Politicising International Finance

Entry prepared for David Levi-Faur, ed., The Oxford Handbook of Governance Financial Regulation and Governance Philip G. Cerny Philip G. Cerny is Professor Emeritus of Politics and Global Affairs at the University of Manchester and Rutgers University and Adjunct Professor of Politics and Public Administration at the University of Limerick.  ABSTRACT The central problematic of financial governance in developed capitalist economies is whether government regulation of financial markets and institutions enables the financial system to operate more efficiently, or alternatively obstructs or even counteracts that goal. The latter state of affairs, labeled “moral hazard” by economists, is at the heart of current debates. This chapter argues that the financial system is a key public good essential to contemporary society, and that the recent global financial crisis has opened up political questions not seriously asked since the 1970s and the arrival of the “deregulation” paradigm and the theory of rational markets, which treated financial markets and institutions as private goods. Without government rules, restrictions, and support, financial markets tend to be beset by monopolistic behavior, excessive risk-taking, “herding” or “momentum,” fraud, and periodic crises, thus becoming even more inefficient. In this context, the very concept of the “efficiency” of financial markets is contested too. Does it mean the efficient reallocation of capital and economic resources from investors to producers in ways that promote stable, continued, and equitable economic growth, or, alternatively, profit-making and rent-extraction for market actors and institutions? To what extent does the traditional emphasis on microprudential regulation undermine macroprudential regulation, requiring the extension and intensification of the latter? At the same time, the globalization of financial markets has made effective governance infinitely more complex, and this chapter briefly surveys some core issue areas that cut across diverse levels of governance, leading to some mixed and partially effective reregulation but also much scope for interest group politicking, regulatory arbitrage, regulatory capture, and regulatory fatigue, undermining the role of the financial system as a public good. Governance of the financial issue-area therefore looks more like the entrenchment of private special interests, unequal access, neopluralism, and “coordinated capitalism,” than like the deliberative, participatory, and inclusive political processes favored by theorists of “network governance.” ********** Introduction: Governing Financial Markets Finance has always involved complex, interpenetrated, hybridized relationships between and cutting across both public and private sectors (Cerny 2011)—the core of the notion of governance. Governments are dependent upon financial markets and institutions both for their own financing when, as often happens, spending exceeds taxation, and also, and perhaps more importantly, to ensure that the private financial system is effectively able to provide sufficient capital for entrepreneurs and firms in order to create economic growth—the core “social policy” of the modern capitalist economy and, in turn, the modern capitalist state. “Governance” itself is an essentially contested concept. In the broadest sense, it simply means how a society is governed, ruled, or managed. In this context, “government”—the more formal institutions and processes of the state—is simply one form of governance. More recently, however, not only has governance come to denote more informal processes of negotiating, bargaining, and policymaking, but the concept of “governance by networks” has also been given a normative, even ideological, gloss of inclusiveness and participation by a wider range of groups and individuals. Such so-called “post-bureaucratic” deliberative processes are sometimes even seen to be more “democratic” than traditional representative democratic government itself (Eagleton-Pierce 2010; Kurt 2010). Finally, with today’s increasing focus on “globalization,” the idea of governance has taken on a transcendent character, referring to a complex mix of transnational, domestic, and subnational processes. Governance in the financial issue-area has furthermore been characterized by complex and varying notions of “regulation.” At one level, the concept of regulation has overlapped with the wider notion of state intervention in the economy in general. For example, the French “Regulation School” sees capitalism as essentially an unstable system if left to itself, requiring regulation to exist in the first place, remain stable, and prosper. At the same time, proponents of traditional laissez faire capitalism and, especially, of “rational” and/or “efficient” market theory, believe that capitalism works best when markets are relatively unregulated and that competition by itself creates an “invisible hand” (Smith 1776/1991) that turns individual self-interest into “enlightened self-interest” and thence to the common interest. In more recent parlance, however, regulation has been refined to mean “arm’s-length regulation,” which, in contrast to “intervention” in general, refers to market design and the capacity of states to enable and promote efficient behavior on the part of market actors—as distinct from attempts to manipulate or control specific market outcomes. Regulation today is therefore about pro-market