Formal Rules versus Informal Relationships: Prudential Banking Supervision at the FSA Before the Crash

Prior to the 2007–9 banking crisis, the UK Financial Services Authority presented itself as a ‘proportionate’ and ‘risk-based’ regulator, preferring firms to adhere to the spirit of high-level principles rather than the letter of detailed rules. Simultaneously, it developed a supervisory regime that was unprecedentedly complex, producing a ‘Handbook’ of intricate secondary legislation that ran to some 8000 pages. Explaining these contradictory aspects of the pre-crisis regime demands a reappraisal of the dominant explanations of the supervisory failures that contributed to the banking crisis. In contrast to accounts that focus on officials' uncritical adherence to efficient market thinking (regulatory groupthink) or the political clout of the financial industry (regulatory capture), this article suggests that supervisory officials' actions can be understood only by reference to their institutional and structural contexts. Amid heightened public sensitivity to risk, officials developed an elaborate and transparent supervisory framework as a defence against potential political censure. At the same time, collegial firm–supervisor relationships were preserved as state-of-the-art risk-management ideas were recombined and repackaged in line with the institutional legacies of earlier ‘club-like’ modes of supervision. Together, these divergent tendencies contributed to overconfidence in the use of predictive risk assessment and neglect of banks' fundamental business risks.     

Central Bank Reform and the Politics of Blame Avoidance in the UK

Following the financial crisis, the UK central bank gained important new prudential powers for upholding financial stability. Yet the reforms diverged significantly from the government’s original plans and arguably produced a suboptimal institutional design. Drawing on theories of blame avoidance, we argue that the changes were motivated primarily by the need to manage reputational risk. Prior to the 2010 election, the two main parties tried to deflect blame for the crisis by putting forward competing proposals for agency reconfiguration. In response, the Bank of England pursued a strategy of agency subversion aimed at reshaping the reforms to minimise future reputational damage. This involved pushing for ‘hard’ delegation to maximise control of new macroprudential powers, while using ‘fuzzy’ delegation to shift microprudential supervision down to subordinate agencies. The article sheds new light on the drivers of post-crisis reform and the importance and limits of delegation as a strategy of blame avoidance.     

Resisting Protectionism after the Crisis: Strategic Economic Discourse and the EU–Korea Free Trade Agreement

In 2006 the European Commission announced its Global Europe strategy, which proposed pursuing a series of ambitious Free Trade Agreements (FTAs) premised on exchanging the EU's remaining ‘pockets of protection’ for market access. The first of these agreements was signed with South Korea in October 2010. This article asks how the Commission's Directorate-General (DG) for Trade could successfully conclude this agreement in the aftermath of the Financial Crisis. Given a strong mobilisation of protectionists with access to policy-makers, this liberal policy outcome cannot be explained purely in terms of institutional insulation, as in much of the literature on EU trade policy, nor be simply ‘read off’ from the material interests of societal actors. This article, therefore, develops a constructivist framework which broadens our understanding of the power of strategically invoked economic discourses. By developing a novel analytical strategy to determine the intentional invocation of such discourses, it is able to show how DG Trade constructed an ideational imperative for liberalisation in Global Europe, enabling it to overcome opposition to the EU–Korea FTA. Beyond its contribution to constructivist scholarship, this article draws attention to the neglected dimension of ideas in trade policy and highlights the continued purchase of neoliberalism after the crisis.     

Federal Reserve System Rising: The Expansion of Board Veto Authority on the Eve of the Great Depression

Most scholars agree that restrictive Federal Reserve System (FRS) policies contributed to the depression’s duration and severity. FRS policy mistakes are attributed to faulty ideas, poor leadership, and decentralised institutions. Extant scholarship treats ideas as constraints which systematically led policy-makers astray. This paper instead focuses on the dual roles ideas play in shaping institutions and uniting coalitions behind institutional projects. It traces the rise and fall of New York FRS Governor Benjamin Strong’s ‘great idea’ that the FRS should promote international monetary stability. Declining support for New York’s internationalism enabled a rural Board faction to expand its veto power from 1928 to 1930. In the critical year following the 1929 stock market crash, Board obstruction of New York FRS attempts to lower its discount and bill rates caused its investments to fall faster than the system’s bond portfolio expanded, forcing outstanding system credit to contract. Beyond showing that the Board’s pre-depression rise mattered, the paper speaks to broader debates about how ideas become empowered to shape policies and inform interests.     

