars and trucks moved quickly from dealer lots to the homes of the blessed. In fact, the speed of the transactions was more than government could handle. The program was wildly popular.

Taken together the trade-ins had an average fuel economy of 15.8 MPG, while the replacements averaged 24.9 MPG. And according to Ford Motor Company, this kind of fuel-economy improvement translates to a reduction of five to ten million barrels of oil consumed over the next five years. (The nation currently consumes nine million barrels a day.) This will be oil that some other people can enjoy.

President Obama cheerfully termed the program “successful beyond anybody’s imagination.” Secretary of Transportation Ray LaHood, who administered the program, said the effort was “a lifeline to the automobile industry, jump starting a major sector of the economy and putting people back to work.” LaHood quickly added that while all this happened, “[W]e’ve been able to take old, polluting cars off the road and help consumers purchase fuel-efficient vehicles.” Economist John Lott surmised that “Only in Washington could a program that is spending money 13 times faster than was planned be labeled a ‘success.’”

Long-Term Costs

Obama’s Council of Economic Advisers (CEA) predicted the economy would be spurred as the auto industry geared up to meet inspired demand.

The program was predicted to raise third-quarter GDP 0.3–0.4 of a percentage point and lift year-end employment by 42,000. August auto sales did indeed reach to the sky, but September sales plunged back into the basement again. The program stole sales from the future; it did not fertilize future sales.

Considering final costs, there’s serious doubt that the program was successful even in the short term. The doubt arises for at least three reasons. First, the program got political support primarily for its much-touted environmental benefits. Carbon emissions would be reduced—but at about ten times the cost of alternate ways of removing carbon. Second, there is Bastiat’s parable of the broken window to consider. And third, there is a serious matter of eroding social norms for conserving wealth. A crushed clunker with a frozen engine is lost capital.

Let’s consider each of these points.

University of California-Berkeley economist Christopher Knittel developed a rigorous assessment of the implied cost of carbon emissions under the clunker program (“The Implied Cost of Carbon Dioxide Under the Cash for Clunkers Program,” www.tinyurl.com/mrmtuy). Knittel made plausible assumptions about the average life remaining in vehicles removed from the road, the average fuel economy associated with those vehicles, and the resulting levels of carbon emission that would have survived in the absence of clunkers. Eventually, of course, the clunkers would have died a natural but less dramatic death. Knittel then estimated the carbon reduction gained by replacing the large fleet of clunkers with a new fuel-efficient fleet. When he ran the numbers, Knittel found the cost per ton of carbon reduced could reach $500 under a set of normal values for critical variables. That fell to $237 per ton under best-case conditions. And what does this tell us? The much celebrated Waxman-Markey cap-and-trade carbon-emission control legislation estimates it costs $28 to reduce a ton of carbon across U.S. industries. Yes, we are getting carbon-emission reductions by way of clunker reduction, but we are paying a pretty penny for it.

Frédéric Bastiat’s brilliant parable of the broken window reminds us that a street hoodlum throwing a brick through a window generates a series of job-generating transactions that might raise GDP by a trivial amount, if it could be measured. Indeed, the idea seems so compelling that people today often speak of the silver lining found in the clouds that create hurricanes. Think of the roofers that become employed.

But Bastiat’s key lesson is that a window has been destroyed—and it had value. Before touting the total benefits of the program we must take account of the destroyed vehicles and engines that represented part of the wealth of the nation. As Tony Liller, vice president for Goodwill, put it: “They’re crushing these cars, and they’re perfectly good. These are cars the poor need to buy.”

Finally, over the eons, human communities have contrived all kinds of devices to transmit critical survival skills and compatible behavioral norms. One of these has to do with conservation of wealth. “Waste not, want not,” we are told. “A penny saved is a penny earned,” we are reminded. Using politics to pay people to destroy valuable vehicles, or to hold crops off the market, or to produce ethanol that may use more energy in production than it adds when burned, teaches a lesson of anti-matter and wealth destruction. Considering all this, Cash for Clunkers sounds like a sorry idea that should not be the model for future policy.

Even though a sorry idea, the Obama administration will soon go forward with a cash for old refrigerators program. Unlike the clunkers program, the appliance plan will not require destruction of the old refrigerators and other items involved. The transaction costs are just too high. Nevertheless, let’s stop Cash for Refrigerators before the idea spreads further.

Related posts:

1. The “I Hate the Poor” Act of 2009
2. Why Not Pay Cash?
3. The Cash Nexus: Money and Power in the Modern World, 1700-2000

Those perceptions have changed now that the Chrysler and GM bankruptcies have set a new standard for the fast resolution of some complex if dubious transactions. So troublesome questions arise: Did these transactions comply with the rule of law? Were the property rights of the secured creditors fully protected in the expedited proceedings? Will the process bring confidence to the credit markets? No, no, and no again. Those three “nos” come as no surprise. The basic classical liberal position is right to insist that the government cannot sensibly occupy the roles of market participant and market regulator simultaneously. All else is detail.

The Downward Spiral

The Chrysler and GM bankruptcies have both remote and proximate causes. The backstory starts 50 years ago with two major developments that sealed the long-term fate of the domestic automobile industry. First the strong union contracts negotiated under the National Labor Relations Act of 1935 enabled the unions to parlay strike threats into rich deals during the 1970s that promised a bonanza to their then-present and -retired workers. Similarly, the large dealer network of the former Big Three, which may have made sense in the 1950s, became entrenched by state dealer-franchise statutes. The joyride could not last. Detroit’s foreign competitors have lean dealer networks and no unions. It was only a matter of time before those foreigners flexed their economic muscle, at which point the Detroit companies lost market share, shed employees, and accrued massive retiree obligations.