or “pro-competitive” regulation, seeking to enable markets to operate more efficiently—“commodifying” regulation, that furthers the marketization of tradeable goods and instruments, as distinct from traditional “decommodifying” regulation, that sought to take economic activities out of the market (Cerny 1990, 1991, 2010a; Foucault 2008). Contemporary regulation works through the public promotion of market-rational private sector behavior rather than through Weberian bureaucratic hierarchies. There is a fundamental collective action problem here. Financial markets are populated, especially in relatively neoliberal states, by private actors. Their incentive structure is based on an assumption that the system itself is characterized by what theorists of political economy call “private goods.” Private goods are those that are divisible in two ways: in the first place, they are “excludable,” i.e. consumers can be excluded from enjoying those goods if they are not willing or able to pay for them; and secondly, they are “rivalrous,” i.e. consumption by one user prevents another from using that good. Markets are generally seen as the most efficient ways to organize the production and consumption of private goods. “Public goods,” in contrast, are neither: consumers cannot be excluded from their use (standard examples are street lighting and national defense); and they are not rivalrous in that consumption by one individual does not exclude others from using them. Mainstream economic conceptions of finance see it as involving private goods, in which case relatively deregulated markets should eventually prove more efficient than regulated ones. However, increasing awareness of systemic risk and the requirements of macroprudential regulation tell a different story. Because of the role financial markets play as the structure that enables and empowers all other economic transactions and production systems, a stable and liquid financial system is necessary for the rest of the economy to work. Therefore it possible to redefine the financial system itself as a de facto public good. Indeed, it is regulation that enables the financial system to work, providing at the most general level property rights, contract law, fraud prevention, anti-trust regulation, etc., along with government promotion, support, and specific guarantees that empower market actors to participate in the system. Regulation is therefore a necessary precondition for preventing market failures and for mopping up after crises. But the regulatory challenge is much greater in a world of globalizing financial markets, where international institutions are often rudimentary and ineffective, and states are increasingly constrained by political interest politicking, regulatory arbitrage, regulatory capture, and regulatory fatigue. Financial Governance, Risk, and Growth Finance can thus be characterized as the “infrastructure of the infrastructure” of capitalism itself—money being exchangeable for all other goods and assets, thereby enabling all other markets and production processes to exist and develop beyond subsistence levels (Cerny 1994a and 1994b). But money and finance in turn derive from profits and surpluses that can be reallocated to other uses through financial institutions and markets. Thus it is in the general interest of society that finance be governed in such a way as to maximize the amount of financial resources that can be so reallocated, and to ensure that they are reallocated to uses that in turn further economic growth and development in general. This includes promotion management of entrepreneurial risk-taking (Bernstein 1996). In static societies, risk-taking is severely circumscribed by religious prohibition, social inhibition, and/or the hostility of the external environment. Capitalist economies, however, grow precisely because individuals and firms are encouraged to take risks and strike out for pastures new. Indeed, it is believed that the “enlightened self-interest” of the risk-takers benefits the system as a whole, entrepreneurs will seek a constructive balance of risk and return, and markets will at least partly regulate themselves. The availability of finance for new investment, for maintaining and expanding existing activities, and for covering short-term fluctuations in operating costs, is crucial for enabling and supporting this entrepreneurial function. As both Michel Foucault (2008) and Margaret Thatcher argued, growth is the core social policy under modern neoliberal capitalism. Without “wealth creation” in the first place, there would be nothing to redistribute. There would be no newly created money to invest, lend, pay workers, finance consumption, redistribute in taxes and government spending, nor to reconcile the competing interests of different groups. Economic growth and the financial activity on which it depends are therefore the preconditions not only for the success of capitalism as such, but also for the political reconciliation of conflicts that underwrite its reproduction. Nevertheless, crises are inherent in this process. As risk-taking gathers speed in the upswing of the economic cycle and those risks are increasingly seen to pay off, two things happen: first, those risks become ever riskier; and second, the attraction of higher potential returns feeds into the risk/return calculus, causing those risks to become ever more dangerous. The props put in place during previous crises often themselves encourage riskier