The Global Financial Crisis-Learning from Regulatory and Governance Studies

8/9/2019 The Global Financial Crisis-Learning from Regulatory and Governance Studies

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The Global Financial Crisis: Learning fromRegulatory and Governance Studies

CHRISTOPHER ARUP

Regulatory and governance studies help locate power and responsibility in theglobal financial crisis. I argue that corporate and state power worked together in

centers like New York and London to shape regulation and that power was spreadaround the world. In the response to the crisis, responsibility for regulation willremain largely systems-based rather than centrally directed. However, thosesystems should be located in the culture of the elites, which are socially andspatially based, as much as in the economics of the markets or the cognition of the

firms. And that responsibility has limits, so there should be greater democraticcontrol of finance and less dependence on finance capitalism for essential services,social security, and environment protection.lapo_322 363..381

The global financial crisis (GFC) has been devastating for many people and

has revealed the instability of the world economy. Yet it would seem the crisis

has allowed some people to profit, and it appears likely that large risks will

remain in the system (International Monetary Fund 2009). The GFC

has raised many issues of concern, the greatest overall being the governability

of the financial system. How might regulatory and governance studies help

policymakers and citizens to think about that systemic issue?1 My forum

piece, drafted in the early stages of the GFC meltdown, pursues this

question and suggests where those studies might and might not assist.

My premise is not a novel one; the prospects for reform of regulation can

only be assessed once we locate power and responsibility within the financial

system. Corporate and state power often work together. Thus, we must

consider whether the responses to the GFC recognize that configuration of

power well enough to reform financial regulation. My main suggestion is that

the cultures of the elites are as important to that reform as the economics of

the markets. The piece has a rather pessimistic conclusion: if elite cultures

cannot be encouraged to reform, democracies should reduce dependence

on finance capitalism for housing, essential services, social security, and

environmental sustainability.

Address correspondence to Chris Arup, Department of Business Law, Faculty of Businessand Economics, Monash University, PO Box 197, Caulfield East, Victoria, Australia 3145.Telephone: +61 3 9903 1026; E-mail: [email protected].

LAW & POLICY, Vol. 32, No. 3, July 2010 ISSN 02658240 2010 The AuthorJournal compilation 2010 The University of Denver/Colorado Seminary


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I. LOCATING POWER

In this first section, I rehearse ways to think about the governance of power

to regulate financial systems. Recent theories of regulation and governance

can help us to locate power among corporations and states. I take up thetools of this theory, first with regard to the experience of regulation in the

financial center of New York and second with regard to the means by which

the power of this center was spread through the world.

A. THE RELEVANCE OF REGULATORY AND NEW GOVERNANCE STUDIES

If regulation is the capacity to influence the actions of others (Baldwin and

Cave 1999), then many actors may be said to be involved in regulation of

the financial system. Similarly, many different people are responsible forthe global financial crisis, including bankers, fund managers, investors,

sellers, advisors, householders, consumers, economists, journalists, politi-

cians, and government officials. Regulatory studies has been especially

enlightening in showing how private actors regulate along with public agen-

cies, mapping all the different directions in which regulation operates and

characterizing the variety of forms regulation assumes (Picciotto 2008;

Scott 2009).

There is much merit in theories that accommodate such a multiplicity of

actors and relations. After all, our first task is to comprehend. Yet this senseof pluralism does not necessarily tell us a lot about the distribution of power

among the relevant actors and relationships. When the framework is accom-

modating like this, it is tempting to think that power must be decentered and

transferable. If responsibility is to be encouraged, policymakers must grasp

this complexity and fluidity of power in financial markets, so that they can

focus and apply pressure where it is most productive to do sowhere it

counts the most (Braithwaite 2009). We should avoid conspiracy theories, yet

still be prepared to hold people responsible for their actions, nominally at the

very least.In new governance theory (King 2008), the concept of the node assists

understanding of how power is shaped and exercised within key systems.

The structure of nodes is important; the way they are set up is likely to

favor certain actors (Shaffer 2004). Yet the theory is dynamic and progres-

sive in its expectations. Influence is attributed to agency and actionthe

power of ideas and conversationsso outcomes can be altered and even

structures and cultures transformed (Sell 2003). A crisis might be a catalyst

for change.