Businesses this fragile cannot survive any external shock, especially the huge meltdown of September 2008. By March 2009 GM had about 61,000 unionized employees in the United States and over 500,000 retirees and their dependents in their various pension and healthcare plans. The liquidation value of its assets was estimated at about $8 billion against stated debts of $172 billion. Not viable. Chrysler was also under water but less so. Neither the Bush nor the Obama administration, however, was prepared to bite the bullet and let the bankruptcy courts slim down these bloated dinosaurs. Instead both administrations opted for billions in cash infusions in the desperate hope of keeping the bankruptcy wolves from the door. The unions for their part gave back some of their perks, including full pay for workers sitting idly on call in stuffy waiting rooms for jobs that would never return. Alas, the rigid bargaining structures with unions made these concessions both too little and too late. But once the Troubled Asset Relief Program (TARP) kicked in, Treasury doled out about $50 billion to keep GM afloat and about $4 billion to do the same for Chrysler.

The Bankruptcy Maneuvers

By early 2009 it was clear that more desperate measures were needed. Two political bankruptcies were the answer. The Chrysler and GM deals have much in common, but the Chrysler deal was more complex and more high-profile, so let’s start with it. Once it became clear that Chrysler could not operate as a stand-alone company, Treasury wooed the Italian automaker Fiat to take a stock position in the company, not for cold cash but for access to small-car technology and some international markets. For these intangibles it received between 20 and 35 percent of New Chrysler, depending on whether New Chrysler reaches certain milestones.

On many points, however, the two deals moved roughly in common. One key action was to keep the United Auto Workers’ (UAW) retiree benefits in play but to cut down on the dealership contracts. Some jujitsu was needed. Recall that the three basic bankruptcy options are liquidation, reorganization, and sale. The Chrysler numbers tell the story. A government expert witness testified that Chrysler was worth only $800 million if liquidated but could be worth as much as $2 billion if sold off intact to another firm. Under the standard bankruptcy rules the proceeds of that sale would be distributed according to a strict priority by claim type. Secured creditors, including the bondholders, come ahead of unsecured creditors, including union health and retirement funds. Without some fancy high-stepping it followed that a simple sale of the assets of the company for the indicated $2 billion would leave the secured creditors a bit under 30 cents on the dollar for their $6.5 billion in aggregate claims but wipe out all future contributions to the union retiree funds. Not good, thought the Obama administration.

To boost the UAW’s fortunes, Chrysler had to be “sold.” But under what rules? By conscious design the bidding was organized in a unique way. The UAW was given a seat at the table to figure out the conditions that would attach to a permissible bid. One of those conditions was to assume the liabilities needed to finance the union health funds at sums in excess of the stated asset values of the corporation.  To keep the union benefits alive, the parties created Chrysler VEBA—its Voluntary Employment Benefit Association—which ended up receiving a 55 percent equity interest in the New Chrysler corporation plus a $4.587 billion unsecured note from that company. New Chrysler was not asked to take over any liabilities for the dealers or indeed for the unsecured tort creditors (persons who were injured by Chrysler products).

When the dust settled, the government noted with some pride that its $2 billion bid was the only one. That sobering fact should not be taken as a sign of its business acumen but as an open confession of its suppression of any sensible auction. The correct process requires the sale of unencumbered assets, which for all we know could have been worth more than $2 billion if extricated from the losing union entanglements.

The GM deal had larger numbers but the same protection scheme for the GM VEBA. Under the previous deals between Old GM and the UAW, the company was liable for about $20 billion in unsecured retirement trust contributions. New GM offered GM VEBA 17.5 percent of its common stock, a new note for $2.5 billion, up to $6.5 billion in preferred stock, and a warrant that allowed New VEBA to purchase an additional 2.5 percent of New GM equity. GM’s other unsecured creditors were owed $27 billion, for which they received far less—somewhere between 10 and 12 percent of New GM, plus warrants. The unsecured creditors who started with more ended up with less. Once again the supposed bankruptcy sale that linked assets and liabilities allowed this financial inversion to go through.

The conscious decisions in both cases to tie the liabilities to the assets, however, totally transformed the proposed sales by cutting out all private bidders. How does an outsider bid for a business known to be underwater? Easy, for a negative value. It offers to take the company off the government’s hands if the government pays it a sum equal to the difference between the stated liabilities and the net asset value. Such negative bids are used whenever the Federal Reserve seeks a new owner for a failed bank whose liabilities exceed its assets’ negative value: The bank that demands the smallest government guarantee wins.

Of course, the Federal Reserve did not run these auctions, each of which had only one bidder. By design the Treasury put forward a bid for Chrysler that had to win. It was willing to pay the $2 billion to buy a business that had a net worth of minus $4.2 billion, computed as follows: Once the government paid off $2 billion to the secured creditors, it then executed its prearranged master plan to invest, in an “unrelated transaction,” an additional $6.2 billion to keep New Chrysler afloat. It now becomes painfully evident that the highly unusual step of tying the sale of Chrysler assets to the assumption of some of Chrysler’s union liabilities drove away all legitimate bidders. No one knows whether the government’s $2 billion valuation of Chrysler is fact or fancy. A government bid of a penny would have won as well, so long as retiree liabilities had to be assumed.
So why on earth should the bankruptcy court allow this novel step? To Bankruptcy Judge Arthur Gonzalez, the answer was easy:

New Chrysler views the skilled workforce as essential to its future operations and, as a natural consequence, has engaged in negotiations with their representative. As part of those negotiations, New Chrysler and the workers have reached agreement on terms for collective bargaining agreements with the UAW. As part of those negotiations, the parties also agreed to modify the funding arrangements for VEBA, the trust which funds benefits for employees and retirees.