behavior, diverting that behavior into grey areas and loopholes insufficiently addressed by existing regulatory arrangements. However, especially since the onset of the recent global financial crisis, critics have argued that there is a problematic threshold between “risk” in the calculable sense and broader “uncertainty”. Theoretical debates increasingly focus on so-called “black swans” and “fat tails” that do not conform to the standard deviations used in the calculation of risk (Taleb 2007) and challenge the claim of financial markets to be “efficient”—i.e. to lead to investments that contribute to economic growth and stability. Vicious spirals leading to market crashes are therefore not “irrational” but normal events (Fox 2009). Indeed, market actors often not only do not appear to be able to predict such events, but also act in counterproductive ways—not so much “irrational” in the broader linguistic sense of the term but ironically conforming to an alternative rationality—leading to vicious spirals that can significantly exacerbate the downside of a crisis. Everything looks rosier as the bubble gets blown bigger. Furthermore, financial “innovation” or the invention and proliferation of new complex financial instruments such as derivatives, seen originally as promoting efficiency and “portfolio diversification”—the widespread idea in recent decades that holding an apparently diverse and complex set of financial securities is inherently stabilizing—has not only led to increasing interconnectedness among markets and what has been called a “cascade” effect both within and across market sectors (Bookstaber 2007), but also to extensive opportunistic behaviour and fraud (Das 2010). Financial innovation by individual firms often creates fashions for copying first-mover firms, leading perversely to the opposite of diversification—copycat emulation, herding behavior, and the concentration of risks around virtually the same products across firms, market sectors, and even the global financial system as a whole. Financial Market Governance in Interconnected Markets There are two main challenges to financial governance. The first is whether the increasing interconnection or tight coupling among financial instruments, firms, sectors, and markets generally, not only undermines the public goods dimension of the financial system, but also alters the structure of the system itself. The second is what role regulators and other bureaucratic and political actors and institutions—not only in national governments, but increasingly in international and transnational institutions—can and/or should play in resolving or mitigating the effects of crises. On the first issue, the failure of large swathes of various national banking systems and the concentration of the industry around a smaller number of larger banks or “systemically important financial institutions” (SIFIs), especially across borders, has created new forms of “concerted” financial capitalism that are leading to an oligopolization of the sector, reinforcing the lack of accountability of the financial system globally (Cerny 2010b: chapter 12). The second challenge is what sort of new or reformed regulatory approaches and processes might be adopted to prevent future “tail events” becoming full blown crises. Despite continuing problems of an uneven and sluggish economic recovery in 2009-2011, the adoption by most governments until recently of essentially Keynesian policy responses—government intervention to support and often subsidize markets and firms (and sometimes to weed out the worst offenders such as Lehman Brothers), as well as various “stimulus” fiscal packages—has been enormously effective in preventing the original crisis from worsening to the extent feared. Nevertheless, political opposition to such approaches grew dramatically in the course of 2010 as political perceptions of their costs rose, whether in the guise of the Tea Party movement in the United States, the deficit-cutting approach of the Conservative-Liberal Coalition Government in the United Kingdom, or the reluctance of Germany (now partially overcome) to bail out governments in Greece and Ireland. At the same time, however, there is still much confusion over the role of financial market regulators and regulatory institutions in both the lead-up to the crisis and the short term reaction to it. The failures of the US Federal Reserve (the Fed) and, especially, the Commodities and Futures Exchange Commission (CFTC) and the Securities and Exchange Commission (SEC), to take the simplest measures to prevent the crisis has been widely noted (Acarhya, et al., 2010). Three key issues are significant here. First, regulatory and legislative measures and court decisions in the United States and elsewhere over about three decades elevated the concept of “deregulation” to an accepted paradigm and “common sense” in the philosophy of government regulation—what has been called “intellectual capture” (Warwick Commission 2009). Second, both the reform and interpretation of detailed rules in the American tradition, on the one hand, and so-called “principles-based” or “light touch” regulation in the United Kingdom and elsewhere, on the other, led to greater regulatory and political tolerance and support of complex forms of financial innovation and what has been called “competition in laxity” and “regulatory arbitrage” among regulators and regulatory systems, as market actors seek to be covered by the least intrusive