Profiting on Crisis: How Predatory Financial Investors Have Worsened Inequality in the Coronavirus Crisis

Since the late 1970s, the world financial system has become the dominant engine of the global economy (Dore, 2008; Epstein, 2005). The rise of finance has exacerbated inequality both within and between countries (Assa, 2012; Kus, 2013; Kwon & Roberts, 2015). This trend appears more pronounced in liberal market economies such as the United States (Kwon & Roberts, 2015), where finance has become a primary driver of rising top incomes and widening inequality (Lin & Neely, 2020; Lin & Tomaskovic-Devey, 2013).

The coronavirus pandemic presents an opportunity to change the unequal status quo. By creating a jolt to social and economic systems, moments of instability open up possibilities for change. As Raewyn Connell theorizes (2019), crises can expose cracks in the systems of inequality that allow people to create alternatives. However, recent economic crises have reinforced the uneven distribution of resources that favors finance, especially following the global financial crisis of 2008 (Grusky et al., 2011; Lin & Neely, 2020).

At first glance, the coronavirus crisis appears straightforward: A once-in-a-century pandemic sparked a health and economic crisis. But behind the scenes is a story of how financial investors have affected the crisis and profited from it. How has finance made society vulnerable during times of crisis? And how do financial investors exploit these vulnerabilities?

We examine how the rise of “shadow banks”—less regulated private credit intermediaries such as private equity, venture capital, and hedge fund firms—has shaped the course of hardship and inequality during the crisis. We focus on the United States because it has the highest concentration of shadow banks (Cox, 2019). Private equity invests in private companies and often proactively influences how executives run the company. Venture capital, a type of private equity, invests in start-up companies and provides guidance to entrepreneurs. Hedge funds invest in both public stock markets and private companies. These shadow banks play an instrumental role in how executives manage companies, which has important ramifications for societal responses to crises, the wellbeing and livelihoods of workers, and inequality throughout the labor market. Shadow banking is a highly lucrative sector of financial services responsible for driving top incomes ever further upward (Flaherty, 2015; Nau, 2013).

Shadow banking during the coronavirus crisis presents a case of capital accumulation through exploiting economic disruption. This case provides another way of conceptualizing David Harvey’s (2003) theory of global capital accumulation through dispossession, which occurs through financial wars against foreign currencies, productive economies, and corporations. In the coronavirus case, capital accumulation occurs through financial investors exploiting the economic system itself during a time of crisis. The coronavirus crisis is indicative of disaster capitalism (Klein, 2007) in which investors capitalize on a society characterized by unprecedented and unmanageable risk (Beck, 1992). Leading up to and during the coronavirus crisis, dispossession has involved the provision of public goods such as health care, health insurance, ambulatory services, and groceries. Financial investors at shadow banks have both created the conditions that exacerbated hardship during this crisis and invested in ways that have allowed them to profit from it. We call this profiting on crisis.

The stakes during the pandemic are high as people face a once-in-a-lifetime health crisis and economic disaster. To date, there have been over 119 million cases and 2.6 million deaths recorded worldwide, and the United States alone accounts for over 29.4 million cases and 530,000 deaths (“Coronavirus World Map,” 2021). The economic ramifications have been harrowing for communities and households. The World Bank reported a 4.3% contraction in global GDP at the end of 2020 (The World Bank, 2021). Employment remains insecure, many renters face evictions, and entire economic sectors struggle. Despite these conditions, U.S. financial markets continue to grow. This boom in market activity captures how a small group of investors is profiting from the crisis, while the majority of people face unprecedented health and economic hardships. This gap is indicative of widening inequality over the past four decades.

