AMERICAN ENTERPRISE INSTITUTE

AEI ANNUAL DINNER 2014: IRVING KRISTOL AWARD PRESENTATION

TRIBUTE: Bill Kristol The Weekly Standard

REMARKS: Arthur C. Brooks President, AEI

PRESENTATION OF THE IRVING KRISTOL AWARD: George L. Priest Chairman, AEI Council of Academic Advisers

INTERVIEW: Eugene F. Fama Irving Kristol Award Winner, 2013 Nobel Laureate in Economic Sciences

Paul Gigot Editorial Page Editor and Vice President, The Wall Street Journal

TUESDAY, MAY 6, 2014

TRANSCRIPT PROVIDED BY: DC Transcription – www.dctmr.com

ARTHUR BROOKS: Good evening, ladies and gentlemen. Please have a seat. Good evening, ladies and gentlemen. It’s my pleasure to welcome all of you to the American Enterprise Institute’s Annual Gala. I’m Arthur Brooks, president of AEI. On behalf of our trustees, our board of academic advisers and our 200 scholars and staff, we’re honored to share this evening with you tonight.

The evening’s festivities are named in honor of the late Irving Kristol, whom many of you knew. He was the great public intellectual and AEI scholar. The Irving Kristol Award, which we will present just a bit later, is AEI’s highest intellectual honor.

As we begin the program, I’d like to turn the mike over, here, at the very beginning, to Irving’s son, Bill, who’s a long and dear friend of AEI’s. He will share a few words about his father’s work and legacy, Bill Kristol. (Applause.)

BILL KRISTOL: Well, thanks, Arthur. I actually thought I would just lead us in the singing of the other two verses of “America, the Beautiful” – (laughter) – all four stanzas of “Star-Spangled Banner.”

I’m very, very – I’m here just to say a word not really about my father’s work and legacy, but just to announce this website that there’s a little piece of announcement of, when you came in, IrvingKristol.org and also a new book of essays posthumously edited by my mother and by my father on Jews and Judaism.

Arthur and I were chatting just a couple of weeks ago, and I mentioned that this project of putting up websites containing the complete curated bibliography of the work of thinkers whose work is worth preserving, worth making more accessible to students especially but to everyone who searches the web, making sure that these people’s work lives on and is easily reachable for young people especially but for everyone else, even if they’re not always assigned in every college course and so forth, that this project had now finished, the Irving Kristol website, IrvingKristol.org. And Arthur said, why don’t you announce that at the Irving Kristol Award dinner? And I said I’d be honored to do so.

This is a curated website that makes my father’s work available to both first-time readers and long-time admirers. It’s presented in a catalogued, searchable format. IrvingKristol.org features the complete bibliography, including interviews, videos, book excerpts, which users can browse by topic.

This is the most recent in the series of websites developed by the Foundation for Constitutional Government, which I’m a director of; Andy Zwick runs it. We’ve worked closely with AEI and they’ve been very helpful to our efforts in this and in other areas.

We’ve already done websites for Harvey Mansfield, James Q. Wilson, and Walter Berns. Obviously, we feel a close association with AEI. Walter Berns is a great AEI scholar. Jim Wilson was for so many years chairman of the Academic Advisers at AEI. Harvey Mansfield, a close friend of AEI. More are to come soon, including Leon Kass, Ed Banfield, Martin Diamond, and many others. We think it is a useful project.

We also – I also am pleased to announce that coming next month from Mosaic Books, a selection of essays, as I mentioned, by my father on Jews and Judaism, edited and with an introduction by my mother—worth reading, I would say. And I’m not biased about this at all.

I want to thank Arthur for the opportunity just to call this to your attention. And I do want to say this is a project that is not officially connected with AEI. We’ve really tried to find the contemporary thinkers whose work we think most worth preserving for future generations, especially of young people, that if it were not catalogued and in an intelligent way, curated, made accessible, made it approachable on the web, that we’d be worried that future generations wouldn’t have the benefit of the work of people who many of us have known and many of us read in the normal course of growing up, and going to college, and in our adult lives.

And I think it is a tribute to AEI that so many of the thinkers we have decided to go ahead and create these websites for have been in one way or another associated with AEI. It really shows that AEI is not just an important and influential public policy institution but has really become, I think, over the last 30, 40 years a central institution in American intellectual life.