Not credible. The onerous union contracts were one key reason for Chrysler’s steady decline before the financial crisis of 2008. No sane bidder affirms losing contracts. Ron Bloom, the administration’s automobile czar, submitted testimony at congressional hearings held in Detroit last July which stressed that the President prudently approved the deal only after the union made deep concessions. But why just ask for concessions? New Chrysler could have gotten a better deal still by starting with a clean slate that only comes from purchasing unencumbered assets. Suppose that thereafter New Chrysler wants to keep some of these workers; the sensible business approach is to hire back only those workers it wants under market-rate contracts in separate transactions. Other positions can be filled by new workers hungry for jobs in a falling economy. Worse still, it is completely inexplicable why New Chrysler wants to pay billions to present retirees in exchange for future work never to be performed. This giveaway corrupted the bidding process. The whole sale should have been set aside and a new sale of assets only should have been ordered.

GM presented somewhat different issues because the only secured creditors were the U.S. and Canadian governments, which ran the transaction. Even the U.S. government cannot shortchange itself, and here it did not look as though anything could ever be left over for unsecured creditors. But even so, there is no explanation as to why this deal favored the UAW unsecured creditors over the unsecured bondholders. The bottom line was another brand of UAW favoritism.

Sale or Reorganization?

The GM case did not provoke any follow-on litigation, so let’s concentrate on Chrysler, which did provoke a legal challenge by the outgunned Indiana Police Pension Fund with its tiny (under 1 percent) interest in Chrysler’s secured debt. How did Treasury deal with these pesky bondholders? Largely by running them out of court without ever letting them expose the soft underbelly of the arbitrary government bid. The key legal maneuver was a determination that the Indiana Pension Fund did not have standing to challenge a transaction in which it had received its fair share of the $2 billion sale value that represented the full asset value. Whatever else happened in the transaction was of no special concern to it, so it could not protest.

Lo and behold, that conclusion is correct if the transaction is a bona fide sale. But the transaction wasn’t bona fide because any bidder could only buy the assets by agreeing to take over the liabilities. It also wasn’t a sale because the UAW pension and health funds kept their interest in New Chrysler. At this point, as my NYU colleague Barry Adler explained in his testimony before a congressional committee, the deal looks more like a “reorganization” that let previous stakeholders in Chrysler retain an interest in the surviving entity. In this case it is easy to “step” the initial sale to the government with the subsequent deal with Fiat and the Chrysler VEBA into one continuous transaction whose result was to realign the interest of existing players. When the dust settled the UAW’s interest as an unsecured creditor of Old Chrysler was converted into an unsecured note from New Chrysler coupled with its new controlling shareholder position. A clean sale leaves no retained interest for any stakeholder in the sold business.

Unlike sales, reorganizations must meet explicit nondiscrimination requirements that require all unsecured creditors to be treated alike. The Indiana Pension Fund was unsecured to the extent that there was a shortfall in Chrysler assets. So it was right to say it should have been treated on a par with the UAW retirement funds, which were also unsecured creditors.

The Fund also had a second line of argument for its position as a secured creditor—that is, to the extent that some assets in Old Chrysler were available to satisfy claims. The Fund insisted that all non-TARP secured lenders should be treated as their own class. This point matters under reorganization rules because a majority of members in each distinct class must give their approval for the reorganization to go through. The Fund argued that its interests diverged from the TARP lenders, who only voted for this disadvantageous plan in response to veiled Treasury threats to go along.

Why did 99 percent of the secured creditors approve a transaction that subordinated their financial interests to unsecured creditors anyhow? Was their consent voluntary—or coerced? In his testimony before the Detroit congressional hearing, Indiana State Treasurer Richard E. Mourdock hinted darkly that undue pressure was placed on the TARP lenders—JP Morgan Chase, Citigroup, Goldman Sachs, and Morgan Stanley—to vote in favor of the sale/reorganization or else. What counts as the “or else” is hard to say because everyone was mum on these communications. No evidence of that sort was presented at trial, even after several other early non-TARP objectors to the reorganization (whoops, sale) mysteriously folded their tents. But how could the 900-pound government gorilla in the closet not have made a difference? Do we really think that investment bankers can’t subtract liabilities from assets to determine net value? Draw your own conclusions of whether TARP banks operate with independent judgment when placed under government oversight.

Taxpayer Standing

There is still one other loose end. The TARP program was intended to aid financial institutions, which does not seem to include Chrysler or GM. But who can challenge this transaction if in fact it did not come within the scope of the TARP program? Clearly, someone should be allowed (in principle) to say that taxpayer money was improperly used to lard New GM and New Chrysler with sufficient dollars to help fund the UAW benefit plans. Why, one might ask, are the retired workers from Chrysler worth special treatment relative to the retired police officers in Indiana, who had to settle for 30 cents on the dollar? But those questions will never be resolved for the simple reason that under modern American constitutional law no taxpayer ever has standing to challenge a transaction that affects all taxpayers. We thus never get to the merits of the deal. This taxpayer-standing rule has been in effect for close to 90 years, and throughout its history it has aided the expansion of State power by shielding dubious transactions from judicial review. The far better rule is to follow the corporate practice whereby any shareholder can challenge the legality of a transaction that affects all.

The Future?

Now that the taxpayer-standing rule removed the last legal obstacles to these two reorganizations, how best to assess the damages from these exceptional procedures? The obvious question is, why allow the Obama administration to pay off its political debts to Big Labor by manipulating bankruptcy forms? And why did the two district courts and the Second Circuit Court of Appeals go along with what seem to be transparent ruses? This does not bode well for those like me who hope that courts will step up to control these political machinations.

