The global financial crisis of 2008–9 reinvigorated scholarly work on the political causes and consequences of financial instability and banking crises. The Wealth Effect offers a distinctive and important contribution to this already large literature. Most existing scholarship examines financial crises through the lens of a regulatory capture perspective in which financial institutions induce regulators to relax rules and then exploit the laxity to become too big to fail and to take on too much risk. The state then bails them out when the inevitable crisis occurs. In contrast, Jeffrey Chwieroth and Andrew Walter locate the cause of financial instability in the logic of electoral politics. They argue that rising middle-class wealth has caused voters to expect the government to enact policies that protect the value of their assets in the face of financial crises. In their words, “emergent middle-class expectations…have prompted modern democratic governments…to opt for increasingly extensive bailouts and other policies aimed at wealth protection…Put differently, we argue that modern governments implement bailouts because their electoral prospects depend heavily on doing so” (p. 67). And because elected officials have such incentives, financial institutions recognize they will be bailed out and thus engage in reckless behavior.
Three elements differentiate this book from existing work and, in combination, produce a very important contribution that deepens our understanding of the politics of finance. First, The Wealth Effect develops a macro and a longitudinal political economy account of banking crises in democratic societies. The work focuses on socioeconomic structure and the political system in the broadest of terms. It focuses our attention on electoral institutions, the interests of the middle class, and the interaction between them. The Wealth Effect effectively describes the emergence and development of a middle-class interest in financial stability over time as a function of their accumulated wealth and of broader institutional change, such as the shift from defined-benefit to defined-contribution pension plans. The work thus offers an important counterpoint to the actor-centered and largely cross-sectional analysis that characterizes most of the existing research on banking crises. Moreover, and more broadly, by focusing on middle-class wealth the work brings the “financialization of everyday life” into the center of our understanding of financial system performance. This constitutes a valuable synthesis that should have an important impact on how we think about the politics of finance.
Second, the underlying theoretical dynamics that the authors develop focus on the unintended consequences of the broader structural and institutional changes that their macro perspective highlights. Indeed, one might even suggest that the authors assume that the political economy of finance approximates a complex adaptive system (though they never use this term) in which multiple agents interact and that this interaction changes the system over time. Private actors gain new interests, public actors attempt to accommodate these interests in an effort to retain power, and these interactions generate outcomes in the form of financial instability and banking crises that no one causes, intends, or desires. This adaptive and evolutionary logic of politics contrasts sharply with the more standard instrumental and consequentialist explanations that dominate political economy of finance research, in general, and the regulatory capture argument, in particular. The work thus stands as a model for an important and distinctive broader theoretical approach to political economy.
Third, The Wealth Effect presents an abundance of evidence analyzed with a variety of methods. The authors assemble fairly comprehensive data describing the accumulation of wealth by the middle class and the resulting increased participation in financial markets (chapter 3). They provide a large-N statistical analysis of the political causes and consequences of government intervention in banking crises in democratic societies that extends back into the late nineteenth century (chapters 5 and 6). The work provides detailed comparative case studies that trace the development of middle-class wealth and expectations during the last 150 years in the United States, the United Kingdom, and Brazil (chapters 7–12). The book thus offers plentiful evidence drawn from multiple sources and analyzed with a variety of methods to strengthen our confidence in its principal findings.
I had two primary concerns about the work. First, The Wealth Effect largely neglects the global dimension of finance. This omission is surprising generally, given the extent of contemporary global financial interdependence. And this omission is surprising more specifically because contemporary research concludes that financial instability within countries typically is driven by global market forces—the so-called capital inflow bonanzas. These large and sustained net capital inflows generate real estate and equity market bubbles, and banking crises often occur when these bubbles pop. A real puzzle, then, which the authors chose not to explore, is why governments have not implemented capital controls and other measures to prevent capital inflow bonanzas and thereby protect middle-class wealth. The Wealth Effect’s theoretical framework might offer a solution to this puzzle: the middle class expects to hold an internationally diversified portfolio, and as a result, governments have no electoral incentive to limit cross-border flows. Another possibility, however, is that, in an age of global financial interdependence, domestic financial institutions earn an increasing share of their revenues through cross-border transactions and thus pressure governments to keep borders open to these flows. Elected officials thus find themselves squeezed between pressures to safeguard middle-class wealth, in part by renationalizing finance, and pressures to retain financial sector revenues by embracing deeper financial interdependence. Bailouts to rescue banks thus become the only politically feasible policy option that governments have.
My second concern is that the book is less clear than it could be about how exactly bailouts of the banking system protect middle-class wealth. As the authors describe, the middle class does not hold its wealth in bank deposits, but instead buys real estate and equities. And bank bailouts may save banks and the banking system, but they do very little to shore up real estate values and equity prices. In the 2008 crisis, for instance, the US government’s effort to rescue banks did not prevent sharp declines in home values and the major stock market indices. The same outcome is evident in the savings and loan crisis of the 1980s. Nor need a stock market correction that erodes middle-class wealth necessarily cause a banking system crisis that would prompt a government rescue. The collapse of the dot.com bubble in 2001–2, for instance, certainly eroded middle-class wealth but did not provoke a significant government policy intervention in the financial system. Thus, the book could do a more thorough job of explaining exactly how and the conditions under which bank bailouts provide an effective response to middle-class concerns about their accumulated wealth.
On balance, however, these two concerns do little to detract from the significance of The Wealth Effect’s contribution to our understanding of the politics of finance. The book constitutes essential reading for every scholar with an interest in the politics of financial crises and will be of great value to anyone whose research touches on the political economy of modern democratic capitalism.