In any case, Arthur, thank you for giving me these two minutes. And now we can go on with some more singing. (Applause.)

MR. BROOKS: Thank you, Bill. No more singing. It’s a thrill every year to see so many of you here together, friends of AEI, celebrating our friendship and values that we hold so dear.

I want to talk just for a few minutes before the main part of our program about what we’re really celebrating, which is more than our friendship. It’s the miracle that you have brought to the world and the miracle that we’re going to continue bringing together.

AEI was started in 1938, nine years after the onset of the Great Depression. Now, to give you a bit of reference on how different the world is today, nine years after the Great Depression began, economic growth was at −4 percent. Contemplate that. That would be like 2017 still at −4 percent economic growth. We can’t even conceive of something like that.

Now, the prevailing wisdom of the time from economists around the nation, the elite economists at America’s major universities, was that this was an utter failure of capitalism and that the United States would only solve its problems when it inexorably found its way toward scientific socialism. That was the conceit of the time that was rejected by this institution’s founders. AEI’s founders, which were people from the business community, understood that only free enterprise could save our country, but they were against the headwinds of a government that was making the Great Depression worse with bad public policy, and, furthermore, turning the American population away from the free enterprise system using the Great Depression as a pretext.

Well, there’s nothing new under the sun. The truth of the matter is that, today, one of the bestselling books of the year makes the same claims about the failures of capitalism that we were hearing in the 1930s. We hear the same call for redistributionist policy instead of increasing opportunity.

What AEI’s founders knew is what we still believe: free markets are very good at correcting themselves but free enterprise is terrible at defending itself. Free enterprise as a system requires defenders. It requires you and it requires me. It requires us to stand up for our values.

Now, let’s remember why that matters so much. And why it matters is not to protect wealth, to protect economic efficiency, to create billionaires. No. The reason that free enterprise matters so much is that it is the only system in history that’s lifted up the poor and done so by the billions. That’s what we stand for. And that’s what I want to remind you of. (Applause.)

Many of you are more or less my age. (Laughter.) What was poverty when we were children? Poverty was a distant and terrible thing that we couldn’t affect. Poverty was a picture in the National Geographic of a child with a distended belly and flies on its face. And you remember what I’m talking about. And all we had to offer was a few prayers, maybe a few pennies. There was nothing that we could do materially to change the set of circumstances.

Now, let’s think how much the world has changed since 1970. In recent years, there’s been a change in the percentage of the world’s population living on $1 a day, at starvation level. What has happened? Has it gone up or down? Well, if you ask the whole population in America today, you’ll find 67 percent of Americans think that hunger has gotten worse, that the world is poorer.

That’s wrong. The truth of the matter is that the percentage of the world’s population living on $1 a day or less adjusted for inflation has decreased since I was a child by 80 percent, an 80 percent decline in the world’s worst poverty, pulling literally billions of people away from starvation’s edge.

You have to ask yourself what did that, what made that possible. Was it the United Nations – it’s almost a laugh line in this crowd – or was it the unbelievable success of US foreign aid? Those are good or bad institutions, depending on your point of view, but they’re not the answer. They’re not the reason that just since 2005, 35 percent of the world lived in low-income countries, but, today, it’s just 11 percent of the world. More than a billion people have risen to the middle class just since 2005.

And we know the reason. It’s not a mystery. It’s six things, my friends, six things: globalization, free trade, property rights, the rule of law, entrepreneurship, and the American military keeping peace in places around the world that have never seen it before. (Applause.)

The American free enterprise system has spread prosperity. It’s spread survival. It’s spread opportunity all over the globe. People saw how you live in America and threw off the chains of their poverty and the chains of their tyranny to be more like you. That truly is what you have done for the world. It’s your freedom and your willingness to sacrifice your time and your talent and your treasure, and even American blood that has saved billions of people from the poverty and tyranny that characterized the whole world until relatively recently.

I am deeply thrilled and I know you are too to live in this great country, and I’m so grateful to AEI’s scholars, to AEI’s donors and to you, AEI’s friends, for what you have done to keep our nation great and strong by defending our leadership and our free enterprise system. Truly, truly your support for AEI’s work and mission are your gift to our country, and our country’s gift to the world, and a gift to global brotherhood. Thank you for doing this. And God bless you, and God bless America. (Applause.)

