We can imagine the emergence of enterprises analogous to Underwriters Laboratories that would specialize in monitoring, inspecting, and certifying banks. We can imagine an evolution of best practices and standards that insurance companies or bank associations would routinely impose on their clients or members as a condition of receiving insurance or association membership.
We can imagine most depositors being unwilling to deal with banks that do not meet the standards that gain acceptance over time. In short, we can imagine a dynamic system of private, contractual, market-based regulation of bank capital and risk.
Part III
Conclusion
The housing boom and bust and financial turmoil could not have been a consequence of free markets because we don’t have free markets. The U.S. government has been intervening long and heavily in mortgage markets, money, and banking. These interventions caused the problems.
In order to protect ourselves from future booms, busts, and financial turmoil, we need to repeal those interventions and free those markets. We need to let our economy order itself spontaneously, with free market prices coordinating everyone’s different actions, profit and loss guiding entrepreneurial innovation, and free market incentives motivating everyone to try to benefit others.
What should housing-finance policy be in a free society? It should be to let markets work. Leave housing finance to the free choices of individuals interacting voluntarily with one another.
The special treatment of housing in the Taxpayer Relief Act should be eliminated; all capital gains should be taxed at the same rate: zero percent.
Fannie Mae and Freddie Mac should be wound down and eliminated. Their very existence creates a dangerous incentive for politicians to seek votes by funneling into housing resources that would be better used elsewhere. As for Congress’s guarantees of loans to Fannie and Freddie, legislative bodies should have no authority to guarantee some people’s investments with other people’s money. The actual performance of investments in creating value should determine how well they pay off, if at all.
But what about helping low-income people find more affordable housing? This admirable goal is best pursued through private enterprises and voluntary associations, not through the coercive powers of government.
What should money policy be in a free society? It should be free banking—non-intervention in money. The Fed should be retired, shut down. The kinds and quantities of money used should be determined by entrepreneurial innovation and profit-and-loss feedback in an unhampered market. Interest rates, like other prices, should be determined by the free play of market forces.
How might we make the transition from central banking with fiat money to free banking and free-market money? That’s a fascinating, challenging question; others have offered pathways to get there (see the end notes for references). For our purposes, what is essential is that excessive money creation helped fuel the feverish overinvestment in housing, and excessive money creation is possible only when governments control the supply of money. Had the money supply been regulated by market forces, one major cause of the housing boom and financial mess would have been eliminated. Free banking and market-determined money is the ideal toward which we should shape our course.
What about lenders who make bad investments? Governments should have nothing whatever to do with them apart from enforcing contracts and punishing fraud. What I said above with respect to lenders to Fannie Mae and Freddie Mac goes just the same for lenders to big investment banks: legislative bodies should have no authority to guarantee some people’s investments with other people’s money. Such authority distorts the price of risk and blocks the profit-and-loss feedback on which improvements in well-being depend. Expectations of rescue distort incentives. And allowing government the power to give taxpayers’ money to particular investors is a pernicious temptation to politicians to advance their careers by doing favors with other people’s property.
Likewise, the government should never bail out bank depositors. The FDIC should be retired, and deposit insurance should be taken over by private insurance companies and/or by other arrangements banks might make to persuade depositors that their deposits are safe.
Of course any private individuals, institutions, or companies that want to rescue creditors or depositors should be free to do so with their own funds.
How should bank capital and banking and financial services be regulated? Efforts in Washington and Basel to design new and better systems of financial and capital regulation are futile. The would-be architects of a system that this time will get it right literally do not know what they are doing. They do not understand “how little they really know about what they imagine they can design.”
The well-meaning bureaucrats in the alphabet soup of financial regulatory bodies cannot know for sure, before the fact, what principles of deposit insurance and bank capital management will create value any better than H.M. Warner knew that nobody wanted to hear actors talk, or Michael Dell knew that Apple Computer should be shut down, or the leadership at Motorola knew that the future of telecommunications was satellite phones. They were all mistaken; they were ignorant. We all are. That’s why it’s dangerous to give anybody the power to coerce.
The best we can do is to let the relentless discipline of consumers’ decisions, transmitted via profit and loss, regulate banks and other financial institutions. Good systemic performance will come about not top-down by intentional design, but bottom-up as the unintended consequence of individual banks seeking to profit by creating value for customers. This dynamic market process cannot be perfect because those engaged in it are so ignorant and prone to mistakes. But the process tends to overcome that ignorance, punish the mistakes, and reward those who do create value.
Free-market discipline is the best regulator of financial services. It is an imperfect regulator, to be sure, but it is the least imperfect regulator available.