rules and regulatory bodies, whether within particular states or across borders. Third, the structure of regulatory systems themselves, whether centralized in relatively few bodies (usually some tripartite combination, as in the United Kingdom, of a central bank, a securities regulator like the Financial Services Authority [FSA], and the Treasury) or characterized by a number of competing regulators supervising particular institutions, as in the United States, often prevents rather than enables effective and coherent regulation. Nevertheless, the deregulatory paradigm has not disappeared, only partially replaced by ad hoc responses. Part of the reason for this is politics. For example, party politics in the United States, combined with extremely effective and well-financed lobbying by a powerful set of bank and non-bank interests in the context of a divided political system with a separation of powers inherently conducive to gridlock in the policymaking process, led to the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010—a cumbersome set of compromises that requires the ex post negotiation of detailed rules and implementation over several years (Acharya, et al., 2010). In the United Kingdom, the Conservative Party ran for office in 2010 on a policy of splitting up the FSA, and the Conservative-Liberal Coalition Government is still finalizing the details. The European Union is also in the course of setting up a range of new regulatory bodies. However, the jury is still out as to whether real convergence both within and across borders will result. Nevertheless the most promising turn has been an intellectual and policy shift towards focusing on “systemic risk” and so-called “macroprudential regulation.” Financial market regulation in the past has been focused overwhelmingly on the supervision of specific firms and markets, i.e. on what is now called “microprudential regulation.” However, the most crucial lesson of the recent crisis has been that of the interconnectedness of those firms and markets. Firm-level profitability has been seen as rational and efficient behavior, whereas on government regulation has been seen as structurally counterproductive. In this context, economists and financial analysts have focused on what has been called “moral hazard.” The concept of moral hazard is rooted in the assumption that what really distorts markets is regulation as such, especially government guarantees to particular institutions and markets that get into trouble. If market actors come to expect support from governments or other non-market institutions, they will increasingly have a perverse incentive to take on more and more risk, building fragility into the system. Government guarantees make excessive risk-taking appear highly rational, until, of course, the obscure threshold from calculable risk to uncertainty and “tail risks” is crossed and the system itself is destabilized and even undermined. This is particularly thought to be true of banks and non-bank financial institutions that are classed as “too big to fail” or “systemically important financial institutions” (SIFIs: Johnson and Kwak 2010). New rounds of bailouts and restructuring always seem to usher in a recovery, but then set the virtuous-to-vicious cycle in motion again, on a greater scale, especially given increasing globalization. Economic Theory in Crisis One of the key factors is that crises are treated as “exogenous shocks,” not as failures of the financial system itself. If we assume that market participants have all the relevant information available to act according to their needs and preferences, then markets will “clear.” When a market clears, all available goods and assets that have been offered for sale will have been bought at a negotiated price acceptable to both buyers and sellers, investors and borrowers. Nevertheless, there are many well-known problems with this approach. Some market participants have more or better information than others, and are thus able to manipulate that information to skew outcomes in their favor. Another is the assumption that supply and demand automatically adjust to each other, which in many cases is simply not true. Furthermore, where there are either too few sellers or too few buyers, they can “corner the market” and impose “monopoly (or oligopoly) prices,” extracting so-called “rents”—profits over and above what would be available in a genuinely competitive market. Finally, there may be insufficient money or finance available for either side in a transaction to be able to bargain properly. This is called a lack of “liquidity.” When liquidity dries up, markets can simply seize up, with no takers for particular goods or assets. In effect, such goods or assets cease to have an “exchange value” in the marketplace. In particular, a range of financial instruments can then no longer be used as collateral for raising short-term funding—crucial for the day-to-day operation not only of financial institutions and markets themselves but also for most non-financial companies—and must be sold off at “fire sale” prices, thereby undermining the capacity of a firm to fund continuing obligations and future investing. Where a range of troubled (or “toxic”) assets is inextricably intertwined, a general loss of confidence can lead to cascades of illiquidity across different markets (Bookstaber 2007), as happened in late 2008. There are not only too few loans available for financing major industrial investments, but