Well, it’s time to turn to this evening’s main event, the Irving Kristol Award and interview with my colleague, George Priest, who will introduce the guests. For those of you who are new to this event, the Irving Kristol Award, named for the public intellectual and AEI scholar that I’ve talked a bit earlier, and so did Bill, is our highest intellectual honor.

The winner is chosen by AEI’s Council of Academic Advisers. And this is a distinguished group of academics from around the country. I rely heavily on this body as I consider the intellectual direction of our institute. And this council has contained some of the greatest minds of the 20th and 21st century, from Milton Friedman to James Q. Wilson.

Now, as it happens, two of our council members passed away this year, economist Murray Weidenbaum, and just two days ago, Nobel laureate Gary Becker. This week, we also lost a former AEI scholar, economist Murray Foss, who was a friend of many of you as well. AEI, of course, and so do you, we celebrate the legacy of their work, all they did for our institution, and we mourn their passing.

To introduce this year’s Kristol Award winner, I turn the podium over now to the council’s current chairman, Professor George Priest of Yale Law School. George Priest. (Applause.)

GEORGE PRIEST: Thank you very much, Arthur. As Arthur has mentioned, this dinner is symbolically, nominally hosted by the Council of Academic Advisers. Now, we actually don’t do anything whatsoever with regard to the dinner. It’s not Marty Feldstein who got the salads this time. We don’t – we don’t touch it at all but it is a symbolic gesture by the – or a symbolic decision by the institute to delegate to this Council of Academic Advisers, a group of academics from major universities around the country, the dinner and the choice of the Irving Kristol lecturer of the year.

As Arthur mentioned, the Irving Kristol lecturer is the highest honor awarded by the institute, named for a man we all know of or knew. We’re very happy that many of his family are here tonight. You saw Bill Kristol, his son, but his widow, Bea Kristol – Gertrude Himmelfarb – my colleague on the council for 18 of her 25 years on the council is here tonight. (Applause.) Bill’s wife, Susan, and their daughter, Anne, and her husband, Matthew Continetti, are also here and we’re very happy to have them. (Applause.)

The Kristol lecturer this evening is a recent member of our council, Eugene Fama. It is very rare for the council to choose one of its own for the Kristol Lecture. Indeed, it’s extraordinary, and it only happens in an extraordinary context.

Some years ago, my friend and colleague, Marty Feldstein was chosen and delivered a brilliant talk on economic policy, how our country can promote economic growth, how it can reduce unemployment. Regrettably, President Obama and Senator Reid were not able to attend. (Laughter.) A few years before that, my predecessor, James Q. Wilson, also gave a brilliant address.

Tonight, it’s my colleague Eugene Fama. I can confidently represent to you that this is – Gene’s appointment does not represent nepotism. This past year, he was awarded the Nobel Prize in economics, an award that everyone, everyone in economics knew Gene should have received many years before.

Gene came to be a member of the council only a few years ago. It’s not that he wasn’t on it. None of us really knew that he had an interest in the applied work that the scholars here do. But he came to our attention by – in a – in a peculiar way. A few years ago, out of the blue, based on no solicitation whatsoever, he made a sizable donation to the institute. And, as Arthur has remarked to me, this shows how great this institute is that even our donors win the Nobel Prize. (Laughter.)

Gene’s life and achievement constitute a wonderful AEI story, and, actually, a wonderful American story too. Gene’s grandparents emigrated to the US from Sicily in the early 1900s before the United States had adopted immigration policies restricting the entry of southern Europeans. And this should be – when you think about Gene’s achievement, this should be thought about when you – when – by those who are considering immigration policies today. His grandparents and parents worked largely at manual jobs.

He was the first in his family to attend a university. He attended, before that, largely Catholic schools in which he reports typically the classes were 60 children in each class. He attended Tufts University. He has written that he was taking courses at Tufts and had an interest at Tufts to be a school teacher, a sports coach. But then he drifted into economics.

Gene has described that during his final year of college, he worked for an economics professor who ran a stock market forecasting service. Gene developed a method for predicting stock values but the method didn’t work, so Gene went to graduate school at the University of Chicago to try and improve it. He was taught there by Merton Miller and Miller’s co-author, Franco Modigliani, both Nobel Prize winners in finance, and by a variety of other luminaries from the University of Chicago and from MIT.