I believe this insight is crucial to how we assess the potential for reform ofthe financial system. Of special relevance is the notion of metaregulation

that those within the system might be given encouragement and guidance to

think better of the consequences of their actions for others (see Parker 2002).

If regulation is to further social responsibility, it must be smart regulation

364 LAW & POLICY July 2010

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that employs soft responsive and reflexive techniques to enlist the support

of those with power. The combination of corporate and state power is not

necessarily a negative.

Yet the query should be raised: does governance or systems-based regula-

tion really offer such potential (Santos and Rodriguez-Garavito 2005)? Somepeople seem habitually on the receiving end of regulation, while others enjoy

the benefits of legal freedoms and entitlements. It is possible that those with

power do not desire to take responsibility for regulation and contribute to its

coordination, except perhaps temporarily when they overreach and endanger

their own interests. While destabilizing, a crisis may be the opportunity for

them to profit from others (Harvey 2006). At first blush, the GFC seems to be

like that.

B. CORPORATE AND STATE POWER IN THE UNITED STATES

How was power organized in the period leading up to the GFC, particularly

in the financial center of New York? This subsection suggests that corporate

and state power were concentrated together. Contrary to what many com-

mentators suggest, neoliberal policies did not lead to deregulation, reduction

of state power, and the dispersal of corporate power. Instead, corporate and

state power combined in financial centers such as New York and was then

projected outwards to other parts of the world. Philosophies were influential

here, such as the efficient markets hypothesis, but also influential were theinterests of powerful market players who benefited from the changes in the

configuration of power on a global scale.

The dominant account of the GFC portrays it as the result of deregulation,

a largely Anglo-American governance phenomenon in which the state

relaxed its controls on the activities of the financiers and the supervision of

their trades. Now the crisis raises the prospects for reregulation. Provoca-

tively, Panitch and Konings (2009) describe this as a mythpart of what

Slavoj Zizek (2009) calls the battle for interpretation of events. Neoliberal

commentators say that deregulation just went a little too far and that now asympathetic fine tuning will eradicate the excesses and correct the failures of

finance.

The situation was always more complicated than this dominant account

allows (see Pistor and Milhaupt 2008). Among their virtues, regulatory and

new governance studies downplay the demarcation between public and

private in characterizing how these systems work (Scott 2009). Theory re-

cognizes that law is involved in constructing and legitimating markets

(Bordieu 2006), not just in containing them. Markets are not presocial.

They are not a natural phenomenon in which law and other kinds of regu-lation simply interfere. This is especially true of financial and other paper

markets (Huault and Le-Montagner 2009).

Granted, there was something of a standoff between corporation and state

in the strategies that the banks employed to avoid prudential requirements.

Arup THE GLOBAL FINANCIAL CRISIS 365



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In the United States, the corporations successfully lobbied Congress and the

Bush administration to repeal the Glass-Steagall Act and collapse restrictions

on their lines of business. The banks and other financiers gained greater

freedom to exploit the fact that some financial activities did not have to meet

capital adequacy requirements. They could rapidly move money betweenmarkets, hugely increasing volatility and magnifying risk. This led to regu-

lated products being repackaged and moved off the books.

The financiers also innovated, creating new instruments to pass on risks.

That gave them confidence to increase their lending and borrowing dramatic-

ally. Securitization and collateralized debt obligations (CDOs) enabled the

risk of loan default, such as subprime mortgages, to be spread around to

other parties (depending on the buy-back conditions), and they formed the

subject matter of secondary and further markets (for example, CDOs on

CDOs) (Tett 2009). Initially used for hedging on commodity prices, deriva-tives greatly expandednotably to credit, permitting bets to be taken on

virtually any price going up or going down. In addition, they spawned

secondary markets such as credit default swaps. Through these devices, the

banks did not just attract other investors; they created an apparatus of

shadow banks and special purpose entities, such as structured investment

vehicles, to offload and offshore risky assets. Hedge funds multiplied dra-

matically in number and placed most of their funds offshore. There was

extensive exploitation of legal forms, the corporation, and the trust; Lehman

Brothers utilized some 2,985 legal entities.Yet these risky practices did not escape the attention of regulators. Trade

in some products was routinely reported to the public agencies. The agen-

cies also had the capacity to scrutinize the newer instruments. Crucial deci-

sions were taken to let the banks monitor their own activities. It is true

some of these decisions came in the form of legislative rules. The Com-

modity Futures Modernization Act of 2000 was sponsored by Republican

Bank and Finance Committee Chair Phil Gramm in Congress and accepted

by the Clinton administration late in its second term (Stiglitz 2009). Faith

in free markets was one reason for its passage, but the dependence of U.S.lawmakers on political donations from corporations was an influence, too

(Talbott 2009).