The lessons we learn from this one case study of one slice of our economy over one period in time can be generalized. The three principles of spontaneous economic order provide a lens for looking into all sectors of our economy to find the truth about how to advance well-being for all. In the concluding chapter we apply the three principles to a sector of economy that is near and dear to my heart: the education of the young.
Chapter Thirteen
Hope for the Future
I learned first-hand the importance to the poor of freeing our schooling markets over the ten years I served as chairman of the board of Children’s Scholarship Fund Baltimore. CSF Baltimore is one of about thirty partner organizations across the country offering privately funded, partial scholarships to low-income children for kindergarten through eighth grade, to help them pay tuition at non-government schools. Since its founding in 1998, Children’s Scholarship Fund partners have provided scholarships of nearly $500 million to some 125,000 students. In my home town, CSF Baltimore has provided almost $10,000,000 in scholarships to 6,166 students over that time.
CSF Baltimore grants only partial scholarships, covering 25, 50, or 75 percent of a child’s tuition up to a maximum scholarship of $2,000, depending on the family’s income. Parents must pay the remaining tuition, a minimum of $500 per child. When families apply for the program, they are put on a waiting list that consistently holds about two thousand families.
Then, as funding becomes available, families are selected at random. Parents choose the schools, apply, and make sure their children meet any admission requirements. Admission is by families: if one sibling wins a scholarship, all do, including younger siblings just reaching school age. Children may attend any legally operating school anywhere, but the great majority of our families choose relatively inexpensive private and/or parochial schools in and around their home neighborhoods.
There are around two hundred such schools in the Baltimore area—Bethlehem Christian Day School, Calvary Lutheran School, Community Initiatives Academy, St. Agnes School, School of Original Thought, St. Joseph School, Bais
Yaakov School for Girls, Kingdom Academy, The Unselds’ School, and scores of others. CSF Baltimore has been awarding on average around $1 million in scholarships each year. In the 2012-2013 academic year, CSF Baltimore supported two hundred thirty students at forty-seven schools. The average scholarship was $1,823; the median tuition per child was $6,400. The average family contribution per child was $3,360, out of an average family income of $32,918.
My strongest memory of my work with CSF Baltimore is of one night in the auditorium of Immanuel Lutheran School, at a meeting of families who had just won the selection lottery for the following year’s new scholarships. They had come to learn about their responsibilities in the program. These included documenting their income, selecting a non-government school for their child, applying and getting their child accepted, and keeping up with payments of their portion of the child’s tuition.
About two hundred parents and grandparents were there that night. My job was to explain the various aspects of the program. While I was explaining how the dollar amount of the scholarships is determined, I emphasized that in all cases families are required to pay a minimum of $500 per year per child to be eligible for a scholarship. (They are not allowed, in other words, to combine CSF Baltimore’s scholarship with other scholarship support to bring the total they have to pay below $500.) I had felt some concern about making this point, fearing that some people might think us stingy. But when I told them that the founders of the program believed it was important for each family to have meaningful financial responsibility for their children’s education, all around that large room heads slowly nodded; all those serious, carefully listening faces showed no trace of resentment, but agreement and support.
At that moment, and every time I have thought of it since, anger flares in me at the broken system these parents were trying to escape. The Baltimore city and Maryland state governments tax residents and businesses enough to spend more than $14,000 per child in the Baltimore City Public Schools—far more than the tuition charged by nearly all the schools CSF Baltimore students attend, and more than double the tuition of most. Yet the schooling the city system offers is generally so poor that these parents are eager to pay again out of their modest incomes to put their children into better, safer schools. The excitement and profound gratitude the parents often express is moving. The waste of taxpayers’ money in the Baltimore City Public Schools is infuriating.
I learned two clear lessons from my work with Children’s Scholarship Fund Baltimore. One is that I dislike raising money. The other is that the poor have far more to gain from free market schooling than do well-off people like me.
But it’s not just low-income families who are getting a lousy deal. Many government schools in upper-income areas are mediocre at best. Every term I’m shocked once again at the proportion of my students at Towson University, from supposedly good government schools, who don’t write correctly. They write sentence fragments, use inappropriate words, punctuate confusingly, shift tenses, misplace modifiers, and often just don’t write down what they mean. They have not been instructed well.
And taxpayers are paying more and more for this mediocrity. Nationwide, over the past three decades, as inflation-adjusted per pupil spending has doubled, student performance by most measures hasn’t improved at all.
What is wrong with American schooling?
American schooling is poor because it is centrally planned by government rather than spontaneously ordered in free markets. It lacks the necessary foundations of healthy economic order: free-market prices, profit-and-loss selection, and the incentives of private ownership and free exchange. Schools attended by most American children are government owned, so we don’t have profit-and-loss feedback to guide discovery of better methods. Schools that create value are not rewarded; those that destroy value are not punished. Without that feedback to guide innovation, schooling stagnates.