also for day-to-day borrowing and lending—whether among banks to keep their books straight; among businesses large and small for purchasing raw materials, paying production costs, maintaining inventories, sales and marketing, paying workers’ wages, etc.; or among ordinary people for paying the bills and getting by. Bankers, investors, businessmen and workers alike are increasingly dependent on credit for their day-to-day activities and basic living. We are all more and more highly “leveraged”—i.e. we use debt to keep the economic cycle expanding. And in an era of heightened global financial mobility, this illiquidity has cascaded unevenly through the entire world economy. “Money Makes the World Go Round” The problem here is that money and finance, as noted above, have in effect turned into a form of gaming the system rather than performing the fundamental function of underpinning the real economy and economic growth. Money is universal, insofar as anything can be exchanged for anything else if you have money to do so. Money, as the traditional triptych goes, is a means of exchange, a unit of account, and a store of value—all of which are necessary for complex systems of commodity exchange to develop. Money itself is therefore “fungible.” In addition to substituting for any other good, asset or commodity, it can also take on different and complex forms—forms that can themselves change quite quickly in markets where different financial instruments are traded. Money is thus also immaterial, or abstract—the ultimate “non-specific asset,” in Williamson’s terms (Williamson 1975, 1985), which can be manipulated in a myriad of ways in mere nanoseconds. But the most important characteristic of money is as finance itself. Money has always been used to invest in and to finance other economic activities. In the contemporary world, this means the actual creation of money through the expansion of credit and debt—i.e. leveraging, as in the use of levers to multiply the strength of a power source, whether man, animal, or machine. We live in an increasingly “leveraged” world. Governments can of course create money by “printing” more of it, having various ways of pumping new funds into the economy by, for example, buying up various debt instruments including government bonds owned by financial institutions. But that can often go into inflation, “too much money chasing too few goods.” Critiques today of stimulus programmes like “quantitative easing,” the purchase by a central bank of a range of relatively safe securities from the banking system in order to inject cash into the wider economy, are based on the belief that such policies are inherently inflationary. However, the most important form of monetary creation is ordinarily carried out by financial institutions themselves that issue loans and underwrite securities that go beyond their deposits or capital bases, increasing their own leveraging. This is tantamount to betting that their depositors, shareholders or primary dealers will not ask for all their money back at the same time. And of course, sometimes they do—which is what happened after the Great Crash of 1929 and again in the recent global financial crisis. Indeed, in recent decades levels of leveraging rose from a relatively safe 1:10 to 1:30, 1:40, or even higher at times for particular financial institutions, including the most systemically important ones. The Roots of the Crisis In reaching these levels of leverage, it has become common in recent years for loans, especially long-term loans, to be split and packaged up into tradable securities or “derivatives” (named after the “real” loans or traded securities, financial instruments, from which they were originally “derived”). Long-term loans were thus transformed into securities that would be increasingly traded in short-term markets. Buyers’ appetites for these derivative securities ballooned during the 1990s and early 2000s because they were believed to be especially safe and risk-free. There were two main reasons for this misperception. The first was that the loans were originally for purchases that were in themselves thought to be safe, especially in the belief that house prices over time would always go up—true in the long term, but dangerous to use as a rule of thumb for short-term transactions. A variety of derivative securities were created using mortgages and loans for car purchases, credit card debt, and the like, and these in turn were bought and sold by huge numbers of financial market participants. The second reason was the reigning financial ideology, mentioned earlier, of “portfolio diversification,” which became especially influential in the booming 1990s and 2000s. Simply put, portfolio diversification counsels that it’s best not to put all your eggs in one basket. Because the sort of derivative securities we have been talking about were seen as “safe as houses,” they were in great demand for hedging purposes. Liquidity ran rampant, buyers were bidding up their prices, and suppliers—from high-flying investment banks to local brokers, often with the complicit support of newly obliging (and credulous) credit rating agencies—were more than happy to create more and more of these assets and sell them aggressively onto the markets. It was a win-win game, or so they thought. Unlike the bank runs of the early 1930s, however, the complexity of contemporary derivative securities has meant that the exact details of their systemic implications are virtually