What the ultimate damage is, no one can say for sure. My hope is that the collateral damage will be contained on the simple ground that since extraordinary remedies are only sought in extraordinary cases, routine bankruptcy practice will remain unscathed. But it is too early to be so sanguine. At least two major bankruptcies appeared to deviate from the rules; others may follow, but only if the United States government is prepared to put substantial dollars on the table, which it won’t in most bankruptcies. But the specter of indirect effects remains. The entire structure of large credit markets, for example, depends on following the rules of the game to the letter. We have already seen that market melt down. Add in bad bankruptcy rules and the risks get larger. Memories are long in credit markets, and in the worst-case scenario the pricing of every major deal could be impacted if deviant bankruptcies become the norm. Let’s hope that Chrysler and GM prove to be one-off concoctions borne of desperation. But don’t bet on it yet.

Related posts:

1. Government Motors
2. Political Activity and Political Expenditures
3. Whose Rules? Whose Law?

For the nearly 250,000 people who signed Jones’s online petition, the arts are touted as critical to our national identity and even a source of spiritual sustenance. Use of the term “art,” however, is rife with conflict—raising more questions than answers. For the purposes of this essay, let’s agree that art, as a result of its examination of the myriad states of the human condition, can be a repository of both empirical and received knowledge and lore, an outlet for specialized creativity, and a cultural bonding agent. But to speak in the high-flown language of art’s ability to convey a national identity is to make teleological claims that can be neither substantiated nor dispelled. It sounds cool, sure, but so does visualizing world peace and (for some) levitating the Pentagon. And the claims for spirituality are best left to the theologians. My heart leaps when I behold a rainbow in the sky, for example, but I’m afraid those refracted light rays may leave others colder than Miss Havisham on her wedding night or a Jack London character attempting to strike his last remaining match.

Different Art, Different Audiences

Defining art and its many purposes and intended audiences is tricky. Classicists, for example, probably would say that art can be appreciated only from a distance of 100 years or more, assuring historical validation from critics, academics, and a refined general public. For this audience, Shakespeare, Michelangelo, and Beethoven are art’s sine qua non. Only recently—within the past 50 years or so—have they been convinced that James Joyce, Virgil Thompson, and Joan Miró belong to the canon.

Others position art at the vanguard of culture—always one step ahead of the rest of us with self-referential and highly individualized creations that eventually percolate to the fringes of the mainstream and exert a huge influence on subsequent generations.

The Cherry Pickers

In between the snobs and the avant garde are the cherry pickers, the multitude who have no trouble bouncing from Mozart and Mahler to Berry Gordy and the Beatles. “It doesn’t have to be old to be classic, it just has to be good” was the classic-rock radio tagline a few years back. Informed cherry pickers recognize that cultural uplift—however pristine or watered-down—can be found at the local cinema, on television programs, and even sandwiched in the spaces between those programs. The 1968 eight-million-selling record “I’d Like to Teach the World to Sing (In Perfect Harmony),” for instance, began as a group effort between gurus at advertising agency McCann Erickson and their client Coca-Cola. It became a hit single.

Cherry pickers can immerse themselves in many different art forms, increasingly blurring the distinctions between high art and low art. High art often borrows from popular (or low) art as evidenced by the work of Roy Lichtenstein and Andy Warhol.

Conversely, popular art borrows freely from high art. The artist Hieronymus Bosch, for example, may be well-known to some, while others know his work only from the use of his “Garden of Earthly Delights” as cover art for an album by folk-rock group Pearls Before Swine or the song “OK, Hieronymus” by British-born rocker Graham Parker. Shakespeare references abound on such television programs as Star Trek. Even Barry Manilow cribbed from Chopin.

In short, let’s acknowledge that art is important for most of us and that the enjoyment thereof is a matter of degrees. One man’s Proust is another man’s Pelecanos. One woman’s Bach is another’s Bachman Turner Overdrive. Cherry pickers are dilettantes, but that need not be used in a pejorative sense, since they can—and often do—create a wider cultural perspective through aesthetic cross-pollination across genres and the blending of high and popular art.

Government-Funded Art

Because art is many things to many different people, how can government-funded agencies hope to anticipate the aesthetics of a wide-ranging, diverse population? The question is moot, of course, but the larger questions remain: Can government money create a nation of renaissance men and women equally conversant in the realms of visual, written, and performance art—and are such ends desirable in the first place? Have government subsidies sparked the creation of any prominent new art, reintroduced the best of historically validated art to new generations with lasting impact, acculturated immigrants to the best of Western thought, ideals, and talent, or led to anything remotely resembling the equivalent of Italy’s fifteenth-century Rinascimento? Whither art without my tax dollars?

In his 2008 book Money for Art, David A. Smith presents a detailed history of U.S. government funding for the arts, beginning in 1817 when Congress commissioned four paintings by John Trumball. Nine years later, Trumball unveiled four historical paintings depicting events of the U.S. Revolution. According to Smith, Trumball was paid $32,000, a sum that rankled several politicians. One disgruntled senator reportedly believed the paintings unworthy of 32 cents, while Smith quotes one congressman’s observation that “if the Fine Arts cannot thrive in this country without government jobs . . . let them fail.”

By the end of the nineteenth century art flourished largely due to the largess of successful businessmen. The Gilded Age captured in the literature of Mark Twain and Edith Wharton was highly fruitful for the nation’s art, witnessing the establishment of the Metropolitan Museum of Art (1870, New York), the Boston Museum of Fine Arts and the Philadelphia Museum of Art (both 1876), the Chicago Academy of Fine Arts (1879), and the Corcoran (1869, Washington). All opened their doors without government money, as did a plethora of other museums, private collections, and art schools.

By the end of the century, art school alumni were producing a surfeit of fine art, which coincidentally is the title of a Jacques Barzun essay warning that government subsidies for art could produce such a large quantity of high-quality art that the nation would be unable to discern between what is merely good, what is very good, and what will stand the test of time.