He has brought to the area of finance and to the understanding of asset pricing and the operation of financial markets an extraordinary intelligence, a steel-hardened vigor and a dedication to empirical research and to understanding how to improve and conduct empirical research that has importantly contributed to how we understand markets and to the image and reputation of Chicago School of Economics.

Tonight, we’re going to have a conversation between Paul Gigot and Gene. And so I welcome them to the stage now. Gene Fama and Paul Gigot. (Applause.)

PAUL GIGOT: Can you hear me? Thank you, ladies and gentlemen. Thank you, George, for the introduction. It’s a great pleasure to be here with the – with the great Professor Fama. And we want to talk a little bit about why he won the Nobel and a few things.

But, first, I want to start with a practical question. I think it’s safe to say that most people in this room have not won a Nobel Prize. What does one do with a Nobel Prize after you’ve won it? I mean, do you – do you wear it at family reunions? Do you stick it in a drawer? Do you have it in your office? What do you do with it?

EUGENE FAMA: It weighs about a pound of 18-carat gold, and it’s about this thick. (Gestures.) So if I wrote it around my neck, I’d need a neck operation within two months. So, basically, my wife is hiding it, actually, at the moment because she’s afraid I’ll give it to the university. And all the kids have a claim on it. She won’t even tell me where it is.

MR. GIGOT: Fabulous. Very shrewd. So you escaped coaching, going into coaching as a young man. And you go to the University of Chicago. And the University of Chicago at the time – I don’t know how many of you know it, but it’s basically full of these giants of the 20th century economics – Milton Friedman, Ronald Coase, George Stigler, Gary Becker. I could go on.

MR. FAMA: Actually, Gary came after I did.

MR. GIGOT: Gary came after you did. OK. Well, you attracted Gary to the University of Chicago.

MR. FAMA: Yeah. Right.

MR. GIGOT: And you emerge as the father – called the father of efficient market theory. Why don’t you – and for this and for the developments later you won the Nobel. Explain to us what efficient market theory market is, what constitutes an efficient market.

MR. FAMA: It’s a very simple statement. It says, in its extreme form that prices reflect all available information. Now, that’s a simple statement but it’s a very difficult statement to test, to submit to data because there’s another piece of the problem. You have to say what the market is trying to do in setting prices. So what that means is you need a companion model of market equilibrium, which is really just a story about what constitutes risk and what’s the relation between expected return and risk. And once you say that, then you can test whether the market actually is efficient.

MR. GIGOT: So it means that the market, at any given time, efficiently measures all of the available information about, say, a stock at that time. Yet, efficient market theory also holds that stock prices, for example, are unpredictable. No?

MR. FAMA: Not quite.

MR. GIGOT: OK.

MR. FAMA: That was – that was the early manifestation of the theory that said prices will follow a random walk. But then, we came around to the idea – this is – when we started thinking of models of risk and return, we said, well, risk varies through time. People’s attitudes towards risk vary through time. That’s going to give rise to (variance ?) through time and what it takes to get people to hold securities, and that’s going to create some predictability in returns, which is totally consistent with an efficient market.

So, basically, what it says is you can’t – the market will adjust quickly to available information and that the unexpected parts of returns will be unpredictable.

MR. GIGOT: But when markets move based upon new information –

MR. FAMA: Right.

MR. GIGOT: – and that’s quickly incorporated in the –

MR. FAMA: Right. Right.

MR. GIGOT: – the efficient understanding of that.

MR. FAMA: There are thousands of studies that document that prices adjust quickly to announcements of corporate events of all sorts.

MR. GIGOT: But one of the implications of your work in finance has influenced, I think it’s something like $7 trillion of investment into what’s called indexed funds.

MR. FAMA: Right. Not enough, actually.

MR. GIGOT: Not enough. But the implication is basically that no individual, except perhaps with luck or mostly luck can outthink, outinvest the market. Is that a fair assumption?

MR. FAMA: That’s the extreme statement of it. Nobody thinks that’s literally true. But there is a simple arithmetic of so-called active management, people that try to beat the market that says, in aggregate, their normal return has to be zero. So the people that are good –

MR. GIGOT: The normal return has to be zero?