From Big Bang to Big Crash: The Early Origins of the UK’s Finance-led Growth Model and the Persistence of Bad Policy Ideas

Using newly declassified documents from the British Public Records Office, we argue that the finance-dependent growth regime that typified the UK economy in the period up to the Great Crash of 2008 has much deeper roots than is commonly realised. We use these documents to demonstrate that the growth of finance was integral to the Thatcher revolution, tying together mortgage markets, household debt, and boom-bust cycles as early as the mid-1980s. We also show how policy-makers in this period were aware of all the weaknesses of this growth model, to the point that they effectively diagnosed what would happened in 2008, back in 1987. We argue that selecting for a finance-led growth model as the preferred growth model so early effectively rendered other possible growth models for the UK unattainable. The result was the shift from an economy characterised by ‘stop-go’ cycles in the post-war period to an economy characterised by recurrent ‘boom-slump-austerity-reset’ cycles in the Thatcher and post Thatcher periods. The 2008 crisis did not change this highly unstable mode of accumulation.     

Globalisation and the Institutional Re-embedding of Markets: The Political Economy of Price Formation in the Bordeaux En Primeur Market

Contemporary analyses commonly attribute the global credit crisis to faulty regulation. What have been the roots of these deficient rules, particularly in Europe, where rapid spill-over from US markets took policy makers and observers by surprise? This article focuses on regulatory liberalism as the paradigm guiding European Union (EU) regulation. It has dominated regulatory thinking for decades, but it has been implemented throughout Europe only since the mid-1990s. This shift can be traced to political institutions that have filtered policy ideas. EU financial reforms have pushed policy from pragmatism, under which it was adapted to political contingencies, to dogmatism, which adapts it to the intellectual exigencies of rigid policy paradigms. Inadvertently, reforms had created an epistemic community in which ‘professional’ rule setters systematically ignored external criticisms. The institutionalised ambition to craft ‘intellectually sound’ policy–rather than policy that simply ‘works’ –generated rules that persistently ignored the financial markets' self-reflexivity and thereby aggravated the crisis.     

Global Investment Environment of the Post‐Quantitative Easing World: The ‘new‐old’ and ‘new‐new’ Normal

Global markets since late 2007 are not ‘normal’, where normal means market conditions we would expect to observe going forward in the absence of any new economic shocks. Financial markets have been dominated by extraordinary central bank policies that were created to deal with challenging market conditions reflecting heightened risk aversion and illiquidity. Markets in the future will have some characteristics that look more like the market conditions observed in the pre‐crisis period, which I call the ‘new‐old normal’ and other conditions that differ from the past, which I call the ‘new‐new normal’. I first review what happened during the financial crisis in terms of developments in three asset classes, equities, fixed income and currencies, to place the forward‐looking view in proper context. Then the transition period from the quantitative easing (QE) era of exceptional monetary policy to post‐QE markets is discussed. Post‐transition, we will see some features of the post‐QE world that will resemble pre‐crisis market conditions, the ‘new‐old normal’ with higher policy interest rates, wider cross‐country interest differentials, lower cross‐asset return correlations and a resurgence of the importance of cross‐country differences in fundamentals in international investing. However, some features of the post‐QE investment environment will be unlike anything observed in the past: the ‘new‐new normal’ with reduced liquidity and more days of exceptionally large volatility and asset price moves due to regulatory effects resulting in a reduced ability of market‐makers to provide inventory buffers for counterparties and electronic trading venues that shut down trading in high volatility periods; low inflation; flatter yield curves; and emerging markets providing less opportunity for diversification gains as they converge to developed financial market characteristics.     