Moreover, financiers were given crucial administrative clearances to

operate after presenting arguments to agency officials that they could

manage the risks themselves. Some decisions, particularly those most

evident when the crisis broke, were based on quite intimate informal con-

versations. Federal officials met with bank executives in New York in

weekend sessions to broker solutions (Tett 2009; Cohan 2009). Yet, if these

deals seem extraordinary, there were also crucial moments of collaborationduring the incubation period as well. One such collaboration was the deci-

sion of the Federal Securities and Exchange Commission (SEC) in 2004 to

allow banks to increase their leverage dramatically by minimizing the

capital they had to keep in reserve against the risk of the CDOs (Tett 2009;




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Taibbi 2009a). It seems regulators had learned little from the massive

bailout of the Long-Term Capital Management Fund back in 1999 (Lewis

2006).

Should these events be characterized as deregulation or something else? I

suggest that the GFC is a story about who prevails within the elite financialinstitutions themselves (Tett 2009) and about the dominance of particular

public agencies aligned with elite interests. Some of the agencies had been

established for different tasks (e.g., the Office of Thrift Supervision and the

Office of the Comptroller of the Currency), and the governments complais-

ance includes failing to rationalize and coordinate them, while at the same

time obstructing the exercise of supervision by the authorities at the state

level. Yet, other agencies, more central to power in financial markets, notably

the SEC and the Federal Reserve Board, maintained close relationships with

the financiers. In prominent remarks, they gave their blessings to the inno-vations (see Stiglitz 2009).

Why might they have done so? In the United States, the practice of political

appointments gave the Bush administration the opportunity to change regu-

lators. Perhaps one reason was the belief they were not neededefficient

markets can be left to make the right decisions. It is possible, however, that

material interests were being considered, too, not just broad philosophies.

When the Bush administration came to office, critical officials were fired,

including the vocal Brooksley Born at the Commodity Futures Trading

Commission (ibid.). Fresh appointments were made from the industry. Thispractice was not new, but the selections did change substantially.

C. INTERNATIONAL GOVERNANCE

Once financial trades straddle borders, regulators are faced with the problem

of coordination between home and host jurisdictions. Given the complexity

and volatility of financial flows, coordination has a challenging technical side

to it (Picciotto and Haines 1999; Davies and Green 2008). But the expert

work on regulation in the last two decadeson consolidated accounts, forexamplehas not been enough. Political economy is the reason why the key

home jurisdictions have not cooperated. Financial interests benefited as

states sought to attract their trade and commerce. Many countries have

worked assiduously to host finance, while the countries of origin relinquished

controls on capital movements and floated exchange rates. Now the flow of

speculative money far exceeds direct foreign investment in firms and plants.

The genie is out of the bottle.

The complicity of states involves not just the marginal states that offer

money laundering and tax-evasion opportunities (some bankrupt PacificIsland states, for example), though structured investment vehicles and hedge

funds were located offshore for this reason, too. The states have included

small nations seeking to prosper from flows of speculative money by offering

high interest rates, low taxes, steady revenue streams, and investor confiden-




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tiality, states such as the European principalities, Switzerland, the Baltic

States, Iceland, and the Republic of Ireland.

The UK governments (both Conservative and New Labour) have played

an especially critical role, supporting the City of London with light-touch

regulatory regimes, coupled with visas and services for wealthy people(Augar 2009). On one view, the British elites have given up on manufacturing

industries and plumped for high-end services supply, making London a

global center for professional services (such as financial, legal, and medical

services) and for luxury goods and services. In addition, Britain has main-

tained an ambivalent relationship with offshore jurisdictions (Kochan

2006); some of the most popular locations include British dependencies, the

Channel Islands, and the Caribbean islandsAntigua, Barbados, Bermuda,

and the Cayman Islands (Brittain-Catlin 2005). They have been havens for

tax avoidance, too. Some 80 percent of hedge fund money is lodged in theCayman Islands (Picciotto 2009).