Policy, however, is only one piece of this puzzle. Thomas Piketty (2014) also identifies the bankruptcies of the Great Depression and destruction of physical capital during the World Wars as radical shocks that stemmed how inequality grows under rentier capitalism, in which income accrues disproportionately to those with capital. Physical capital has not been threatened on the same level during the coronavirus pandemic. But, we argue, the key difference between the shocks of past crises and the pandemic lies in how the current era of financial capitalism relies on exploiting labor and capital itself, through complex financial vehicles, for example, derivatives, that become divorced from the real economy. The activity of shadow banks during the pandemic reveals how financial investors accumulate capital through private and risky investments that exploit vulnerabilities in the economic system during a time of crisis. In a context of less regulatory scrutiny than in the postwar era, the opaque and speculative nature of shadow banking prevents the crisis from acting as a shock to capital-driven inequality, allowing inequality to grow rather than contract.

Yet instability can create opportunities for systemic change. The decades following the Great Depression is called the “Great Compression” because of declining inequality ( Goldin & Margo, 1992 ; Grusky et al., 2011 ). To a large extent, the policy response led to this compression: The New Deal introduced the federal minimum wage, higher taxation, stimulus spending, Social Security, and other welfare programs. In contrast, the policy response to the Great Recession boosted liquidity, penalized fraud, and reduced systemic risk, restoring the financial order that exacerbates inequality ( Lin & Neely, 2020 ). To date, the government response to the pandemic has more closely followed the latter crisis with respect to the implications for inequality.

Neoliberal policy regimes have been a primary driver in relaxing financial regulations and the subsequent rise of financial capitalism. Neoliberalism refers to a set of economic policies and practices guided by a market ideology that believes that markets have an internal stabilizing logic and less regulated, competitive markets will reach equilibrium ( Harvey, 2007 ). Although neoliberal market activity is embedded within a particular regulatory and policy context ( Brenner & Theodore, 2002 ; Sassen, 2004 ), financial markets can nimbly traverse a network’s “flow architecture” ( Cetina, 2004 ) that can become divorced in speed and content from the underlying real economy. The rapid pace of financial markets promotes imitation and causes extreme price movements ( MacKenzie, 2003 ), which heighten instability and lead to more frequent crises ( Harvey, 2011 ).

Last, the nature of their investments and the potential to generate high profits make shadow banks ideal for studying how the financial sector contributes to inequality in the labor force and instability in the economy. Shadow banks often make rapid, short-term trades that can create bubbles and crashes, as in the mortgage crisis precipitating 2008 ( Gorton & Metrick, 2009 ). Furthermore, leveraged buyout firms, distressed debt investors, and activist hedge funds profit from investments in flailing companies with the goal to turn them around, which can promote these companies’ growth but can make them more prone to bankruptcy and failure ( Appelbaum & Batt, 2014 ). Shadow banks also invest with the goal of maximizing shareholder value, which weakens workers’ bargaining power, funnels money to executives and shareholders, and thus contributes to widening inequality ( Appelbaum & Batt, 2014 ). Finally, shadow banks provide high earnings both to their employees and to their wealthy investors, as discussed above, increasing the top incomes and wealth concentration among elites. Shadow banks have contributed to widening inequality and increasingly precarious work over the past 40 years ( Kalleberg, 2011 ; Lin & Neely, 2020 ).

Second, while shadow banking is relatively unknown among the public, it has been the fastest growing areas of finance since the early 1980s ( Antill et al., 2014 ). Institutional investors and wealthy elites have reduced their traditional investments in public markets and increased their investments in shadow banks such as private equity, where returns have historically been higher ( Mauboussin & Callahan, 2020 ). 1 This trend intensified in the aftermath of the 2008 financial crisis. As investment banks faced liquidity problems, the U.S. government tightened banking regulations and the Federal Reserve lowered interest rates, leading institutional investors to shift their funds to shadow banks less encumbered by regulators ( International Monetary Fund, 2014 ). Both in the previous and current crises, these firms have presented an alternative to the large investment banks and provided opportunities to make higher investment returns. Thus, the shadow banking industry grew substantially—by 75% to $52 trillion ( Cox, 2019 )—as investors lost trust in the “too big to fail” financial institutions in the aftermath of 2008. Shadow banking’s rapid growth paved the way for the current crisis.