The Causes and Consequences of the Misdiagnosis of the Financial Crisis in the United States

Using an analytical framework that divides banking crises into ‘classic’ and ‘secondary’ crises, this article analyzes the banking crisis that broke out in the United States in the summer of 2007 and the response of US authorities. While quite simple in itself, this framework allows for a novel interpretation of the unfolding of the crisis and for evaluating US authorities in the design and implementation of crisis resolution mechanisms. As suggested by the title, the principal hypothesis of the article is that the crisis was fundamentally misdiagnosed, leading to a flawed bailout that all but guarantees its inefficacy in bringing the US financial system back to health at a reasonable fiscal cost.     

The Stagnation Tendencies of Neoliberalism: A Review Essay

In his 2012 book, From Financial Crisis to Stagnation, Thomas Palley argued that the financial crisis of 2008 would be likely to result in a period of long-term stagnation. Both the crisis and the predicted stagnation, Palley argued, were the outcomes of policies pursued since the 1980s; the persistence of those policies explains the stagnation. Underpinning the policies and their consequences are the flaws of the neoliberal macro model and the particular role played by finance in that model. The rejection of Keynesianism meant the abandonment of the commitment to full employment. The neoliberal paradigm rests upon a foundation of ‘bad ideas’ that are located in political philosophy as much as in economic theory. Palley’s argument has a bearing on recent discussions among mainstream macroeconomists, whose interest in secular stagnation has been revived by the ‘ongoing crisis’. These discussions have left mostly unanswered the question of the causes of stagnation. The present essay argues that Palley’s concept of ‘structural Keynesianism’ can benefit from a closer association with the analysis of structural transformation and its effects on policy regimes and stagnation tendencies.     

What Motivates Members to Participate in Co‐operative and Mutual Businesses?

Abstract *** : This article reports the findings of a project entitled ‘The participation of members in mutual businesses’. A previous project developed a theoretical model of what makes people participate, focusing on the participation of public service users in council housing and social care services. The current project builds on this work, applying the ‘mutual incentives model’ to a population sample of area committee members and a random sample of non‐participant members of a very large UK consumer co‐operative, the Co‐operative Group. Two arguments are presented as to why such research is needed. First, member participation in co‐operative and mutual businesses is becoming an important issue both for this sector and more generally for public policy. Second, a comparison between a public services setting and a co‐operative setting enables us to extend and further test the theoretical model. Two main features of the model are outlined: a ‘mutual incentives theory’ that goes beyond other models to combine individualistic and collectivistic motivations, and the ‘participation chain’, a synthesis of existing knowledge that joins motivations to three ‘links’ that we call ‘resources’, ‘mobilization’ and ‘dynamics’. The article then summarizes the project methodology, and reports the main findings. As in the public services project, on the ‘demand’ side, collectivistic incentives prove to be dominant over individualistic, but with some individual ‘internal’ benefits also being important. On the ‘supply’ side, skills derived from previous experience were important, as were a positive evaluation of opportunities to participate, and recruitment through existing networks. We then compare the findings to those from the public service users and from a regional co‐operative society; Oxford, Swindon and Gloucester Co‐op. Collective motivations are dominant in all three datasets, but are shown to vary in interesting ways that have important implications for member participation strategies.     

Death by a Thousand Cuts? Financial Political Power and the Case of the European Financial Transaction Tax

Since the global financial crisis, a variety of explanations have been advanced to account for the weak response by policy-makers to the issue of financial regulation. This paper focuses upon the strategic political mobilisation of financial actors in order to provide a better understanding of their influence within regulatory battles in the post crisis era. It does so through a case study investigation of the European Union Financial Transaction Tax. Despite garnering support from leading member states, the European Commission and Parliament, and a majority of the European population, the policy has failed to materialise as a result of several postponements and unresolved negotiations at the Council of the European Union. Policy-makers have also gradually backed away from the aggressive proposal designed by the Commission, committing to a range of exemptions that threaten to render the policy ineffective at raising significant revenue and at preventing industry avoidance of the charge. The case provides evidence of a cohesive political strategy conducted primarily by transnational financial associations and demonstrates the unique capacity of financial actors to secure favourable regulatory outcomes. Specifically, this influence is exercised through the recruitment of non-financial sector allies and by exploiting the structural dependency fears of policy-makers.     

