The contribution of wealth concentration to the subprime crisis

What is it about?

The crisis that broke out in mid-2007 was caused by the fact that the collateralised debt obligation (CDO) market had grown to a size sufficient to wreak general havoc when it suddenly collapsed. Several authors have argued that economic inequality was important to the growth of this market. This paper attempts to strengthen this argument by concentrating attention on global wealth concentration. After summarising recent evidence on the negative impact of investor demand on US bond yields in the pre-crisis period, new evidence regarding the specific contribution of high-net-worth individuals to this negative impact is presented. The paper then goes on to show how, after having helped to cause a yield problem in the major US debt markets, high-net-worth individuals (via hedge funds) continued to be a major source of the pressure on US banks to resolve this yield problem through the mass production of CDOs.

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Why is it important?

The majority of mainstream economists and government policy makers continue to believe that the financial crisis was caused by a mixture of deregulation, wrong incentives and a lax monetary policy rather than by an increasing unequal distribution of income and wealth. For that reason they continue to prioritise structural changes in the financial system rather than structural changes to the current system of inequality. The conclusion that falls out of the above analysis is that as much priority needs to be given to income and wealth redistribution as to financial regulation, because economic inequality had coprimacy with regulatory failure as a root cause of the financial crisis.