Reregulation and Fragmentation in International Financial Governance

Abstract

Every global financial crisis generates new regulatory responses. What kinds of responses are emerging so far from crisis that began in 2007? How are these responses similar to or different from those that followed last major crisis of 1997-1998? Arguably this crisis marks an important turning point in governance of international financial markets. Not only is there a significant reregulation of international financial markets by leading Western governments, but crisis is also unleashing centrifugal pressures that may lead toward a more decentralized and fragmented form of international financial governance over medium term. The G7's Push for Reregulation The world is clearly changing when top international bankers announce kind of intellectual conversion that chief executive of Deutsche Bank, Joseph Ackerman, did in March 2008. I no longer believe in market's self-healing power, he announced. A few weeks later it was turn of influential columnist of Financial Times of London Martin Wolf to declare that rescue of Bear Stearns marked day when the dream of global free-market capitalism died. (1) By September, political leaders such as French president Nicolas Sarkozy were echoing this message. Self-regulation is finished, he proclaimed, Laissez faire is The all-powerful market that is always right is finished. (2) These dramatic statements highlight seriousness of current global financial crisis. But they also reveal how different its political implications are from last global financial meltdown a decade ago. In 1997-1998, global financial markets were severely shaken by a series of crises emanating from developing countries. Policymakers in G7 countries largely attributed those crises to mistakes in government policy. The afflicted countries had borrowed excessively and had to be encouraged to exercise greater discipline. Their financial regulatory and supervisory practices were deemed to be inadequate and to require improvement to meet international standards, particularly Anglo-American standards. G7 officials even blamed themselves for encouraging excessive risk taking in international financial markets through their backing of ever larger IMF rescue packages. At core of these views was belief that global financial markets themselves were not to blame for crises. This trust in markets was also reflected in G7 decisions in subsequent decade to assign an increasing range of regulatory functions to private financial actors such as banks, credit rating agencies, and accountants. (3) As preceding quotations make clear, political dynamics associated with current crisis could not be more different within G7 countries. There is a strong consensus that same market actors who were previously assigned important regulatory roles have been key culprits in triggering current crisis. Private financial institutions and markets have been particularly criticized for their failure to recognize risks involved in various market innovations associated with new models of securitization. Sub-prime mortgage loans were transformed into securities, which were then bundled and sliced up into tradable portfolios with distinct risk profiles. As credit risk was transferred and traded to parties far removed from original source, its quality became more obscure and was consistently under-priced by credit rating agencies and other institutions. Once crisis broke out, far-flung diffusion of subprime mortgages also intensified erosion of confidence because of widespread uncertainties about who actually held these products and what their levels of exposure were. Particularly opaque were over-the-counter (OTC) derivative markets, including enormous market for credit default swaps. Here private actors (predominantly highly leveraged hedge funds) engaged in private bilateral deals without a formal clearinghouse or exchange that could minimize counterparty risk and force margin requirements for all contracts. …