Noah Smith discusses an interesting question in his latest at Bloomberg:
“why do so many Wall Street people seem to hate [Fed policy]”
He goes on to describe three theories:
- The Rentier Theory which states that Wall Street serves the rich and Fed policy can cause inflation which hurts the wealthy.
- the Fed Whale theory which states that the Fed is so powerful that it can diminish the power Wall Street might have over the market.
- the Behavioral Theory which basically states that low rates makes it hard to charge higher fees.
There’s a good deal of truth in each of those, but I think we can add to it since, well, I am a financial type.
People who are directly involved in the markets tend to believe that the markets are irrational and unstable. Traders make a living taking advantage of the mistakes that other traders make. They tend to think like gamblers – that is, there’s a well understood probability distribution as Noah says. But when someone comes in and starts changing the rules then the game looks “rigged”. Likewise, when the Fed comes in and starts tinkering with the markets the game looks “rigged”. This makes it much harder to predict that probability distribution.
There’s also a strong behavioral aspect here. Traders tend to love behavioral finance because they can relate to it. Traders see how irrational their own thinking is so the whole field of behavioral finance seems so intuitive and obvious to us. Financial types worry about Fed intervention because they (we) think that the markets are made up of irrational and behaviorally biased investors. If you take those irrational investors and do things that might make them act even more irrational then that could cause bubbles or other market turbulence that could actually makes matters worse.
I personally don’t think the concerns expressed by financial types about Fed intervention are unwarranted (because I am a biased financial type). After all, the Fed is basically an entity designed to make the banking system more efficient. But the Fed is hardly an infallible entity acting in a perfectly rational fashion. And I guess that’s ultimately the concern – if you have this uber powerful entity steering the markets or exerting an excessive amount of influence in one direction or another then it makes sense that their good decisions will look very good and their bad decisions will look very bad. I am certainly not one who is against Fed intervention at times, but I think it would be equally silly to assume that the Fed is infallible or that its actions can’t negatively impact the economy. So that’s why I think it’s healthy to approach Fed policy with some level of skepticism….
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