First, despite their enormous volume of assets and large impact on global capital flows, shadow banks make up some of the more complex, opaque, and less-regulated subsectors of finance ( Antill et al., 2014 ). The nature of their investments makes shadow banks less transparent than investment banks. These firms provide credit through a wide range of complex financial vehicles called alternative assets, such as asset-backed securities, collateralized debt obligations, asset-backed commercial paper, and repurchase agreements. Furthermore, shadow banks invest in public markets, in private markets—direct investments in companies that have not gone public—or in a combination of both. Investments in private markets draw less scrutiny than those in public markets, making shadow banking activities less transparent.

Shadow banks have played an important role in the shareholder value revolution ( Appelbaum & Batt, 2014 ) and contributed to the increasing polarization and precariousness of work ( Kalleberg, 2011 ). Shadow banking refers to any kind of nondepository (i.e., nonbank) credit intermediation provided by asset managers (e.g., private equity, hedge fund, and venture capital firms), broker-dealers, and finance companies ( Antill et al., 2014 ; International Monetary Fund, 2014 ; Pozsar et al., 2010 ). Shadow banks provide an opportune case for studying how finance has affected the current crisis for three primary reasons.

Behind the headlines of personal protective equipment (PPE) shortages and vaccine developments is the role of shadow banking in making society more vulnerable to crisis and then profiting from these very vulnerabilities. The work of shadow banks has impacted the health care sector’s ability to respond to the pandemic and exacerbated the burden on frontline workers. In what follows, we first examine how shadow banks in the United States place pressure on executives to make business decisions that can endanger the welfare of many people and social institutions designed to protect the collective wellbeing. These financial investors have worked to dismantle and privatize the institutions responsible for protecting people, both when they are in the labor force as well as when they have exited it, such as during periods of unemployment and sickness. In particular, shadow banking has contributed to efforts to hollow out the health care industry and disenfranchise the low-wage service sector, putting frontline workers at risk and inhibiting the societal response to the coronavirus crisis. The opacity and complexity of shadow banking suggest that this sector has the potential to do more damage than the traditional banking sector.

We then outline how, both before and during the coronavirus crisis, high-net-worth and institutional investors, such as endowments and pension funds, have increased and plan to continue increasing allocations to these industries. Pensions and company-sponsored retirement accounts do not cover everyone, leaving out many workers, especially those whose benefits have been cut due to the shareholder value revolution.

Last, we investigate how, as the downturn unfolds, investors are shifting their financial holdings to profit on the misfortunes of frontline workers, vulnerable populations, and distressed industries. For example, investors are speculating on mounting insurance premiums (Brush, 2020); flailing travel, leisure, retail, and restaurant industries (Chung, 2020); distressed real estate assets, such as retail and hospitality; and niche industrial spaces, such as self-storage, data centers, and medical offices (Gujral et al., 2020; Jacobius, 2021). After governments withdraw financial support, unemployment is likely to remain high and foreclosures and business bankruptcies will likely ensue. Investors are planning accordingly to profit on the crisis and the fallout of the crisis.