When Theodore Roosevelt became president, he helped infect the American population with his passion for art. But Roosevelt’s views on art were somewhat provincial. He famously disparaged Modernist art in a review of the 1913 New York Armory Show and openly sneered at American painters who traveled abroad for their subject matter. Before leaving office in 1910 he ordered the establishment of the Commission of Fine Arts (CFA) to encourage arts and culture in Washington. Proving the wisdom of Ronald Reagan’s adage: “The nearest thing to eternal life we will ever see on this earth is a government program,” the CFA received $10,426,000 in 2008 federal money. For 2009 the CFA requested only $2,234,000—covering only department salaries.

The New Deal of the 1930s found innovative ways to fund art by offering commissions to artists seeking work. In 1933 some out-of-work artists formed the Unemployed Artists Group, which eventually became knows as the Artists’ Union (AU). The AU unsuccessfully sought the establishment of a cabinet-level Department of Fine Arts.

Although the New Deal programs for artists expired when the nation emerged from its financial travails, they left an indelible imprint on the nation’s cultural mavens. As Smith so aptly states: “The New Deal’s most important legacy to artists . . . was a mild sense of entitlement among professional artists and the beginnings of strong organization and collective action to pressure the government to respond to artists’ needs.”

While FDR’s administration was busy inventing new sleight-of-hand parlor tricks to divert tax dollars to individual artists, others took a more honorable route. Automotive scion Edsel Ford and his wife Eleanor, for example, became the Detroit Institute of Art’s (DIA) greatest benefactors by commissioning art from the likes of Diego Rivera and purchasing with their combined fortune works for the DIA’s permanent collection. They even took it upon themselves to cover the museum’s payroll during the Great Depression.

Fiscal restraint for government arts funding fell like dominoes in the 1950s and 1960s. Eisenhower approved the National Cultural Center (completed with government funds and renamed the Kennedy Center during the Johnson administration) in 1958; Kennedy ordered Congress to establish the National Council on the Arts, which during the LBJ administration became the overseer of the National Endowment for the Arts (NEA). Reports of the first meeting of the Council mention that work progressed only in the morning, because members Harper Lee and John Steinbeck needed to sleep off their lunch-hour tippling—auspicious beginnings for an institutionalized steward of American tax dollars with a budget that reached $176 million in 1992 and receded to $145 million in 2009 plus the $50 million stimulus supplement.

Artists In Their Own Words and Works

Most artists believe that without government subsidies, quality art would disappear. “The voice of the artists has been relegated to entertainment or a marketable commodity or to a nuisance, but neither the political class nor the mainstream media are paying attention to what the artist is saying and that to me is worrisome,” Mexico-born performance artist and National Public Radio commentator Guillermo Gómez-Peña told me in a 2008 interview. “We can see since the mid-’90s art has been defunded systematically throughout the world not just in the U.S. but also in European societies that were leaders in that funding in places like Germany, the U.K., France or even Eastern European countries that took very good care of their artists. Even Mexico, for centuries paid very careful attention to its artists.”

Although Gómez-Peña, a very articulate, intelligent, and accomplished artist, adopts a pessimistic view of art without government support, he attaches to it an almost religious urgency: “In a sense, this systematic attack on the arts by the political class, the corporations, and the mainstream media has resulted in the spiritual impoverishment of society.”

Likewise, Dolores Wilber, a Chicago filmmaker I interviewed in 2006, believes public funding of private art is a net positive for the American people: “Art is a reflection of the society and it’s about creativity and being alive and has provided a lot of positive things in the social fabric with every society whether it’s democratic or a totalitarian government. . . . I think it’s a great thing about our country that in general we do support art making.”

Serious art and serious artists can survive—and have survived—without subsidy. In fact many of the greatest poets of the past 100 years pursued careers that greatly enhanced the literature they produced: William Carlos Williams was a doctor; Wallace Stephens was an insurance broker; former NEA head Dana Gioia worked as an advertising/marketing manager for General Foods; T. S. Eliot was a banker and editor; and Gary Snyder worked as a lumberjack and fire lookout. Many current artists are also tenured faculty at esteemed universities that pay them healthy sums to court their respective muses.

Gómez-Peña and Wilber are earnest, but one also senses a degree of hubris in their overstatements of art’s transformational and spiritual powers—as well as their belief that it’s the public’s responsibility to pay for it. After all, we can accept the importance of art privately without the concomitant expectation of having to pay for someone else’s transcendent experience. In fact, it wasn’t government largess that created and distributed HBO’s The Wire and The Sopranos, arguably the pinnacle of the last ten years of visual storytelling; Coppola’s Godfather epic; the Beatles’ Sergeant Pepper; or even initially transferred millions of consumer dollars to Robert Mapplethorpe and his estate—it was talent, drive, unfettered creativity, and the public’s willingness to purchase these works on their own terms rather than the whims, opinions, and highly subjective tastes of government bureaucrats.

Related posts:

1. Agricultural Subsidies in Great Britain
2. Ending Farm Subsidies Wouldn’t Help the Third World? It Just Aint So!
3. Subsidies Hurt Recipients Too

The government of the United States spent the year debating major new undertakings, ranging from health care to climate change to energy development to tax reform. Yet a far more fundamental shift, in the form of a rapid and pervasive expansion of government power over the private sector of the economy, has been going on in stealth. Shifting economic power from individual decision-makers to the national government characterizes virtually every policy proposal being debated in Congress.

Take tax policy. A 131-page document issued by the Treasury goes way beyond recommending the extension of some of the expiring Bush administration tax cuts. For example, the fine print contains more than a dozen ways of discouraging American firms from doing business and investing overseas. Supposedly minor technical changes also would have a severe impact.

For example, eliminating LIFO (last in-first out) inventory accounting would raise business taxes over $60 billion in one decade. The Treasury also wants to revive four corporate environmental taxes that were eliminated in 1969. There’s no relation between the tax burden these four taxes would impose on a company and the pollution that company generates. This bears an uneasy resemblance to Willie Sutton, who robbed banks because that was where the money was.