Where governments have sought to retain control over financial flows,

inwards and outwards, they have been pressured in international forums to

liberalize. The United States and Western European governments have had

the major say in shaping International Monetary Fund (IMF) and World

Bank policies. These organizations made liberalization the condition for

assisting Asian nations in their financial crises after global traders, especially

the hedge funds, withdrew money at a rapid rate. The target of the reforms,

it was said, was crony capitalism and administrative sclerosis (Krugman2009). But the impact was broader. These countries were not permitted

to bail out local businesses, and there was widespread hurt (Buckley

2009). Resistance was portrayed unfavorably (e.g., the stance taken by the

Malaysian government).

State power has also been applied in favor of finance through bilateral

investment treaties (BITs) and the investment chapters of the new free trade

agreements (FTAs) that the United States and the European Union (EU)

have been pursuing vigorously with smaller and developing countries. While

the FTAs do vary in content somewhat, the U.S. model pursues an expansivedefinition of investment that runs beyond foreign direct investment to take in

speculative trade (Schneiderman 2008). Like BITs, such FTAs provide pro-

tections once investments have been madeguarantees of fair and equitable

treatment and protection from indirect expropriation. Some go further now

and grant preestablishment rights toothat is, rights of entry or access to the

host countrys investment markets.

Such treaties follow up with provision for international arbitration, the

rights of investors to take complaints directly against states to international

tribunals. Argentina is defending a number of cases arising out of its responseto an earlier debt crisis. Arbitration tribunals are developing jurisprudence

governing the extent to which these investor rights and protections can be

squared with the states power to take emergency measures or to persist with

general public regulation. Yet, it should be noted the membership of the




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World Trade Organization (WTO) has kept the liberalization of investment

largely out of its multilateral agreements, and the global history of invest-

ment regulation includes the failure of the Organization of Economic

Cooperation and Development (OECD)-sponsored multilateral agreement

on investment (MAI) (Arup 2008).My own research focuses on liberalization of trade in such professional

services as legal, accountancy, and financial services (ibid.). Exporting home

countries have followed various legal routes, including negotiations under

the General Agreement on Trade in Services (GATS) of the WTO and the

FTAs, to encourage host countries to liberalize market access for foreign

financial services suppliers. It is clear from the GFC that the service suppliers

do not merely respond to the demands of clients and consumers; they create

financial instruments and trade in their own rightthey are both intermedi-

aries and principals.The exposure to international financial markets has placed pressures on

governments in other ways, too. They have been pushed, for example, to cut

back on social services and sell off public services in the cause of reducing

budget deficits and public debt, while private borrowing in Western coun-

tries, especially the Anglo-American economies, has expanded greatly. The

private credit ratings agencies threatened to downgrade governments if they

did not introduce austerity measures. At the same time, they were triple-A

rating the new financial products of their private clients in a huge conflict of

interest.In Australia, for instance, state governments have favored public-private

partnerships to source transport, energy, and water projects, even when

government borrowing and tender for construction would have been

cheaper. Financiers gained commissions engineering such projects. Yet, most

often the risks were not privatized; the government gave financial guarantees

and remained liable politically to provide the services. Another example is the

national air carrier, Qantas. Already privatized, it was the subject of a take-

over bid from a U.S.-based private equity fund. The deal failed at the last

minute, and this fund later collapsed during the GFC.I have detailed this liberalization because it shows that law has actually

undermined the regulatory autonomy of national governments. It has helped

to create global markets. Liberalization has produced an extra layer of

international regulation. Some of that regulation is prudentially minded

(Picciotto and Haines 1999). While Basel I was a norm produced by a

functional regulators network, the Basel Committee for Bank Supervision,

and not a hard law international treaty, it gained considerable legitimacy

among national governments. Yet this layer of regulation changed, too. While

Basel II embraced more financial instruments at the same time the committeewas persuaded to adopt a systems-based approach, allowing the banks to use

their own internal processes of risk assessment to determine the level of capital

holdings needed to guard against default or a liquidity crisisthat is, all their

obligations being called in at the one time (Davies and Green 2008). The U.S.




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government was slow to accept Basel II, partly because some thought the

approach would weaken requirements (Picciotto 2009).