Micro-Geopolitics: Capitalising Security in Laos’s Golden Quadrangle

Enclosure, dispossession and displacement loom large in current debates about the recent boom in transnational farmland deals, and about Chinese agribusiness for export in particular. Often under-examined, however, are the ways that legacies of geopolitical conflict shape the inevitably uneven distribution of enclosure, dispossession and displacement. This paper constructs a case of these ‘micro-geopolitical’ legacies by examining a Chinese rubber planting ‘promotion’ project in northwestern Laos’s emerging ‘Golden Quadrangle’ development region. It argues that longstanding concerns about security inform the ways that local authorities deploy investment projects that are otherwise seen as examples of ‘foreign’ land grabbing. Further, it shows that while the geographical aims of foreign agribusiness mesh with state-mediated resettlement efforts (a darker spin on the narrative of ‘win-win’ cooperation), these activities often precede current land deals rather than result from them. Chinese agribusiness in Laos’s upland interior thus appears less as a driver of displacement than a means for attempting to secure in place a particular (if precarious) configuration of population and security.     

Public Information Quality with Monopolistic Sellers

We show that in markets with asymmetric information, even if there is full agreement on the choice of optimal information quality, entrusting the choice of (unverifiable) public information quality to traders who benefit from such information leads to inefficiencies. However, delegation of information quality choice to an independent agent who is precluded from sharing in trading profits results in efficient implementation. This result provides a game-theoretic rationale for current institutional arrangements where a private organization that is independent of market traders, the Financial Accounting Standards Board, determines the standards for public disclosures.Journal of Economic LiteratureClassification Numbers: D41, D42, D82.     

Fiscal policy and capital mobility: the construction of economic policy rectitude in Britain and France

This research examines the regulatory response of the European Union to the global financial crisis, addressing the questions of whether, how and why the global financial crisis has changed the ‘old’ politics of financial services regulation in the EU and resulted in the emergence of a ‘new’ politics. It is argued that, with a good dose of political opportunism and ‘anti-free market’ rhetoric, a continental advocacy coalition sponsoring a ‘market-shaping’ regulatory approach has capitalised on the crisis, tipping the balance of regulatory power in the EU in its favour, as compared to the pre-crisis situation.     

Distance and beyond: What drives financial flows to emerging economies?

A major theme in the empirical literature is whether country-specific ‘pull’ or external ‘push’ factors drive international capital flows. In this paper we show that pull-push interactions matter: the response of international investors to country-specific developments depends on global volatility/liquidity stress conditions. We model asset-trade behaviour of investors: with limited information, strong institutional quality ‘pulls’ asset demand; mounting tensions in global markets amplify portfolio adjustments. We derive an empirically testable equation for cross-border bank flows to emerging economies (EMEs) and focus on pull-push interactions that trigger financial vulnerabilities. We find that global volatility amplifies demand for institutional quality, prior to the recent crisis, implying that EMEs with weak institutional settings are exposed to sharp capital retrenchments. In the aftermath of the crisis, the liquidity easing in advanced economies drives down concerns for EMEs' developments, boosting flows and challenging EMEs' ability to use capital controls to mitigate unbridled flows.     

Tracing the causes of the banking crisis

We add the Bernanke–Gertler–Gilchrist model to a modified version of the Smets–Wouters model of the U.S. in order to explore the causes of the banking crisis. The innovation of this article is estimating the model using unfiltered data allowing for non-stationary shocks in order to replicate how the model predicts the crisis. We find that ‘traditional shocks’ account for most of the fluctuations in macroeconomic variables; the non-stationarity of the productivity shock plays a key role. Crises occur when there is a ‘run’ of bad shocks; based on this sample they occur on average once every 64 years and when they occur around 10% are accompanied by financial crisis. Financial shocks on their own, even when extreme, do not cause crises – provided the government acts swiftly to counteract such a shock as happened in this sample.     