Inevitably a variety of technical tax provisions will increase the paperwork burden on business. The penalties for failing to file information returns (such as Form 1099) promptly and accurately, for example, will rise in a very complicated, three-tiered fashion.

On the expenditure side, the typical stimulus project increases the power of government in private business decision-making. The bailout of the automobile industry is really an inefficient method of financing union pension and health plans. The stockholders got zapped and the bondholders poorly treated. The taxpayers are left holding the bag, especially considering the restrictions on importing the really fuel-efficient cars General Motors produces overseas. Apparently, the new General Motors factory for building compact cars was chosen on the basis of “carbon footprint” and “community impact.”

It is hard to keep a straight face when analyzing the Cash for Clunkers program. For example, owners of the biggest old “clunkers” got a $3,500 credit for trading in an old vehicle for a new one with an improvement of just one mile per gallon. Surely, it would have saved energy if the Treasury had just mailed the $3,500 checks directly to Detroit!

Of course, the Obama administration is making some reductions in federal spending. It is reportedly imposing a 9 percent reduction in the budget for the division in the Labor Department that polices fraud and other illegalities on the part of labor unions. As noted below, a simultaneous expansion of business-oriented antitrust enforcement is taking place.

The Business of America is Government

Turning to regulation, one of Ralph Nader’s biggest disappointments during his heyday as a “consumer advocate” was the failure of his proposal for a new Consumer Protection Agency. He should be a bit happier now: The administration’s financial regulatory plan creates a powerful new Consumer Financial Protection Agency (CFPA).

This new free-wheeling agency would take authority now divided between the Securities and Exchange Commission (SEC) and the Federal Reserve System. In a change guaranteed to cause confusion, the CFPA would share authority with the Federal Trade Commission. The new regulatory agency would also have a mandate to give consumers more economic education. Educators find that especially scary.

Moreover, the agency will have its own money pot, independent of the normal congressional appropriations process. It will be financed directly by fees assessed on “entities and transactions” across the financial sector.

The Treasury’s financial plan contains many other expansions of government power over business. The Federal Reserve System would have new authority to oversee any large financial entity whose failure the Fed thinks could generate “systemic risk.” The Treasury would head a new Financial Services Oversight Council to “resolve” the inevitable jurisdictional disputes among federal agencies. A new Office of National Insurance is to be established in the Treasury to monitor “all aspects of the insurance industry,” a sector of the economy traditionally under the province of state governments.

The SEC will require the registration of all advisers to hedge funds and other private pools of capital with assets over a given threshold. It also will have the power to inspect the books of the advisers and to ensure compliance by their clients. In addition, the power of the SEC will be expanded by legislative proposals to give it a more active role in guiding the compensation committees of all public companies.

Further, the Federal Deposit Insurance Corporation will have new authority to take over and shut down financial institutions (not just banks) whose failure is deemed to pose “systemic risk.”

Viewed in their totality, these technical financial changes would represent a historic expansion of government. Sadly, there is little comfort in the Treasury’s warning in its 88 pages of detailed proposals: “More can and should be done in the future.” Comparisons with the New Deal of the 1930s are too timid. Shades of Alexander Hamilton!

Business-Climate Change

The complicated climate change bill that recently passed the House of Representatives would dramatically expand government power over the economy. Again, the fine print deserves far more attention than it has received. For example, buried in the 1,201 pages of detail is a provision authorizing the Department of Transportation to require automotive manufacturers to produce vehicles that can run on methanol (wood alcohol), a fuel not widely available.

Other provisions, as expected, have little to do with the subject of global warming. For example, contractors on some energy projects must pay employees at least the locally “prevailing wage.” This well-known code means, in practice, paying higher union wage scales, thus letting unions set wages even for non-union firms.

Many federal departments are trying to climb aboard the economic stimulus bandwagon. The Department of Justice wants to help out by showing that antitrust should be a “frontline issue” in the response to the problems facing the economy. Apparently, business is not getting sued often enough. Incredibly, one new assistant attorney general views antitrust enforcers as “key members of the government’s economic recovery team.”

When we step back and try to add up all the tax, spending, and regulatory actions and proposals of the new Obama administration, the result is clear: a cumulative squeeze on private decision-making and a more slowly growing economy in the years ahead.

In the process, private businesses will be discouraged by a host of government policies from making major new investments, especially long-term investments with payoffs far in the future. The likelihood of higher taxes and greater inflation resulting from the huge budget deficits that are likely to arise in the next several decades, abetted by lax monetary policies, are the key negative factors. The American public is likely to have a long wait until the national unemployment rate gets back down to the 7.6 percent that was reported when President Obama took office in January 2009.

One fundamental point deserves to be stressed. For the next several years, in the inevitable tension in public policymaking between economic prosperity and income redistribution, the American people can expect income equalization to get the government’s priority over improvements in people’s living standards. The average American, at best, will receive a more equal slice of an income pie that will be far smaller than the public expects.

Related posts:

1. Limits to Monetary Expansion
2. Union Power and Government Aid
3. A Number, Not a Name: Big Brother by Stealth

Habeas corpus is a rarely invoked legal writ, or document, widely considered to be the cornerstone of individual liberty. Also known as The Great Writ, habeas corpus (ad subjiciendum) is Latin for “you may have the body” (subject to examination). The writ is a civil action with the force of a court order, which requires a custodian, usually the government, to produce a detainee.

The purpose is not to determine the detainee’s innocence or guilt but to evaluate whether the detention itself is lawful; that is, does it satisfy the standard set by the law of the land? If the imprisonment is judged to be valid, the person must submit to a trial or whatever procedure is prescribed. If the imprisonment is invalid, the person must be released. In short, the government cannot imprison you without just cause and due process.

