Let's ignore the fact that a 71-year-old economist who won the Nobel Prize can still change his views every week on bank regulation. One would think he would have found a stable theoretical framework to think this through by this time? Monetarism has obviously not been very helpful. Note instead the interesting reason he gives for his new scepticism: when they put their money in a bank, depositors cannot know if their money is in a secure account or in a risky investment.

          Isn't this one of the fundamental problems with the current banking system, that is, fractional reserves? You think your money is there and you can retrieve it at any time, but the bank only keeps a fraction of it in its vaults and has lent most of it to someone else. Austrians and others before them have been saying for centuries that this was a sort of fraud that led to unsustainable leveraging and to booms and busts. Mr. Lucas is right to see that there is something wrong here. He just hasn't found a good explanation of why and what should be done about it, and so he adopts the default position of confused free-marketeers, which is that more regulation must be the answer.

          The article tells us about another left-wing Chicagoite, Douglas Diamond, who refused to sign the petition against Paulson's bailout because he believes governments have no choice but to provide safety nets for banks and tougher oversight. Again, the explanation given by the finance professor for parting with his colleagues is quite interesting:
 

Diamond began studying bank failures when he was a doctoral student at Yale in the 1970s. The 1963 book that Friedman wrote with Anna Schwartz, "A Monetary History of the United States, 1867- 1960," provided the foundation. A copy, held together by Scotch tape, sits on Diamond's desk, even though he concluded at Yale that a main premise was wrong. Diamond rejects Friedman's view that banks failed in the 1930s because the U.S. money supply contracted as panicky Americans started hoarding cash and the Fed reacted too slowly. Diamond sees the money supply as less significant than Friedman did. Banks failed, he says, because their assets weren't readily converted into the cash that depositors were demanding.

          Is it just me or do I see a pattern here? There is no explicit mention of it, but just like Mr. Lucas, Mr. Diamond seems to have realized that the fractional reserve system (that's what the last sentence is referring to) is a crucial part of the problem. His solution however (if his views are correctly reported in the article) is to have governments impose even more regulation on the banking system and to intervene to save it when it is on the verge of collapse. When it's precisely because governments control the monetary system, condone banking fraud and constantly save banks from the consequences of their fraudulent practices that we have this problem.

          Chicago school economics is in such a mess that it's hard to decide who we, as Austrians, should sympathize with: the inflationists who are still claiming to defend free-market principles, or those going over all the way to the interventionist side but who may be doing it on the basis of a legitimate preoccupation with the fractional reserve system.

          One can't help but agree with arch-Keynesian James Galbraith, who is quoted in this article as saying that "The inability of Friedman's successors to say anything useful about what's happening in financial markets today means their influence is finished."