There is little freedom of exchange between American parents and schools; most parents surrender their taxes and send their kids where they are assigned. If a parent would prefer to have her child in a school run by one of the charter school companies beginning to operate across the country, she can’t just switch; she and other parents must go through the slow, political process of persuading the school board to authorize the charter school company to open another school. Thus school performance and school funding are almost totally disconnected. Regulation of schools is by legislation and bureaucracy. That regulation has been largely captured by the teachers’ unions and administrative bureaucracies who use government schools as a jobs program. (I do not blame the teachers themselves, many of whom are excellent, heroic, and very poorly served by the system.)
Reformers in various regions are trying to improve education within the system of state control by means of charter schools. Charter schools are tax-funded schools that are in various degrees independent of the school system, including, importantly, being free to hire (and fire) non-union teachers. Progress via charter schools is slow and uncertain, however, because the teachers’ unions and school system bureaucracies oppose them politically and make it difficult for new charter schools to open.
Let us close Free Our Markets with one last thought experiment about education based on the principles of spontaneous economic order we have been considering: creative destruction in a totally free market. Suppose all schools were privately owned, and thus subject to profit-and-loss selection. Suppose parents and schools were free to exchange tuition money for schooling on terms they see fit. Suppose educational entrepreneurs stood to make significant profits when they find better, cheaper ways to help children succeed. What then?
What might spontaneously ordered schooling look like? Who might own schools? What entrepreneurial innovations might we see in organization, in teaching methods, and in curriculum? Who would decide on the curriculum? How might market forces regulate school quality? Would it be affordable? Even to poor families?
We can’t know, of course, but let’s speculate.
We concede at the outset that free market education would not be perfect—nothing human is perfect. But we’ll find good reasons to believe that the principles of spontaneous economic order apply to education, and that education ordered from the bottom up would far outperform the top-down government schooling of today.
What Needs to Happen: Parents Decide Where the Money Gets Spent
The essential reform is to let parents, not bureaucrats, decide where tuition dollars get spent. Here’s a simple way to think about how this could happen. It’s not what I recommend—that’s coming in a moment—it’s just a simple way to start to think about it: Take all the tax money that now goes to the country’s government schools. Instead of giving it to school boards to allot to all the district schools, good or bad, give it to the parents. Divide the money up into equal shares for the children in each grade, and let the parents spend it on any school they choose, anywhere in the area, or the world, for that matter. THEN the schools would have to perform. If they didn’t, parents would take their children and their money elsewhere. Just like other businesses—and churches and charities and clubs—schools would have to perform well or close. Again: parents, not bureaucrats, must decide where the tuition dollars get spent.
Now one step further—and this is what I recommend: Cut out the government middleman. Repeal all the taxes now raised for schooling, and leave it to parents to pay for their children’s schooling themselves, as they pay for their children’s food and clothing. Parents are paying for schooling now through their taxes; take the tax collectors and school bureaucracies out of the loop. Let parents deal directly with schools. Separate school and state, in the same manner—and for many of the same reasons—we separate church and state. Religion is too important to be in the hands of politicians. We don’t let government provide churches, synagogues, or mosques; we don’t let it pay the salaries of clerics, or decide the nature of worship. We leave religion entirely to the private sector, and religion thrives, in poor areas a
s well as rich. We should treat schooling the same.
I want to acknowledge the concerns of my readers who are anxious for families too poor to pay for adequate schooling with their own resources, or even with help from others in the private sector. I don’t believe there would be any such families because there are so many voluntary ways in which schooling for the poor might be paid for, some of which we’ll explore later in this chapter. But for those worried that the poor would not get schooling in a free market, I suggest thinking in terms of a part-way measure: complete free markets in schooling, except using tax money to provide “school stamps” for those who otherwise would not be able to go to school. Like food stamps, which can be spent at any business that sells groceries, “school stamps” (the common term for which is “school vouchers”) could be spent at any legally operating school, on school supplies, on courses online, and the like.
Providing food to poor people at government-run food dispensaries would be absurd. Government food-supply bureaucracies would be inefficient and expensive. The public would constantly protest about the poor quality of the food, and taxpayers would complain about its high cost.
It makes much more sense, if the government is to concern itself at all with getting poor people fed, to give them food stamps and let them spend those at ShopRite, Safeway, Kroger’s and Walmart—stores that have to compete with one another on price, quality, variety of foods offered, location, etc. The government helps the poor pay for their food, but it leaves food provision to private enterprise.
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