Although habeas corpus is not commonly raised as a legal challenge, it has been mentioned with some frequency in recent issues—from the prison at Guantanamo Bay, Cuba, to the detention of illegal immigrants to the FLDS ranch raid by Texas child-welfare services. Critics of these government actions claim that they erode the principle of habeas corpus. The word “unconstitutional” is often used because the Constitution is the legal standard that an imprisonment must ultimately satisfy in the United States.

In the course of discussing such events, theoretical questions about The Great Writ arise. Is it a natural right or a privilege granted by government? If habeas corpus is a privilege, does government have an obligation to extend it to all people regardless of citizenship? If it is extended only to citizens, are there circumstances through which a citizen can lose the “privilege”? Purely practical questions arise as well. For example, do constitutional constraints bind only the federal government and not the states?

Apart from rights theory and practical considerations, another aspect of habeas corpus deserves attention because it explains why the writ is invoked so often in debate though so rarely in court: namely, its psychological impact. Habeas corpus is a powerful concept that evokes strong emotions. This is largely because it is viewed as a litmus test for whether a government is a dictatorship. In his article “Habeas Corpus: The Lynchpin of Freedom,” Jacob Hornberger of the Future of Freedom Foundation explains how habeas corpus is the enforcement arm of all other rights. Using First Amendment guarantees of free speech as an example, he writes,

[H]ow is that provision enforced? Editors, critics, and protestors would be languishing in some military detention center. . . .What good would it do to point out that people have the constitutional right to speak their mind, criticize government policy, and petition the government for redress of grievances? The president and the military would be in charge. . . . The doors to the cells would remain locked.  The prisoners would be unconditionally subject to whatever treatment their jailers wished to impose. The prisoners would be prohibited from going to court to complain or to seek redress. That’s where habeas corpus . . . comes in.

Michael Zander, emeritus professor of law at the London School of Economics, expands on the psychological importance of the Great Writ: “Habeas corpus has a mythical status. . . . In reality it is no longer of great practical significance as there are today very few habeas corpus applications, but it still represents the fundamental principle that unlawful detention can be challenged by immediate access to a judge—even by telephone in the middle of the night.”

Thus, despite debate and periodic suspension by government, habeas corpus has endured within law because the idea of an authority having the power to imprison someone without cause is abhorrent to general sensibilities.

Historical Background

According to the eighteenth-century jurist William Blackstone, the first instance of the term “habeas corpus” appeared in 1305. But the concept is generally assumed to have been part of the common-law tradition at the time of Magna Carta. Signed in 1215 by King John, Article 39 states: “No freeman shall be taken, or imprisoned, or disseized, or outlawed, or exiled, or in any way harmed—nor will we go upon or send upon him—save by the lawful judgment of his peers or by the law.” (The wording evolved over time.)

Magna Carta assumed political and legal prominence in the early seventeenth century when it was reinterpreted and used to advantage by the lawyer and parliamentarian Sir Edward Coke. Coke was a passionate advocate of common law over supreme monarchy; he famously proclaimed in Parliament, “Magna Carta is such a fellow that he will have no sovereign.” In 1628 he helped to draft the Petition of Right, which became a foundational document of the English Constitution. The Petition detailed the specific liberties of freemen, which legally constrained the king. For example, martial law could not be declared during a time of peace, and prisoners could use habeas corpus to challenge the legitimacy of their imprisonment.

The reinterpretation of Magna Carta had a profound impact on the American colonies, the charters for which were drafted during this period. Indeed, Coke may well have been one of the authors of the Virginia Company charter. These charters guaranteed that colonists would enjoy “all the rights and immunities of free and natural subjects.” Moreover, American revolutionaries like Thomas Jefferson and James Madison were intimately familiar with Coke’s four-volume Institutes of the Laws of England. When drafting their own documents to ensure liberty, the Founding Fathers drew heavily on his ideas. For example, the Third Amendment of the Bill of Rights derives from the Petition of Right’s ban on billeting troops.

The Founding Fathers also drew on the Habeas Corpus Act of 1679, which passed Parliament during the reign of King Charles II and strengthened that right against the power of the king. When it crossed the Atlantic to America, however, habeas corpus underwent a subtle but significant change. In England it was a weapon against monarchy that originated in the “rights” of nobles and only later grew to embrace the average person. In America it began as a core protection that every individual enjoyed against any governing authority.

The only specific reference in the Constitution occurs in the Suspension Clause (Article I, Section 9—“Limits on Congress,” Clause 2): “The privilege of the writ of habeas corpus shall not be suspended, unless when in cases of rebellion or invasion the public safety may require it.”

Although the reference is brief, it is highly significant that this particular protection of civil liberty is in the body of the Constitution while similar protections, such as the right to trial by jury, occur only in the appended Bill of Rights. There, the closest reference to habeas corpus occurs in the Sixth Amendment, which states a defendant must “be informed of the nature and cause of the accusation.” Thus the explicit inclusion of The Great Writ in the body of the Constitution suggests its importance for the Founding Fathers.

Nevertheless, the constitutional guarantee was a federal one and did not extend to those in state custody.

Habeas Corpus in the U.S.

The most famous habeas corpus case in pre–Civil War America was that of the slave Dred Scott, who attempted to sue for his freedom. An earlier and similar case in England would have given Scott reason for hope. In 1772 an African-American slave named James Somersett ran away from his master while they were both in England. He was recaptured but sympathizers obtained a writ of habeas corpus that required his captors to produce Somersett in court where he sued for and won his freedom. This case set the legal precedent that slavery was unlawful within England proper.

Almost a century later Dred Scott petitioned the U.S. federal court for a writ of habeas corpus; it was granted and later upheld by a court of appeals. Nevertheless, in 1857, in one of the most controversial cases in American history, the U.S. Supreme Court ruled against Scott seven to two. The court found that no slave or descendant of a slave could be an American citizen and so Scott was not a “person” within the purview of the Constitution. He did not possess the right of habeas corpus.

