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Finance must serve society during the COVID-19 crisis – not disrupt it

Gli eccessi finanziari sono la causa della volatilità del mercato. Occorrono misure severe per far funzionare la finanza per il bene pubblico: la crisi di Covid-19 è un’opportunità per ri-regolamentarla verso una transizione giusta e sostenibile. Da “openDemocracy”.

Now that the financial markets are in turmoil, authorities are providing ever stronger measures and extra capital. But the panic in the financial markets is very much of its own making. The financial industry succeeded for years in fiercely opposing intervention and regulation that would have prevented the current financial distress. Authorities now have to face the resulting weak regulatory framework and restrict the viral excesses of the financial industry’s behaviour. Rather than fleeing and waiting on the sidelines, financial players should invest in companies and measures that fight against the economic fallout of to COVID-19.

The frenzied reaction of the financial markets to the coronavirus – first ignoring, then fleeing – is a logical consequence of the rules of the game. Regulations still allow very short term buying and selling by all kind of speculative traders – high frequency traders, short sellers, automated computerized trading with algorithms, day traders and fund investors. Their immediate selling and buying is facilitated by broker-dealers, stock exchanges, investment bankers and ‘market makers’. Now, in times of market volatility, some are seeing handsome returns.

The weak regulatory regime, loose monetary policy and low interest rates, together with extreme freedom of capital movement, have allowed many in the investment industry to make huge profits over the last years. These profits could now be reinvested and put to work. The five large US investment banks made $ 118 billion in profits in 2018. The investment fund industry made a good haul, with e.g. BlackRock making an annual net profit of $ 4.48 billion by managing $ 7 trillion by the end of 2019. Flow Traders, a Dutch high frequency trader and market maker, made a profit of € 53.1 million in 2019 down from € 160.9 million in 2018.

These profits came from taking ever higher risks in search of high yields. What are the risks in the financial system which will aggravate successive supply shocks, demand shocks, financial shocks, oil shocks, health shocks and economic shocks?

The risks and profit making come at a price

Many corporations have been able to borrow and issue bonds even if they were hardly or not credit worthy (“junk bonds”). Investors eagerly bought risky bonds because of their relatively high interest rates. Not only banks have engaged in risky lending but also non-banks with much fewer buffers to face non-performing loans. Total corporate debt rose to $ 13.5 trillion at the end of 2019, which is more than twice the amount in December 2008. Non-repayment of this debt when the economy goes into recession will send shockwaves through the financial sector. Because of the interconnections in the financial system, the global debt pile of government, household and corporate debt, estimated at more than $ 253 trillion at the end of 2019, can dangerously unravel and affect the economy.

The asset managing investment fund industry rapidly grew to more than $ 66.4 trillion under management in 2019 in close connection with the financial markets. Well-known investment funds are “passive”, they just follow financial market movements by using indexes. Recent fund growth came from integrating risky corporate and government bonds. Popular (passive) exchange traded funds (ETFs) have shares that can be bought and sold immediately on exchanges. Thus when prices fall on stock markets, fund and ETF share prices drop, and investors massively sell them off.

Experts have been warning that investment fund managers will have to sell even more of the millions of shares and (government and/or corporate) bonds they are collectively holding, exhausting their reserves and worsening the downward interconnected price spiral to irrationally low prices. An overlooked aspect is that investment fund managers have over the years been pressing corporations to increase their profits, often at the expense of social and environmental protection and paying taxes. This has resulted in growing inequality and undermined public services, which now impede a social safety net for riding out the coronavirus pandemic.

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