II. GOVERNING REGULATION

This section offers an assessment of the responses to the GFC. Proposals for

reform of regulation are identified. It appears the focus will remain with

systems-based regulation, so it is vital that we review the nature of those

systems. In doing so, we should move beyond a preoccupation with cognition

and calculation to a concern with cultures and values. How, though, can

value systems be affected? Is this reorientation just a recipe for despair?

A. BACK TO THE STATE?

When the crisis broke, some commentators saw it as undermining the legiti-

macy of neoliberalism and providing a case for reform of regulation. Reform

proposals included bringing the newer instruments within the capital

adequacy regimes, increasing liquidity requirements, and stiffening proce-

dures to protect consumers. For such regulation to work effectively, it would

have to be coordinated between jurisdictions. Yet, the international response

to the GFC must raise doubts that regulation will change in this way. Instead,the government responses reveal a reluctance to coordinate regulation. So

far, the responses are marked by a series of temporary and piecemeal mea-

sures. After two years, executives and legislators are still talking.

The Bush administrations first aim was to save the big banks. It bears

repeating that hundreds of billions of dollars were involved. Officials nego-

tiated directly with executives from the stronger institutions to take over

those about to collapse (except Lehman Brothers). Together with massive

injections of public funds, this agency of the state has produced even bigger

institutions. These have gathered a greater share of investments from themarkets, the commercial banks in particular profiting at the expense of the

smaller and more local institutions. More centralized and fewer in number,

they provide a clearer contact point for government regulation, yet they have

more market power and they have become, even more so, too big to fail.

The change in the U.S. administration should mean greater reform. The

government began to take equity in the institutions it was saving. Nonethe-

less, officials were at pains to reassure markets that the institutions would be

reprivatized as soon as they were returned to profitability. Moral hazard was

created when the funds were directed to those who had caused the crisis. Forexample, most of the billions of bailout funds for the American Insurance

Group (AIG) went back to Goldman Sachs (Taibbi 2009b). Although

Goldman Sachs experienced losses, the allegation is that it also made money

from shortselling AIG.2 Some of the institutions were able to refuse the




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funds; lately, others have been returning them to avoid satisfying the condi-

tions. Joseph Stiglitz (2009) suggests they might have become too big to be

restructured.

The Obama administration is seeking to reform regulation of the trading

markets. Yet, its proposals soon met resistance, as the experience with effortsto regulate derivates illustrates. Industry quickly warned that reform should

not stifle innovation and undermine the sectors advantages for the national

economy. Core industry groups such as the International Swaps and Deriva-

tives Association and the Credit-Default Swap (CDS) Dealers Forum

lobbied hard to limit requirements (Morgenson and Van Natta 2009). The

reforms for regulation of derivatives trading distinguished standard deriva-

tives from those characterized as privately negotiated and customized. Stand-

ard derivatives would be traded on public and transparent exchanges; they

would be subject to clearance requirements to manage their impact. Privatederivatives, on the other hand, would bear only some recording and report-

ing requirements. Frank Partnoy (2009) has argued that such a distinction

would create an enormous loopholean error perpetrated only a decade

earlier when the Commodity Futures Modernization Act was enacted.

Fragmentation of authority to regulate was a weakness that financiers

exploited to avoid regulation. Even if it is able to get some version through

the Congress, the Obama administration may fail to integrate regulatory

responsibility domestically. Internationally, a real test is the resolve of the

G20 governments to coordinate international regulation. In its July 2009communiqu, the G20 (2009) agreed to pursue reforms. Since then the Basel

Committee for Bank Supervision (2009) has been working on Basel III.

Progress is being made. Under Basel III, more financial instruments are to be

covered by capital-asset ratios. On the capital side of the ratio, Basel III

would tighten the definition so that only pure equities are counted. On the

asset side, Basel III would rely less on the financiers own assessment of the

riskiness of the assets.

Yet, it is not agreed how high the ratio should be for prudential regulation

(Briefing 2010). A similar controversy surrounds the liquidity coverage ratio.The committee will probably make recommendations and leave the final

arrangements once again to the discretion of the national systems. Mean-

while, the Obama administration has taken another tack, focusing on

restricting the activities of the deposit taking government guaranteed com-

mercial banks (Chan and Dash 2010; see further below). Consequently, there

is a divergence between European and American approaches; at Davos this

January, the executive officer of the Bank for International Settlements,

Jaime Caruana, criticized the Obama proposals.3

Another test is the coordination of regulation against tax avoidance. Taxavoidance was one reason financial funds went off balance and off shore. The

Bush administration had put a stop to U.S. cooperation with the OECDs

harmful tax practices initiative. The Financial Stability Forum backpeddled

on action against offshore havens (Davies and Green 2008). While tax havens




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are part of the G20s reform agenda, it is likely the strategy will remain one

of naming and shaming the most outlandish states.

