I’m a fan of Felix Salmon, who is as likable as he is intelligent and informed. But he’s published a reader comment that advances a pretty wrong-headed idea:

The bigger problem here is Milton Friedman. There is an absolute refusal to recognize the possibility that, for a variety of reasons, the lenders will not act in their own best interests unless forced to do so. That runs directly contrary to the axiomatic tenets of neoclassical economics – surely sophisticated businesses will always pursue their own economic self-interests, and have the ability to discern it.

This is a caricature of “neoclassical economics” and of Friedman himself. I’ll admit that like most conservatives and libertarians, I’m a great admirer of Friedman, so I have a dog in this fight. And, as this WSJ Review & Outlook recounts, I think it’s very clear that Friedman recognized that firms often don’t act in their best interests, and that some kinds of prudential regulation can play a valuable role. Julian Simon, a devout believer in the power of free markets, proposed an ingenious solution for the problem of airline overbooking:

In the first quarter of this year, some 23,380 passengers were forced to give up their seats, a 17% increase over last year and the highest rate in at least a decade as airlines try to serve passengers with fewer flights. Bumping only affects two of every 10,000 passengers, but that is small consolation for those who miss appointments or family obligations. Southwest was recently fined $200,000 for its bumping policies. The feds want to raise payments for those involuntarily bumped to $600 from $400 for short delays and to as high as $1,300 from $800 for lengthy delays.
Which brings us to Simon, who in 1977 on these pages proposed an auction system in which airlines would offer passengers on overbooked flights a gradually rising reward for giving up their seat. For example, if 115 passengers showed up for a flight with 100 seats, the airline would start to offer, say, a $300 voucher to passengers who agreed to take a later flight. If there weren’t enough takers at $300, the airline would increase the offer to $400, then $500, a free round trip ticket, etc., until 15 passengers volunteered. Auctions like this are highly efficient ways of allocating a scarce resource.
Airlines resisted this idea at first, fretting about “administrative practicality” and arguing that passengers would collude.

It’s at this point that regulators stepped in, as Simon described in a Cato policy brief:

In 1978, the Civil Aeronautics Board (CAB) mandated an auction plan to reduce the number of involuntary bumpings. Since then, whenever there is an oversale, airlines have been required to ask for volunteers to wait for a later flight, using whichever incentive system the airlines choose.

One admirer of Simon’s approach was … Milton Friedman:

When economist Milton Friedman heard of Simon’s auction solution, he wrote that he was “utterly baffled” that “opportunities for large increments of profits are being rejected [by the airlines] for wholly irrational reasons.”

It’s at this point that many advocates of more intrusive government regulation will say that Friedman was making their case for them. But of course the public sector is not known for its flawless rationality. What we need is a sensible balance between what regulators can realistically accomplish and giving private enterprises room to experiment and to fail and to succeed.

Of course banks are bureaucracies and bank executives are human. But governments suffer from the same limitations, and many other limitation that are unique to opaque, hierarchical institutions that are not subject to vigorous competition.