Before heeding the money-tightening whispers, it’s worth considering what the financial interests of the whisperers might be – Law & Economics Prof Blog

12 Nov

http://lawprofessors.typepad.com/law_econ/2015/09/who-wants-the-fed-to-raise-rates.html

By BDG

The Fed left interest rates alone, and not everyone is happy about that.  As Matt Yglesias argues, leaving rates low indefinitely is at least defensible, as long as inflation stays as low as it is (fuel prices are creating a lot of deflationary pressure here and elsewhere).  So who are the people clamoring for higher rates, and why are they clamoring?  

Maybe some of the clamor is related to compensation structures.   Lots of fund managers get paid based on their clients’ returns — most famously, private equity managers get 2 & 20, where the 20 is a slice of the nominal gain in asset value.   In an environment where the fed funds rate is so low, returns to all assets are lower.   The manager gets paid the same 20% regardless of whether the client could have earned almost the same money investing in treasuries.  So, from the manager’s perspective, why not push that rate up?

On the other hand, fund managers also win if Yglesias is wrong and the current loose money policy creates inflation.  The 20 percent is typically based on nominal, not real, returns.  So the client bears most inflation risk.  (This is, of course, quite different from the usual arrangement for salaried workers — why is this allocation of inflation risk optimal for fund managers but not CFOs?)

So, long story short, two points.  One, as always, is that it’s good to be a fund manager.  Another is that, before heeding the money-tightening whispers, it’s worth considering what the financial interests of the whisperers might be.  

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