incomprehensible to everyone except quantitative “rocket scientists”—and even they were lured into the various micro/macro black holes in the financial system. As the crisis was gestating, ordinary people knew only that they could suddenly afford to get loans or jobs where they couldn’t before, and that they could continue to do so as long as the economy kept expanding. Former Senator Phil Gramm, one of the most ardent deregulators of the 1990s and adviser to 2008 Republican presidential candidate John McCain, continued to boast about how his mother, a poor nurse, could only afford to buy a house and send him to university because she had managed to get a subprime mortgage. To many, therefore, increased leverage meant personal achievement and social mobility as well as economic progress. Of course, some financial market actors realized that they could get money for nothing. This is starkly illustrated by the hugely corrupt pyramid (or “Ponzi”) scheme set up by the former NASDAQ head Bernard Madoff, which collapsed spectacularly in December, 2008. In most cases, however, the pyramid was built up by quite sophisticated market enthusiasts who thought a new era had arrived. Finally, they believed, you could take more and more risks without becoming less safe. The crash was triggered, as we all know, by an oversupply of “subprime mortgages”—long-term loans granted to house buyers often with “no income, no job or assets” (so called “Ninja” loans)—which were then split into different levels or “tranches” (supposedly some safer versus others more risky), repackaged into tradable derivatives with complex combinations of tranches, and sold on to other buyers. Such “collateralized mortgage obligations” were one subcategory of “collateralized debt obligations” (CDOs) that were sold all over the world to both sophisticates and suckers, high-end financial institutions and local governments, pension funds and hedge funds. There were also increasingly complex derivatives of derivatives (CDOs of CDOs). All of these were supposed to be hedges, not highly speculative risks. But the hedges turned into ditches, as illiquidity cascaded through not only financial markets and real economies the world over. Preventing Future Crises? Until recently, financial regulatory reform was a major agenda item, but it has been eclipsed by other policy issues. Today, fiscal policy—in particular, cutting government deficits—and currency exchange rates have come to the forefront. The biggest underlying question of all, however, is still whether and how liquidity cascades can be prevented in the future. The range of policy ideas canvassed is extensive, and although some are being adopted in different countries, some are not. The following list only touches some of the most important and well-known bases; the situation is far more complex and continually evolving at the time of writing. Leverage limits to keep debt under control, like the ones actually lifted by the US Securities and Exchange Commission in 2004; Better capital adequacy requirements for banks, also restricting acceptable forms of capital to those that are relatively risk-free, especially equity; Greater transparency and more rigorous statistical oversight; Consolidating, restructuring, and/or even creating regulatory bodies, as well as improving private sector oversight through private trade associations; Using formal clearing houses for derivatives transactions, requiring the use of collateral to bolster liquidity in times of stress; Regulating hedge funds, private equity, and other previously unregulated or only marginally regulated non-bank financial institutions and market actors; Adopting more rigorous accounting standards; Prohibiting banks from trading on their own accounts (the “Volcker Rule”), introducing a greater degree of fiduciary responsibility; Imposing new taxes on banks and financial transactions at various levels, whether simply to increase revenue, or to constrain certain kinds of financial transactions, or to set up bailout funds so that taxpayers in general are not liable and moral hazard is supposedly reduced; Introducing new financial instruments with built-in “triggers” to convert from debt to equity when a bank’s capital runs low; And, most politically contentious of all, altering patterns of pay and compensation for bankers themselves, especially bonus payments. Whether these sorts of measures will be sufficient to prevent or control future crises is contentious and hotly debated. Furthermore, whether they will be sufficient to provide effective “macroprudential” regulation of the financial system in general, rather than merely increasing microprudential regulation and leaving what I have called the macro/micro “black holes” in the system, is perhaps the most uncertain aspect of the re-regulatory process. Financial crises are a regular hazard in an evolving capitalist world and always endanger economic stability and growth (Minsky 1986; Nesvetailova 2007). The capacity of states to proactively avoid serious market failures in advance has always been undermined by a combination of (a) the capability of market actors to play the regulatory game, find loopholes, and avoid restrictions, (b) the herding instinct, described to by the former Citigroup Chairman and Chief Executive Officer Chuck Prince as “As long as the music plays, you've got to get up and dance,” (c) the relatively static nature of regulatory structures and controls once adopted, and (d) the