What's the Matter with Wall Street ?

In his widely read (but not read by me) book "What's the Matter with Kansas" Thomas Frank asks why lower middle class people in middle America vote for Republicans against their own self interest. I wonder why wealthy investors vote for Republicans against their self interest. Brad DeLong wonders why they favor tight money and austerity against their self interest.

It should be clear that rich investors have done poorly when the president is named Bush and very very well when Clinton or Obama were if office. In general the rich get richer even faster when a Democrat is president.

Brad writes

It made sense for those of my great-great grandfathers who were rich back before World War I to be hard-money guys. The investment vehicles open to them were land that pretty much had to be rented out at fixed nominal rents, bonds that paid fixed nominal yields, and equities where–unless you ran the business–you were quite probably a fool soon to be parted from his money by financial engineering. But it made no sense for my rich grandfather after World War II to be a hard-money guy. He had a much bigger portfolio of assets to invest in: equities backed by more-or-less honest accounts, land that the coming of automobiles and superhighways and the move to the sunbelt meant could be developed as suburbs, as well as leveraged resource speculations. He profited immensely from investments in all of these. Yet, in his heart of hearts, he remained a hard-money guy.

And it really makes no sense for my contemporaries to be hard-money believers. Yet an astonishing share of the rich among them are.

A great and enduring puzzle…

He disagrees with his grandfather. This is what his "we are the 100%" photoshop effort means.

There are two separate issues actually three "fear, surprise, ruthless efficiency, and near fanatical devotion to the Pope!" No I mean support for hard money, austerity, and Republicans. I will try to focus on hard money (but I will fail). It seems likely that the Fed open market committee (FOMC) will raise the target federal funds rate some time this summer. This is an odd choice since inflation is below target and the dollar is rapidly appreciating. Why would the FOMC even consider doing something so odd ?

It is reasonably clear that financiers and policy makers who are in constant contact with financiers support tight money. Here I give up on finding an excuse to type "high priests" and link to these excellent posts.

Why ?

1. Economics as a morality play. The market is our judge and rewards virtue -- no pain no gain. I think this view is most frankly expressed by Michael Kinsley when he says we should eat our vegetables. Kinsley provides a valuable service, because he doesn't present any argument related to the effects of policy.

Here I think it is clear why the rich are eager to assume that the market rewards virtue -- they have been rewarded by the market and wish to believe they are virtuous. It must be tempting to assume that wealth is the result of effort and then tempting to apply the logic to countries as well as individuals. If there is an easy painless way to create more aggregate wealth, then it is harder to believe that the wealthy earned their individual wealth through great effort.

2. Sub sub class interest. Within the 1%, there is an organized, energetic subset who benefit from tight money. There is a very strong nominal rigidity at zero on returns on deposits. This is based on norms and people's sense of what is fair and reasonable. it is not the zero lower bound (I get negative nominal returns on my 2 bank accounts). But it means that bankers have a safe source of income roughly equal to the interest rate on T-bills. It has been argued, for example by Jeremy Stein, that the FOMC must guarantee bankers safe returns high enough to cover administrative costs or else bankers will gamble. The argument appears to be that bankers are telling us that we have a nice looking economy and it would be a shame if anythign were to happen to it, so how about we guarantee them 2% safe or else it might get blown up again.

It is true that tight money makes it easier for depository institutions to obtain profits. They have a good thing going in which they provide depositors liquidity and maturity transformation in exchange for paying a very low (or zero) interest rate. It only works if returns on the money obtained paying zero interest are higher than the cost of maintaning bank branches ATMS and all that. At current interest rates, they can earn those returns by taking risks or, change their whole business plan, and charge depositors for the services (as Italian banks do). Switching from no fees to fees can make people angry (although my US bank did informing me by mail I assume and I am only mildly irritated).

This does not make tight money good for investment banks, broker dealers, hedge fund managers or, obviously, industrial firms. Yet the fairly narrow interest group of commercial bankers has a clear common interest. They also have a very explicit role in influencing Fed policy through the selection of Federal Reserve Bank presidents.

3. partisanship. To discuss tight money, I must discuss Wall Streets unsurprising but marked Republican slant. Here the strange thing is that it has markedly increased during the Obama administration while markets are going through the roof. I suppose the even stranger thing is that, not so very long ago, many hedge fund managers and all of the top management of Goldman Sachs were Democrats. In any case, it isn't odd that rich investors tend to favor the GOP, since Republicans are very dedicated to attempting to serve their interests (incompetently) and sincerely praise them. Republicans favor tight money and austerity if and only if the President is a Democrat.

Notably, two salt water economists who advocate austerity and tight money, Martin Feldstein and John Taylor, are extremely partisan Republicans (click the link to Brad again).

Loose money increased the probability that Obama would be re-elected and that Clinton will be elected. Therefore, loyal Republicans must oppose it.

I think it is very possible that financiers favor their flatterers over those who actually make them richer.