"Des waerelds doen en doolen, is maar een mallemoolen,"

"Des waerelds doen en doolen, is maar een mallemoolen," engraving from Het Groote Tafereel der Dwaasheid, 1720.

"The actions and designs of the world go round as if in a mill." South Sea bubble financial crisis.

Wednesday, November 20, 2013

Global inequality spurring global excess demand for securities

Excess demand for high yields is the main culprit of the financial crisis. This very interesting perspective is proposed by Ph. Lysandrou here. While lots of attention was devoted to the supply side of the problem, less attention was directed at the factors pushing Western financial industries to come up with new financial products and high yield securities. Lysandrou's starting point is that governments and corporations are not viewed anymore as organisations who require external funding to carry on a certain function. Instead these organisations are now viewed by investors as containers of wealth. This new nature of corporation and governments depends on their capacity to issue securities. 

These past decades, the demand has been coming from four groups of investors: 1. large institutional investors 2. commercial banks 3. sovereign wealth fund 4. High net worth individuals. The pressure these groups created was exacerbated by some constraining factors such as standardisation (necessary to the commodisation of securities) and slow regional market development (EME's supplied only 15% of the global stock of securities). 

Banks and intermediaries thus responded to this pressure by getting creative and finding ways of supplying more standardized securities by making tranches out of packages of subprime mortgages. Lysandrou's paper is particularily interesting in that it isolate a particular group: high net worth individuals, 
who in 2006 numbered 9.5 million (a figure that represents just over 0.01% of the world's population of 6.8 billion) and who had combined wealth of $37 trillion, more than half of which, $19 trillion was in securities ( a figure that represents just under 10% if the total financial claims on the world's governments and large corporations. 
HNWI were the most important supplier of finance of hedge funds, who were the main buyers of CDO. Financialisation might have increased income inequality, but income inequality might also have caused financial innovation, triggering the last crisis. 

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