Capital Flows into Shadow Banking Against a backdrop of surging infection and mortality rates in the United States, stock markets are soaring as capital flows into public and private financial markets in anticipation of massive returns on investments in specific sectors that stand to benefit from the pandemic (Barro, 2020). Public markets, which hedge funds invest in, provide a barometer of these capital flows. The S&P 500, for example, took a dive in March and then rallied for months, closing 2020 at a record high with an annual increase of 16.3% despite the increasingly dire situation facing the health care sector and the accompanying economic fallout (Troise, 2020). Precipitous upticks in unemployment, business closures, and economic chaos would seem to be a recipe for dismal performance in stock prices; however, with historically low yields in cash and bond markets, investors are seeking investment opportunities in areas of finance where returns will skyrocket due to the pandemic. These wealthy individuals and institutional investors are flocking to shadow banking, in particular, because it is proactively sourcing opportunities emerging from the pandemic (Bernstein et al., 2019). Indeed, investors’ appetite for shadow banking stands to grow considerably, with many expecting to increase their financial commitments, in spite (or perhaps because) of the uncertainties. Investors are motivated by the potentially higher financial returns offered by shadow banks, which can outperform investments in public stock markets, especially when interest rates are low. The assets managed by the alternative investment sector, a subset of shadow banks that includes hedge funds and private equity, ballooned to more than $10 trillion as yield-hungry investors poured capital into the industry during 2019 (Preqin, 2020a). These trends will likely continue as the pandemic plays its course. In a June 2020 survey, 63% of surveyed investors said the pandemic has not affected their planned alternatives commitments, with 29% looking to increase investments in alternatives (Preqin, 2020b). The fact that shadow banks are emerging as a “winner” of the pandemic is not unique to this crisis. During the financial crisis of 2008, shadow banks were among the first to rebound and then profit from the crisis because they did not face the same liquidity problems as investment banks (Bernstein et al., 2019). Private equity firms and other shadow banks actually increased their fundraising during the last financial crisis as investors pulled their money from large financial institutions (Arundale & Mason, 2020; International Monetary Fund, 2014). It does not appear that the current crisis will hamper investment allocations to shadow banks in the long term. Investors’ increasing allocations to shadow banking reflect broader trends over the past 30 years, as the industry has been the fastest growing in the financial sector (Antill et al., 2014). For example, from 1990 to 2007—just before the financial crisis—the assets managed globally by hedge funds grew 50-fold and have since grown by another third (“Hedge Funds in Trouble,” 2008). And these trends have continued in recent years. Globally, private equity fundraising reached $535 billion in 2020, with North America setting an all-time record of $350 billion in 2019 (McKinsey & Company, 2020a; Mendoza, 2021). Similarly, the value of venture capital deals skyrocketed to a 1-year record high of $156 billion in 2020 (Venture Monitor, 2020). “Dry powder,” large pools of capital set aside for rapidly emerging opportunities, is an important metric for shadow banks. In anticipation of pandemic-induced opportunities, investors are pouring capital into private investment vehicles, with total private capital dry powder reaching a record $2.4 trillion at mid-2020, a hundred billion dollar increase compared with the end of 2019. And, as we examine in the next section, hedge fund investments have been so profitable during the crisis that the industry is still growing despite investors redeeming up to $100 billion in 2020 (Laurelli, 2020). The long-term growth of shadow banking, before and during the crisis, reflects how the sector has lobbied regulators and governments to change policy in their favor. For example, the National Venture Capital Association launched an initiative to promote the positive impact of venture capital on the coronavirus battle. The Association led a letter-writing campaign to the congressional leadership to communicate the “critical work that VC-backed start-ups are undertaking to advance cures, treatments, and products needed to fight COVID-19” (Temkin, 2020). Meanwhile, 8,100 venture and private equity portfolio companies received an estimated $13.4 billion in loans from the U.S. Paycheck Protection Program designed to incentivize small businesses to continue paying their employees (Thorne, 2020). Critics questioned whether companies with access to private funding and that constitute high-risk ventures should receive the government stimulus. Last, the influx of capital to shadow banks during the pandemic has been funneled into the hands of an elite group of mostly white men, who not only make higher incomes from managing these assets but also make decisions that affect the rest of society. The firms owned by white men manage nearly 99% of the $69 trillion U.S. asset management industry, including hedge fund, real estate, private equity, and mutual fund firms (Lerner, 2019). The decisions these white men make about where to invest that money and which companies should survive the crisis will shape the course of society for decades to come. Based on these numbers, it should come as no surprise that companies founded solely by women garnered only 2.2% of the total capital invested in U.S. venture-backed start-ups in 2018—compared with 85% for ventures founded solely by men (Clark, 2018). One industry report found that men comprise nearly 91% of venture-backed start-up founders and 77% of founders are white (RateMyInvestor & DiversityVC, 2019). The high flows of capital into these industries not only raises the top tail of economic inequality, it also limits who makes decisions about which businesses to fund in response to the crisis. Gender, racial, and class disparities in who controls the funding during the coronavirus pandemic will have lasting ramifications for social inequality.