The writ continued to be intimately connected with slavery. During the Civil War, President Lincoln suspended habeas corpus in both 1861 and 1862; it was not restored until 1866.

The first suspension came early in the Civil War through an edict in 1861, when an estimated 20,000 Confederate sympathizers in Baltimore tried to block the movement of Union troops to Washington, D.C.

John Merryman, an officer in the Maryland cavalry and a secessionist, was among the thousands arrested. He petitioned for a writ of habeas corpus, which was granted by Chief Justice Roger B. Taney—the same Justice who presided over the Dred Scott case. Taney ordered the military to bring Merryman before the court; the military refused, citing Lincoln’s edict of suspension. Taney ruled that Lincoln’s suspension was unconstitutional because such a measure required an act of Congress. Lincoln basically ignored the ruling and continued to expand the territory throughout which habeas corpus was suspended.

The second suspension occurred when Congress instituted America’s first national military draft in July 1862, which incited widespread rebellion. On March 3, 1863, Congress passed the Habeas Corpus Act, legitimizing Lincoln’s former suspensions and approving any others he might make for the duration of the war.

Lincoln’s earlier suspension had been so broad as to allow local authorities to arbitrarily arrest anyone they personally considered to be disloyal or whose politics they simply disliked. Some of those arrested had done nothing more than criticize Lincoln. Union General Henry Halleck famously arrested a Missouri man merely for saying, “[I] wouldn’t wipe my ass with the stars and stripes.” Estimates of those arrested range widely, but overall 10,000 to 15,000 were probably imprisoned and denied a prompt trial. The Habeas Corpus Act, however, limited the time a person could be held without trial and so removed one of the most contentious aspects of the imprisonments.

It was not until 1866, with the court case ex parte Milligan, that the impropriety of the imprisonments themselves was put on trial. But the issue was legalistic and not based on civil liberty. The Supreme Court ruled that applying military tribunals to civilians in areas where civilian courts still operated was unconstitutional.

The post–Civil War period also resolved the issue of whether the right to petition for habeas corpus was purely federal or extended to the states. A Reconstruction act established that those held in state prisons and jails had the right to petition for a habeas review in federal court; this meant the writ applied to everyone imprisoned in America. Since then, the majority of habeas petitions reviewed in federal court have come from state prisoners through state courts for state crimes. This makes habeas corpus a rich area in terms of the relationship between federal and state courts and federal and state law.

Contemporary Implications

History seems arcane but it assumes a living, breathing status when courts rule based on precedent. This was apparent in what is arguably the most significant development in habeas corpus within the last decade: Boumediene v. Bush (2008). The case began with a writ of habeas corpus submitted to the U.S. Supreme Court on behalf of the foreign citizen Lakhdar Boumediene, who was detained in the American military camp at Guantanamo Bay.

In November 2001 President Bush had asserted the authority of military commissions to try prisoners taken in Afghanistan or Iraq as “enemy combatants.” In early 2002 he established Camp X-Ray in Guantanamo and claimed that since the camp is not on American soil, the prisoners had no rights under the Constitution or the American legal system. Representatives of almost 200 detainees filed habeas corpus submissions over the next three years.

In 2004 the Supreme Court heard the first of these cases—Rasul v. Bush. The court’s landmark ruling found that the American legal system had authority to decide whether foreign “enemy combatants” were being wrongfully detained. In response, the Defense Department established Combatant Status Review Tribunals—nonpublic hearings that reviewed whether detainees met the criteria necessary to satisfy the designation “enemy combatant.” These tribunals were widely criticized as not fulfilling the requirements of Rasul. For example, the Court had affirmed a detainee’s right to be assisted by counsel, yet the tribunals did not permit this.

To quell growing criticism over the Guantanamo detainees, Bush signed the U.S. Military Commissions Act (MCA) in October 2006. Congress stated its intention “to authorize trial by military commission for violations of the law of war, and for other purposes.” The MCA explicitly abolished habeas corpus rights for noncitizens.

Boumediene—which consolidated with the earlier petition Al Odah v. United States (2002)—tested the constitutionality of the MCA, specifically appealing to the clause in the Constitution stating that the right to challenge detention “shall not be suspended” except in cases of “rebellion or invasion.” In June 2008 the Supreme Court’s 5–4 decision effectively struck down the MCA as an unconstitutional denial of habeas corpus; the ruling also asserted the jurisdiction of federal courts over such petitions from Guantanamo detainees who had been tried under the MCA.

Theoretical Questions

Along with history, theoretical debates have driven the evolution of habeas corpus.

The key theoretical debate concerns whether habeas corpus is an inalienable natural right that preceded the State or a privilege granted by government. An inalienable right is one that cannot be transferred or taken away.

The Declaration of Independence, of course, embraced natural rights as the basis of liberty when it stated, “We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and the pursuit of Happiness.”

If any right can be called “inalienable,” habeas corpus must be included on that list. As noted earlier, the right not to be imprisoned unjustly is the foundation on which all others rest. Indeed, in the absence of habeas corpus, the rights of due process—including trial by jury and facing your accuser—become meaningless.

The body of the Constitution contradicts both the Declaration of Independence and the Bill of Rights on habeas corpus, however, because the Suspension Clause makes it alienable and a privilege granted by government. Under certain circumstances defined by government, it can suspend habeas corpus, putting all other rights at the pleasure of the authorities.

Despite the contradictions and political maneuvering, the United States enshrined habeas corpus as a foundational right for every human being on American soil.

No external threat or internal problem can dismantle the individual freedoms on which America was created. Only government and the American public can accomplish that.

Related posts:

1. The “Stable Bulwark of Our Liberties”
2. We Win One (So Far)
3. The Great American Revolution