Friedman: Trust markets to weed out corporate wrongdoers
Company insiders with knowledge of bad behavior should be encouraged to profit from their information, Milton Friedman said in an interview on CNBC's Power Lunch.
12:00 PM EST March 12, 2003
Milton Friedman, a Nobel laureate in economics, is a senior research fellow at the Hoover Institution and co-author, with his wife Rose, of "Two Lucky People: Memoirs." He recently sat down with CNBC's Michelle Caruso-Cabrera for a wide-ranging interview. Below is an edited version of their discussion of corporate scandals.
Michelle Caruso-Cabrera: Many Americans feel jilted by the market. They feel that when you look at the situation with Enron (ENRNQ, news, msgs) and WorldCom (WCOEQ, news, msgs), they were ripped off.
Milton Friedman: Well, they were.
Caruso-Cabrera: What do you think was the cause of all these scandals?
Friedman: I think we should ask the question of how they were discovered. How did we find out about Enron?
Caruso-Cabrera: Somebody blew the whistle.
Friedman: No, the stock market tanked their stock. The fact is the market is a very effective mechanism for uncovering cases like that.
In fact, if I may say something that’s very heretical, one of the reasons we've gotten things like Enron is because we've been increasingly outlawing insider trading, but insider (trading) is the most effective means of making sure a company that does the wrong thing is penalized for doing so.
Public served by profit motive
Caruso-Cabrera:: What do you mean?
Friedman: Here you've got a company like Enron which is doing fraudulent things. People on the inside know about it. One of the best ways to bring it out is to make it profitable, to make that knowledge profitable to them. A whistleblower takes a chance, doesn't gain anything by it. But a person on the inside who knows things are going wrong, who just engages in selling in Enron stock, can make money on it and at the same time serve the market purpose of driving down the price of the stock. And that alerts other people.
Caruso-Cabrera: Right now there are requirements for inside traders, they have to notify …
Friedman: Well, insider trading is illegal. There are people going to jail for insider trading and I think it has been a great mistake. You want more insider trading, not less. You want to give the people most likely to have knowledge about deficiencies of the company an incentive to make the public aware of that.
Caruso-Cabrera: By selling and hence driving down the stock price.
Friedman: Or by buying when it’s the other way around.
Regulation of insider trading is excessive
Caruso-Cabrera: Right now when an executive buys or sells they have to notify the SEC, and it becomes public record and everyone pays attention. Is that a good thing or a bad thing?
Friedman: That’s why things go as far as they do. That's why Enron gets to the stage it is.
Caruso-Cabrera: So it shouldn't be a requirement that they have to publicize that they've sold stock?
Friedman: I think not. It never used to be, you know, this is not a matter of the last 20 or 30 years.
Caruso-Cabrera: So you're saying it would be the volume of selling, not who is selling, that would drive the stock price lower and hence signal to other people.
Friedman: Of course, it doesn't matter who is selling. If you're selling, somebody has to buy. In order to get somebody to buy, you've got to encourage them, the price has to go down.
You see, as is so often the case, people attribute things to the free market which are really the consequences of government interference with the free market.
Again and again it turns out that except for you and CNBC and the like, the free market doesn't have a public-relations mechanism. It doesn't have public defenders, as it were. The government always has a public defender. It has a straight access to the media and to the public airwaves. So you haven't heard anybody saying that maybe one of the reasons that we had Enron, Worldcom and so on was because of excessive government controls and regulations of insider trading and of their activities in general.
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