If the crisis does not bring more coordination, it might lend impetus to

those regulators who are seeking to enforce existing laws. We can expect

pursuit of the most egregious frauds, such as Bernie Madoffs Ponzi scheme(Seal 2009). Initiatives that strike deeper, challenging the principles of the

system, look less likely to succeed. A litmus test is the fate of the U.S.

Department of Justice case against the UBS bank seeking to crack Swiss

bank secrecy. This secrecy is backed by Swiss laws; the Swiss government has

come out in UBSs defense, saying cooperation under a recently concluded

tax treaty will be sufficient. Some names of American investors have been

volunteered in a settlement of the case. Each of these victories is likely to be

hard won.

B. MORE SYSTEMS-BASED REGULATION

Not all, though, is negative. New governance and regulatory studies see value

in combining state with corporate power. It is plain to see that financial

systems are too complex and fluid to rely on single-minded state-centered

directives. Even those in favor of reform suspect that elaborate reregulation

will lead to further innovations in financial instruments and markets. Some

will be devoted to working around the rules. While it is galling to be told

that safeguards will be avoided, the technical fixes do lack credibility. To beeffective, regulation must enlist the cooperation of those with power. Experi-

enced industry figures are needed to help with design and to get the industry

on the side of regulation.

Certainly, given the evidence, it is unlikely the GFC will provoke a shift to

any kind of command-and-control regulation. Yet, neither does it seem likely

that accountability will come as a result of civil law actions, even though civil

law is the most private, market-based form of legal regulation. Despite the

injunctions of the economics textbooks, threats to the system have taken

priority over moral hazard. Those left in the lurch, household and localinvestors, are contemplating protracted and uncertain litigation.

Therefore, indicators suggest that the focus will remain with systems-based

regulation. But what definition should be given to those systems now, if

regulation is to influence how the actors within them think and choose? An

economic account is the most obvious explanation for the risk taking that

precipitated the crisis. Convergence heightened competition, and the manag-

ers and traders were driven by the demands of owners and investors. Much

has been made of moderating the economic incentives they received: the

performance bonuses and stock options that motivated them to maximizereturns in the short term.

Yet, when the crisis broke, the public was warned against a show of anger

towards such practices. For example, one industry leader counseled that the

crisis should not become a crude morality tale (Guardian Weekly, April 3,




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2009). Inside the logic of neoliberalism, such practices are natural and

rational behaviours. Policy analysts are turning to behavioral economics,

organizational sociology, and crowd psychology to understand why many of

the participants seemed to misjudge even their own interests. George Soros

(2008), for example, suggests the answer lies in the mutually reinforcingreflexive behavior of the herd; Robert Schiller (2008) finds it in irrational

exuberance and the play given to animal instincts.

While an advance on rational actor theory, these characterizations seem to

relieve individuals of accountability to others for the consequences of their

actions. They can be quite forgiving, even fatalistic, for they stress cognitive

failings. Another such benign reading of the events has the financiers search-

ing, idealistically, for systems that can, finally, eliminate risk, but building

such systems on abstractions of mathematical formulae (the quants) and

on computer technology. In a virtual world, loss of personal contact, speed-up, loss of affect, and decontextualization, all cause financiers to overlook the

human variable in how markets behave. There has been a general shift in

cognition; it is happening to driving on the roads, too (Ballard 1973). In this

competition for interpretation of the events, neuroscience is gaining ground.

Susan Greenfield (2003), Oxford professor of synaptic pharmacology, now

recommends a focus on the thought processes of young male traders brought

up on computer games; a related explanation stresses the role of dopamine,

a chemical in the brain.

C. BUT WHAT SYSTEMS?

I think this question holds the key to thinking about reform of regulation. I

shall argue that the cultures of the elites are as important to that rethinking

as the economics of the markets. Because it is hard to identify the shape of

systems that are based on culture and even harder to find points of attach-

ment and influence, the argument appears to rest on shaky ground when

compared to the alleged certainty of economic method. Approaches focusing

on cognition and calculation have the virtue of modesty. How, after all,would we, the commentators, have acted in such circumstances? Nonetheless,

the GFC suggests our research needs the help of other disciplines, such as

anthropology, criminology, and gender studies, to gain insight into these

systems. Law and policy studies have deployed their insights in other fields.