changing endogenous character and exogenous scale of crises themselves. Thus bureaucrats and politicians are continually (a) like “generals fighting the last war”, (b) intellectually co-opted into the dominant market paradigm of the era (as well as more directly captured by market-based interest groups), (c) prone to “regulatory fatigue” because of the complex political and bureaucratic processes required for effective regulatory reform; and (d) vulnerable to regulatory arbitrage and competition in laxity. At the same time, however, the new regulatory politics do not hark back to direct intervention in markets, but retain a neoliberal focus on attempting to improve market performance and promote competition through arm’s-length regulation while simultaneously attempting to develop anti-cyclical regulatory policies to prevent further bubbles. In these circumstances, however, states go down their own roads, depending on their vulnerability to crisis, their particular “variety of capitalism,” their internal political structures and processes, their interest group and political party constellations, their existing regulatory regimes, etc. Each of the issue-areas outlined above also has a critical transnational dimension that cannot be easily reconciled given the lack of any overarching international institutional authority or global financial architecture. The new G-20, originally set up as a meeting of finance ministers in 1999 but extended to summits of heads of state in 2008 and followed by calls for extensive re-regulation in 2009, has since been sidelined by a lack of consistent regulatory policymaking across borders. After the November 2010 summit in Seoul, attempts to forge concrete cooperative policies were replaced by the so-called “Seoul Consensus,” based on the notion that states would have to develop their own policies incrementally. Cooperation proved ephemeral and convergence ad hoc. Today, the most optimistic analysts of re-regulation tend to put their faith in stronger national regulatory reforms, arguing that they will not necessarily lead to regulatory arbitrage and inadequacy but to greater regulatory emulation and convergence over time (Warwick Commission 2009; Germain 2010). However, this chapter takes a more cautious view, especially given the weaknesses of international cooperative mechanisms. Regulatory inadequacy will simply be transformed into new modes of financial innovation, risk-taking, and uncertainty, especially at transnational/global levels. And the more successful the quasi-Keynesian economic stimulus packages and monetary easing that governments have been prioritizing prove to be, the more “business as usual” will come back. Lobbies and political factions will be able both to obstruct reform and to shape it to their own interests. For example, although the Basel Committee on Banking Supervision has been working on a new system called Basel III for nearly two years, their recommendations at the end of 2010 were still not fully agreed. States are working on their own regulations, often increasing the amount of capital banks, especially SIFIs, must hold against their loan assets, while at the same time bank lobbies are furiously trying to relax those standards. Furthermore, the G20 in 2009 put the development of bank taxes and levies as part of insurance funding so that it was the banks themselves, rather than taxpayers, who would fund the rescue of failing institutions, at the centre of their proposals for regulatory reform. However, such taxes were removed from the final version of the Dodd-Frank Act, and different countries are toying with a range of different approaches (if at all). Finally, bankers’ pay has faded to a large extent from the policy agenda despite its social and political salience. This brings us to a second possibility—waiting for markets to reform themselves. Daniel Gross, in his book Pop! Why Bubbles Are Great for the Economy (2007), argued through several historical case studies that bubbles at first generate economic growth, wealth creation, innovation, technological change, infrastructural upgrading—and wider prosperity—and then get out of hand. Success breeds greater risk-taking and the once virtuous spiral morphs into a negative feedback loop, eventually ending with a “pop.” Nevertheless, his argument goes, once the bubble has popped and the economy has picked itself up, innovations are restructured and revived on a more limited, restructured and rationalized basis, leading to new era of stable economic growth and development. Similarly, authors such as Sebastian Mallaby argue that hedge funds, sometimes seen to be at the heart of the crisis, may also be at the heart of the recovery (Mallaby 2010; Hill 2008). Unlike banks, hedge funds have been remarkably flexible, many have failed without systemic fallout, and their relatively small size means that they actually do channel investment into the real economy rather than simply gaming the system. But whether market actors such as hedge funds or other financial institutions themselves, freed from—or in spite of—moral hazard, will be able to play the market correction role that economic theory envisages is yet to be seen. Conclusion Mainstream economic conceptions of financial markets see them as involving private goods. However, increasing awareness of systemic risk and the requirements of macroprudential regulation tell a different story. Because of the role financial markets play, a stable and liquid financial