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. 

Financialisation, Economy, Society and Sustainable Development

FESSUD is a EU financed research project to understand how finance can better work for the economy and society at large. I went to its annual conference (a month ago...) but I am not ashamed to to say (a month later) that it was very interesting. Some posts to follow on the papers presented there,  hopefully during the course of this week (or this month). Some papers on European financial systems here. 

The Wall Street - Washington corridor

Robert Zoellik, former president of the World Bank is to be appointed as chairman of International Advisors at Goldman Sachs. 

The amounting evidences against financialisation

Bruce Barlett gathered a good list of findings on the broken financial sytems of western countries and their effect on economic growth. It might be slowed down, because financial sectors compete with other ones for scarce ressources (human ones, most importantly), because they diverts investments in the real sectors of the economy and because of rising fees paid by nonfinancial companies. 

These empirical evidences is proving that the effects of big financial sectors on economic growth (to say nothing about rising income inequality, increasing political weight and the changes it induces on corporate governance). In other words, they show the costs of size. Which Western societies could maybe accept if financial sectors were at least efficient in what they are supposed to do (i.e. allocating capital). Far from it, there are plenty of evidences that they became casinos. Not only the piggy eats some money - which could be normal - but is loosing some too. Because its broken. 

Missing the good old scandals

Patrick Chappatte for the International Herald Tribune, July 18, 2012

If you think the LIBOR fraud were difficult to understand, wait until the alegation of this one are proven to be true. FINMA - Switzerland financial regulator - is investigating some swiss banks for possible manipulation of FX rates, among which the WM/Reuters FX rates, used as benchmark for "90 percent of currency derivatives contracts, such as swaps and options". It is getting harder and harder to even joke about it :)

The main function of financial systems?

Is now clearly to allocate risk, instead of capital. What purpose serve catastrophe bonds if not diversifying risks? this one exemple might not be enough to argue the functional shift of an entire industry, but one has to note nevertheless that catastrophe bonds might have done well because they are not correlated to stock markets....where prices are supposed reflect all known information and rational market participants act accordingly. Rational actors of financial systems have to resort to gamble on natural disasters to diversify their portofolio, showing once more (as if we needed more proof by now) that financial markets are not efficient at reflecting fundamentals. 

Natural disasters as safe heaven from stock markets

Leonardo Da Vinci - Natural disaster

Betting on the likelihood of natural disasters has been one of the best investment since the financial crisis, after silver, gold, high-yield bonds from the US and EU countries. Catastrophe bonds are a fixed-income investements, but contrary to others, issuers do nothave to pay the full amount of the bond or the interest in the event of a natural disaster. 

Now get this: 

So why have cat bonds done so well in the last few years? Because they have practically no relationship to financial markets. This doesn't mean they're particularly safe: we've written before about the possibility of a bubble forming in the insurance industry. Then again, when the entire market can shift after a few comments from Federal Reserve chairman Ben Bernanke, as it did this week - or rests on the health of dubious bets from the financial industry - gambling on the likelihood of a natural disaster doesn't sound like such a bad idea. 

The stock market has become so unpredictable and so detached from economic fundamentals that natural disasters have become an alternative to it.