MR. FAMA: Zero, before costs.

MR. GIGOT: Before costs. OK.

MR. FAMA: So after fees and expenses, it has to be negative.

MR. GIGOT: It’s negative.

MR. FAMA: And that’s arithmetic. That’s not a high proposition. So what does it mean? It means the really smart ones eat the really dumb ones. (Laughter.)

MR. GIGOT: That’s true generally in most of life, actually. But it also means that –

MR. FAMA: But the passive guys are out of the game. They get the efficient market return.

MR. GIGOT: And it means that a dumb guy like me, if I want to invest, I should just put my money in an indexed fund because there’s no other chance that I’m going to be able to hire somebody who’s smart enough to make more than what the indexed fund is doing. And, by the way, I’ll also pay more for the privilege of investing with him.

MR. FAMA: I don’t know anybody who that doesn’t hold for, actually. Maybe my range of acquaintances isn’t broad enough.

MR. GIGOT: But then how do you explain somebody like Warren Buffet, who is supposed to have beaten the market for generations?

MR. FAMA: Yeah. OK. That’s a different realm. I mean, nobody says that somebody that adds something to a business can’t make an unusual return. Now, somebody do something real. But just – by the way, he says he can only predict – he can only find a company once every few years, that if he had to find – if he had to construct a portfolio of 150 stocks that were underpriced, he wouldn’t be able to do it.

Now, that’s an aside. I could go into a two-hour discourse on this. But here’s the problem in the kind of example that you gave. You’re picking out the winner out of a big tournament. And the problem is thousands of people are in that tournament. And the probability that one guy does well for a long time is very high when thousands of people are playing the game. So it’s like saying, what’s the probability of flipping 10 heads in a row? It’s very low. But if 3,000 people flip 10 coins, you’re going to see about 30 times – maybe that’s too high, but you’re going to see multiple times that you get 10 heads in a row.

MR. GIGOT: So it’s not impossible for somebody like Buffett to beat the market because there are millions of investors, and he can do it if he picks the right stocks.

MR. FAMA: Right.

MR. GIGOT: It’s just that it – he’s a –

MR. FAMA: The problem is you can’t tell the difference between luck and skill because when people hold undiversified portfolios, the range of outcomes that can occur simply by chance is enormous.

MR. GIGOT: Right.

MR. FAMA: So a good person who actually has skill, they end up in the wrong end of the distribution, and a bad person, who doesn’t have any skill but is lucky, can end up in the high end of the distribution.

MR. GIGOT: Did you get a fee for all the $7 trillion that were invested based on your theories?

MR. FAMA: No, I didn’t.

MR. GIGOT: Settle for the Nobel. (Laughter.) There is a competing view about market behavior, as you know very well. And it’s associated in part with many people, but one in particular is your co-Nobelist last year, Robert Shiller.

MR. FAMA: Right.

MR. GIGOT: And that theory of behavior, if I could market –

MR. FAMA: It’s not a theory, by the way, but go ahead. (Laughter.)

MR. GIGOT: We can go into that.

MR. FAMA: Yeah.

MR. GIGOT: But it’s a view of market behavior that says that, in fact, there’s – it ascribes a bigger role to human psychology.

MR. FAMA: Right.

MR. GIGOT: And, to sum it up, some people would call it the madness of crowds. There are market panics.

MR. FAMA: Yeah, well that’s what they talk about, but –

MR. GIGOT: That’s what – that’s what they talk about. And his view is that the markets are often irrational and inefficient. And he’s propagated this view very, very assertively. And, in fact, you gave competing Nobel lectures. So where is Professor Shiller wrong?

MR. FAMA: Well, I can’t absolutely say he’s wrong. But the problem is that that area of finance is really just an attack on market efficiency. They don’t provide an alternative story that I can go out and test. So I ask him continuously, OK, give me your model so I can test it. He won’t.

MR. GIGOT: But I think he would say – I’ll give you a test. It was Black Monday in 1987 when stocks fell 10 percent in a day. There’s a market test of irrational behavior.

MR. FAMA: That was a mistake.

MR. GIGOT: Explain that.