system is necessary for the rest of the economy to work. Therefore it is crucial to redefine the financial system as a de facto public good. It is regulation that enables the financial system to work in the first place. Moral hazard is not something that stops the system from working; paradoxically, it is a necessary precondition for the system to work in the first place, to prevent market failures, and to mop up after the crisis. History tells us that capitalism is too serious a business to be left to the capitalists alone. But the challenge for designing and implementing effective, enabling regulation is much greater in a world of globalizing financial markets, where international institutions are often rudimentary and ineffective, and states are increasingly constrained by political interest politicking, regulatory arbitrage, regulatory capture, and regulatory fatigue. Without this fundamental change of focus, financial governance will continue to be characterized by a structural conflict of interest between market actors concerned with the generation of profits for their own sake, and the collective interests of the economy and society. Governance of the financial issue-area today therefore looks more like the entrenchment of private special interests, unequal access, neopluralism, and “coordinated capitalism,” than like the deliberative, participatory, and inclusive political processes favored by theorists of “network governance.” REFERENCES Acharya, Viral V., Thomas F. Cooley, Matthew P. Richardson, and Ingo Walter, eds. (2010). Regulating Wall Street: The Dodd-Frank Act and the New Architecture of Global Finance (Hoboken, New Jersey: Wiley) Bernstein, Peter L. (1996). Against the Gods: The Remarkable Story of Risk (New York: Wiley) Bookstaber, Richard (2007). A Demon of Our Own Design: Markets, Hedge Funds, and the Perils of Financial Innovation (Hoboken, New Jersey: John Wiley and Sons) Cerny, Philip G. (1990). The Changing Architecture of Politics: Structure, Agency, and the Future of the State (London and Newbury Park, CA: Sage Publications) _____________ (1991). “The Limits of Deregulation: Transnational Interpenetration and Policy Change,” European Journal of Political Research, vol. 19, nos. 2 & 3 (March/April), pp. 173-196 _____________ (1994a). “The Dynamics of Financial Globalization: Technology, Market Structure and Policy Response,” Policy Sciences, vol. 27, no. 4 (November), pp. 319-342 ______________ (1994b). “The Infrastructure of the Infrastructure? Toward ‘Embedded Financial Orthodoxy’ in the International Political Economy,” in Barry Gills and Ronen Palan, eds., Transcending the State-Global Divide: The Neostructuralist Agenda in International Relations (Boulder, Colorado: Lynne Rienner), pp. 223-249 _____________ (2010a). “The Competition State Today: From raison d’État to raison du monde,” Policy Studies, vol. 4, no. 1 (January), pp. 5-21 _____________ (2010b). Rethinking World Politics: A Theory of Transnational Neopluralism (New York: Oxford University Press) _____________ (2011). “Saving Capitalism from the Capitalists? Financial Regulation After the Crash,” St. Antony’s International Review, vol. 7, no. 1 (forthcoming) Das, Satyajit (2010). Traders, Guns and Money: Knowns and Unknowns in the Dazzling World of Derivatives (Harlow, Essex: Financial Times Press, revised edition) Eagleton-Pierce, Matthew (2010). “On the Genesis of the Concept of ‘Governance’: A Post-Bureaucratic Perspective,” paper presented at the Critical Governance Studies Conference, Warwick Business School, December 13-14 Foucault, Michel (2008). The Birth of Biopolitics: Lectures at the Collège de France, 1978-1979, translated by Graham Burchell (London: Palgrave Macmillan; French edition 2004) Fox, Justin (2009). The Myth of the Rational Market: A History of Risk, Reward, and Delusion on Wall Street (New York: HarperBusiness) Germain, Randall (2010). Global Politics and Financial Governance (Basingstoke, Hampshire: Palgrave Macmillan) Gross, Daniel (2007). Pop! Why Bubbles are Great for the Economy (New York: HarperCollins) Hill, Andrew (2008). “Ten Reasons Why You Should Go and Hug a Hedgie,” Financial Times, December 18 Johnson, Simon and James Kwak (2010). 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown (New York: Pantheon Books) Kurt, Omur (2010). “The Network Governance Approach and Participation in the Public Policy Process: A Critical Look,” paper presented at the Critical Governance Studies Conference, Warwick Business School, December 13-14 Mallaby, Sebastian (2010). More Money Than God: Hedge Funds and the Making of a New Elite (London: Bloomsbury) Minsky, Hyman P. (1986). Stabilizing an Unstable Economy (New Haven, Connecticut: Yale University Press) Nesvetailova, Anastasia (2007). Fragile Finance: Debt, Speculation and Crisis in the Age of Global Credit (Basingstoke, Hampshire: Palgrave Macmillan) Smith, Adam (1776/1991). An Enquiry into the Nature and Causes of the Wealth of Nations (Amherst, New York: Prometheus Books) Taleb, Nassim Nicholas (2007). The Black Swan: The Impact of the Highly Improbable (New York: Random House) Warwick Commission on International Financial Reform (2009). In Praise of Unlevel Playing Fields (Warwick: University of Warwick), http://www2.warwick.ac.uk/research/warwickcommission/report/ Williamson, Oliver E. (1975). Markets and Hierarchies (New York: Free Press) Williamson, Oliver E. (1985). The Economic Institutions of Capitalism (New York: Free Press) 1