The Economic Driven by Politics as Values: The Example of Pharmaceuticals in France

Considering that the definitions of politics which dominate political economy are actually synonyms for other terms (politicians, powering or strategising), and in order to focus research more sharply upon the political itself, this article proposes a robust alternative: politics as the mobilisation of values to change or reproduce the institutions that orientate economic activity. Drawing upon constructivist strands of institutionalism, political sociology and industrial economics, this definition is used to build an analytical framework for understanding the ‘political work’ which determines the policies of both firms and public regulatory authorities. Specifically, using this ‘politics as values approach’, a fundamental tension within capitalism between the values of Freedom, Security and Equality is closely examined. This is tackled by studying conflicts within the definition of these three values during the regulation of specific industries, together with their prioritisation. To illustrate the heuristics of this analytical framework, the case of recent change within the regulation of medicines in France is then developed. Far from simply resulting from a drug ‘scandal’, this approach shows that this change was caused firstly by a value-driven conflict within pharmacology and, secondly, by its impacts upon the way administrators, journalists and politicians have reframed the Freedom–Security–Equality value hierarchy.     

Economics in Institutional Perspective,Memorial Essays in Honor of K. William Kapp

In the past, the standard discussions of market failures in economics textbooks confined themselves to issues involving externalities, public goods, and common property (open access). Subsequent to George Akerlof’s famous article “The Market for ‘Lemons,’” discussions of the problems created by asymmetric information gradually became standard fare, but the issues raised by thinking of asymmetric information in economic matters extend far beyond the used car and health insurance markets that are normally used as the paradigm cases. In fact, consideration of the problems of information will inevitably lead to an examination of the problems of market manipulation and fraud, especially in light of the 2008 financial crisis. Akerlof has travelled this path himself as indicated by his recent book with Robert Shiller, Phishing for Phools (2015). Akerlof and Shiller provide a litany of examples of manipulation and deception in advertising and in many markets including financial markets. They also have a chapter on “The Resistance and its Heroes” that highlights some of the people and agencies that have worked to expose and reduce phishing, but this chapter is remarkably sparse. What this article attempts to do is to fill out some of this history by focusing on the work of American institutional economists from Veblen to Galbraith, who critically examined the issues of manipulation and deception in advertising, salesmanship, and finance. Some general considerations relating to the problem of fraud are also discussed.     

Great Recession and Macroeconomic Theory: A Useless Crisis?

ABSTRACT

The global financial crisis of 2007–08 and the subsequent Great Recession have pushed many economists to acknowledge a fundamental limit in the theoretical models elaborated after the monetarist counter-revolution: these models disregard the financial system. The years following the Great Recession have thus been marked by the development of what can be called the ‘Financial Frictions Approach’, a theoretical approach based on the addition of the financial system to the New Keynesian DSGE model. The results of this line of research are beginning to appear also in macroeconomics textbooks. Significant examples are the publication of the seventh edition of Blanchard’s textbook, and the publication of the third edition of the textbook co-authored by Blanchard, Amighini and Giavazzi. The objective of this work is twofold: (i) to show that the new model presented by Blanchard, Amighini and Giavazzi, which reflects the results of the ‘Financial Frictions Approach’, does not allow to elaborate a coherent explanation of the Great Recession and (ii) to present the pillars of an alternative theoretical model based on the lessons of Keynes, Schumpeter and Minsky.     

Research collaboration and behavioural additionality: A New Zealand case study

Generating the greatest benefit from public research programmes is a major aim for industry managers and policy administrators alike. However, how to measure whether benefit has occurred createsf a considerable dilemma for managers and policy-makers. One approach centres upon the concept of ‘additionality’ or ‘what difference the policy has made’. Traditional ‘input additionality’ measures of subsequent research and development activity, for example, neither incorporate all impacts nor give adequate signals about adequate signals about aspects of ‘output additionality’, such as the impact on increased competitiveness at the level of the firm, or national competitiveness, the ultimate goal for the majority of research policies. An intermediate form of impact, ‘behavioural additionality’, centred upon changes in a firm's subsequent managerial behaviour, is considered to provide an alternative, yet compelling perspective on the impact of public support on the conduct of research. This study outlines empirical eveidence found for the various forms of additionality in a New Zealand collaborative research programme. It discusses how managers and policy administrators can exploit the occrrence of behavioural additionality to maximize the impact of a research policy, on the basis that modified behaviour is likely to strengthen a policy' latent abilityto influence the creation of output additionality. In such circumstances, the study suggests that managers and policy-makers should be identifying those interventions that lead to sustained improvements in mangerial practice, and in competitiveness, and should be managing their diffusion within firms and throughout industries.