MR. FAMA: Definitely – the market makes mistakes in evaluating information. But if you look at the entire record, what you see is that the market is almost uncanny in predicting recessions. And it’s almost uncanny in predicting the ends of recessions. I put a chart in my Nobel paper that will appear in the American Economic Review showing just – I mean, you don’t have to do any tests. Just look at it and you can see the market predicting these things quite effectively. Now, not always. Sometimes it misses. Eighty- seven was a particularly bad one. That one – but it went away almost immediately thereafter.

MR. GIGOT: It did go away almost immediately, which is – leads one to question, well, why – if the market is so –

MR. FAMA: I’m willing to say that one day out of 40,000, the market was wrong. (Laughter.)

MR. GIGOT: But for that day, it was inefficient.

MR. FAMA: Right.

MR. GIGOT: I mean, before that, it had been very efficient, like 10 percent.

MR. FAMA: Right. Right. Right.

MR. GIGOT: Then it fell and then it made its way back.

MR. FAMA: Well, my first lecture – I have many former students here – they will attest that my first lecture every year is this as a model. We call it a model because it’s only an approximation to the world. If it were the world, we would call it the world, not a model, you know. (Laughter.)

MR. GIGOT: OK. But you will – well, do you concede that, on occasion, markets behave irrationally? That is, they incorporate stock prices, say, or real estate prices, for example, in the last decade, that were not a reflection of genuine value?

MR. FAMA: Here’s the problem with that. Suppose they – take the stock market. The stock market went up dramatically and then it crashed in 2008. And this happens periodically through time. It’s almost always associated with recessions. That was a humongous recession. There was a big price correction. In ’74, ’75, there was another big one. And, of course, ’30 to ’32, you had a monster. But all of these are just responses to economic activity. Projections of profitability look bad. People get more risk averse. Both of those things push prices down. There’s nothing irrational about that.

MR. GIGOT: And, over time, the market will give the best reflection of the fundamentals economically.

MR. FAMA: Over time and over short periods – in very short periods of time.

MR. GIGOT: In a very short period of time.

MR. FAMA: Very short. So you cannot say that there are never bad prices. Of course there are. The problem is I don’t think you can identify them. That’s the issue. You can’t identify when they’re – when they’re bad. So, for example, go to Volcker’s irrational exuberance, right?

MR. GIGOT: Greenspan, I think.

MR. FAMA: I’m sorry. Greenspan.

MR. GIGOT: Which was delivered, by the way, the famous phrase –

MR. FAMA: I’m not a big fan of central bankers. So I tend to confuse them. (Laughter, applause.)

MR. GIGOT: That he issued –

MR. FAMA: After he issued, after the he said that, the market went up some fantastic amount. And then, when it finally did come down, it didn’t come down anywhere near that point in time. And that’s the problem with these so-called bubble episodes. People identify bubbles with 20/20 hindsight basically.

MR. GIGOT: Is there – so is there no such thing as an asset bubble?

MR. FAMA: No.

MR. GIGOT: Really? There isn’t?

MR. FAMA: Well, I – I don’t know because nobody has ever told me how to test for one. It’s always – I know one when I see one, you know, but that doesn’t work with me.

MR. GIGOT: Well, you know them after you’ve seen them burst.

MR. FAMA: If all you’re saying is that the prices went down, fine. You want to call it a bubble – it doesn’t mean anything to me unless it was a predictable decline.

MR. GIGOT: OK, I want to give you a market test. I think it was this morning – I saw The New York Times’s Robert Shiller quoted as saying that stock prices currently are getting very expensive based on their historical valuation. And we could be in for an adjustment, small or large. Should we all sell today based on that?

MR. FAMA: I don’t think so.

MR. GIGOT: You don’t think so?

MR. FAMA: No.

MR. GIGOT: When should we sell? (Laughter.)

MR. FAMA: You should sell when you want to consume. After all, you invest to consume. That’s the whole – or to give it away. That’s another form of consumption.

MR. GIGOT: So you don’t – we may – as far as you know, we are not in a – the stock market is not currently overpriced or in a bubble?

MR. FAMA: No. I don’t think anybody can tell that. Price is high – pretty high relative to earnings, but that’s been going for – that started in 1980 and progressively going on more or less since that time.

MR. GIGOT: OK. So let’s shift to the real economy, not asset prices but the economy. And we’re living in this era of post-financial crisis, post-Great Recession. I want you to go back and look at the causes of that, of those two events which have obviously caused an enormous amount of damage to the cause of free enterprise. And many people blame capitalism and the failure of regulation for those two events, the financial crisis in particular. Do you share that view?

MR. FAMA: No. I don’t. The financial crisis, to the extent that was due to what was going on in housing, that was – that was an outgrowth of government policy from the beginning of – from the early 1990s, where the government’s excessively tried to make housing more available to people who wouldn’t have qualified in the past. And then you get a big recession, and, all of a sudden, there are lots of people that can’t pay their mortgages. I don’t think that was a failure of finance. I think it was basically a failure of government policy. And, by the way –

MR. GIGOT: You can applaud. (Applause.)

MR. FAMA: Everybody wants to blame that period on finance. but the problem is the financial markets always lead real activity. So the fact that the market crashed doesn’t mean the market caused the recession. You cannot tell based on the data whether the recession caused the financial crisis or vice versa.

MR. GIGOT: Really?

MR. FAMA: Yeah. You cannot tell. Timing doesn’t mean anything because finance always precedes real activity.

MR. GIGOT: So if the – if the government had, say, not intervened to bail out Bear Stearns –

MR. FAMA: Yeah. Right.

MR. GIGOT: – had not taken over Fannie and Freddie –

MR. FAMA: Right.

MR. GIGOT: – had not done the various things it did –

MR. FAMA: Right.

MR. GIGOT: – is it possible we would not have had a recession?

MR. FAMA: Oh, no, no. The recession, I think, was already in the works. The fact that people were defaulting on their mortgages – people don’t wake up in the morning and walk away from their houses, you know. Usually it’s because they can’t make the payments. So I think we were already headed into a recession at that point. Now we’ll never know. I said at the time, boy, it would be a nice experiment just to let these guys fail because failure doesn’t mean that the assets go away.

MR. GIGOT: Right.

MR. FAMA: Temporarily, they might have depressed prices, but, eventually, they’ll get purchased by other people and be put back into play. Now, no government, Republican, Democrat or otherwise, will ever let that happen. The inclination is always to bail.

MR. GIGOT: Right.

MR. FAMA: In bad circumstances, the inclination is always to bail. But what really came out of that period that really bugs me as the worst possible perversion of capitalism is the whole idea of too big to fail. That somehow has to get taken off the table. (Applause.)

I don’t think Dodd-Frank really lays a glove on it because the real problem is that these too-big-to-fail institutions basically have a put option on the asset side of their balance sheet.

MR. GIGOT: Right.

MR. FAMA: Which inflates the value of their debt, basically makes it riskless because the government is going to pay it off. Now, one way to take that off the table is to increase the equity requirements, not like they’ve been talking about them though. They have to go up to maybe 20 or 25 percent equity financing of these too-big-to-fail banks.

MR. GIGOT: Instead of – instead of 10 percent.

MR. FAMA: Yeah. Instead of 10.

MR. GIGOT: Instead of 10 percent.

MR. FAMA: Ten, we’re talking about, is a big number.

MR. GIGOT: For all you bank shareholders out there, he said that that’s money that you have to –

MR. FAMA: Well, that doesn’t hurt. There’s nothing – well, Miller got the Nobel Prize for the Modigliani-Miller theory, which basically says the way you finance yourself is irrelevant. And the banks will scream, and say, we need all this debt financing because otherwise it will be idle money. Well, look at mutual funds. They’re 100 percent equity financed. No problem there.

MR. GIGOT: It sounds as if you don’t think the financial system today is any safer than it was in 2008, or would you say it is?

MR. FAMA: If we had another recession like that one we’ve just had, we probably would again face the same problems.

MR. GIGOT: Do you have any greater confidence in the ability of bank regulators to be able to – there’s a softball for you – (Laughter.)

MR. FAMA: Yeah. Right.

MR. GIGOT: – to be able to predict the next crisis, financial crisis, and prevent it?

MR. FAMA: Remember, George Stigler was my colleague for many years. Sam Peltzman was my same vintage colleague for many years. And what I take out of their work, well documented I think, is that even the best-constructed regulation is bound to fail because it gets implemented by regulators. (Laughter, applause.) And, you know, there is this capture theory, which is well documented, that’s –

MR. GIGOT: Regulatory capture.

MR. FAMA: Regulatory capture says eventually the regulators gets captured by the people that they regulate. So I think more complicated regulation is worse than less complicated regulation. The big negative thing to come out of the crisis is, I think, massive amounts of new regulation, which is, in my view, a tremendous deterrent to business.

MR. GIGOT: So a much simpler solution would have been raise the capital levels to 20, 25 percent, reduce the regulation –

MR. FAMA: Yeah.

MR. GIGOT: – and then let them operate –

MR. FAMA: Well, you’d still have to watch them because if they have that much equity capital, they’re going to try to get even riskier, right? So you’re still going to have to watch them. But I think it would have been, in the long term, very healthy to have let the banks fail. Now, there would have been a lot of short-term pain associated with that. But what you would have found after that is too big to fail wouldn’t be an issue anymore. We wouldn’t have the perversion of the financial system that we’ve come to basically live with. Now, banks are paying dividends now. That’s crazy. They should be forced to hold that to build up their equity base, but they don’t want to build up their equity bases.

MR. GIGOT: Arthur, is Jamie Dimon a donor, a contributor? (Laughter.) I just want to check.

So we’ve now had five years of an ostensible recovery but growth is subpar, has been –

MR. FAMA: Right.

MR. GIGOT: – can’t get above 3 percent. The jobless rate is going down but very slowly. There’s a school of thought out there that says this is the best that we could do after a financial crisis of the kind we had because that’s just what historically we should expect and you couldn’t really – can’t really do any better. Do you buy that theory or do you – do you think that government policies have contributed to the slow growth?

MR. FAMA: I think government policies have contributed to it. I don’t buy the theory because, implicitly, what it’s saying is there isn’t enough savings out there to finance investment. But the world is flooded with people trying to invest. I mean, interest rates wouldn’t be so low otherwise and stock prices wouldn’t be so high otherwise. I don’t buy that argument at all.

MR. GIGOT: Do you have like two or three suggestions that we – if we could it right now, what – the government could do right now to help growth, what would they be, just a couple of things?

MR. FAMA: How about taking a year off? (Laughter, applause.) Now, wait a minute. Suppose we close one department at a time. (Laughter.)

MR. GIGOT: Once a month?

MR. FAMA: Yeah. Once a month. So you could start with Agriculture, Labor, Commerce.

MR. GIGOT: There are a lot of jobs in this room. There are iron rice bowls here you’re getting at.

MR. FAMA: Well, one of the big outcomes of the financial crisis is going to be a massive increase in government bureaucracies.

MR. GIGOT: That’s right. What could those of us who believe in economic liberty and the cause, what could we do better to promote it and to make sure that we come out of this period with a revived economy, renewed public support for liberty and economic freedom and policies?

MR. FAMA: Economic freedom, freedom in general is continuously under attack by governments. I mean, you just have to go back to Hayek and earlier before that, the Austrian – other Austrian economists. Government is always trying to expand its tentacles.

And I don’t think – at the risk of offending people in this room – I don’t think it’s much different among Republicans or Democrats. They’re all sinners. (Applause.) If anybody asked me, “What’s the difference between Republicans and Democrats?” I’d say they both like to spend. They just disagree about what they’re going to spend it on. (Applause.)

MR. GIGOT: So what can we do?

MR. FAMA: To –

MR. GIGOT: Other than put them all out of business?

MR. FAMA: I started donating to AEI because I like Arthur’s message. He’s pounding all the time, saying, it’s opportunity, and capitalism has raised people out of poverty. Socialism has never worked anywhere. But, somehow, people have very short attention spans with respect to that issue. So I think you have to keep at it.

MR. GIGOT: And on that note, thank you very much, Professor Fama.

MR. FAMA: Thank you.

MR. GIGOT: Thank you all very much.

MR. FAMA: Thank you. (Applause.)

MR. BROOKS: I have just one word to say besides endorsing Professor Fama’s idea that donating to the American Enterprise Institute is a singular act of protecting liberty. And my only words are “thank you” to Professor Fama. Thank you to Paul Gigot. Thank you to all of you. Enjoy your dinner. (Applause.)

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