I would draw a comparison with ethnographic studies of dangerous driving,

youth gangs, family violence, looting, and vandalismJean-Pierre Hassoun

(2005) does so to understand financial trading. Trying to explain the reckless

and destructive behavior of the GFC, the accounts of the insiders and jour-

nalists gravitate towards these interpretations. One of the best, by FinancialTimes writer Gillian Tett (2009), credits her social anthropology studies at

Cambridge for many of her insights. Certainly, one interpretation that comes

through the literature is that macho men (madmen?) are to blame for the

foolhardiness of the GFC; accounts of behavior at Bear Stearns and Barclays




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Bank (Burrough 2008; Cohan 2009), and even across the country of Iceland

(Lewis 2009), would seem to support this thesis.

My recommendation is further research into the norms and values of the

financial elites. The sociological studies of Bell (1976), Lasch (1995), and

Sennett (2006) show the way, indicating how, at least under certain condi-tions, capitalist elites tend to wield power without taking responsibility for

the people and communities they affect.4 In his response to the GFC, Presi-

dent Obama cites such a culture of irresponsibility. If these systems are to

be regulated, it is necessary to break the lines between the economic and

culturalto look again at the conditions under which such elites live and

learn. In culture we might find the explanation for the irresponsibility

maybe, too, a point of attachment for regulation. From this viewpoint, such

conduct is not the product of an impersonal economic machine; it results

from the ethical and lifestyle choices that influential individuals make(Jennings 2002).

These choices can be located both socially and spatially. Of course, there

was subprime home lending in smaller towns and improvident investments

by local municipalities. But demand only really took off, and the risks per-

vaded the system, when the bankers in the core invented the secondary

markets to avoid their own responsibilities. Likewise, the critical failure is

not the conduct of the day traders who were paid performance bonuses but

that of the owners and executives who devised these incentive systems. It

is not the accommodation offshore that counts but the decisions takenonshore in the metropolitan home jurisdictions to go offshore (Cameron

and Palan 2004).

Spatially too, these events show how tightly clustered decision making has

been. From the accounts of the GFC, it can be seen how quickly meetings

between bank executives and government officials could be convened; social

networks are alive. While globalization allows activities to be dispersed

across physical space, such design and management decision making is still

concentrated in key cities (Sassen 2002, 2005; Parr and Budd 2000). Most

hedge fund managers are located in the urban regions of London and NewYork.5 New York and London are physical proximities, desirable places to

live and congregate, where regulation is governed face to face. Even techno-

logical advantages may accrue. With high-speed computer trading, banks are

said to gain a split-second advantage by having a giant server located right

next to the New York Stock Exchange.

III. PROSPECTS FOR REFORM

A. REFORM OF FINANCIAL INSTITUTIONS

How, then, could these networks be regulated? Points of attachment should

be cultural as much as economic. To encourage responsibility, we have




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somehow to enter the elites own networks (Riles 2000; Appelbaum, Gessner,

and Felstiner 2001; Dezalay and Garth 2002). John Braithwaite (2009) is of

this mind, I think, when he recommends we apply his techniques of restora-

tive justice to the elite firms. Reasserting personal liability might encourage

more responsibility, too (Picciotto 2009). It might also be necessary to lookbeyond the firmsfor often this is too lateto the formative cultural influ-

ences on the financial elites: to private schools, graduate business programs,

professional associations, research centers, arts and philanthropic founda-

tions, style and opinion leaders, and finance media, perhaps even to gentle-

mens clubs, where people congregate and socialize and which they respect as

their points of reference. If this sounds old-fashioned, consider a related

sectorthe Warhol economy in New York. To understand how this oper-

ates, Currid (2007) identifies nodes of creative exchange, the role of nightlife,

formal institutions, and the social production system.Perhaps a start would be to encourage continuing education, community

service, and the promotion of a professional ethic. Braithwaite (2009) also

advocates a strategy of negative licensing, the power to take away the finan-

ciers rights to practize. Yet, it is hard to see where that regulation could be

attached, for finance does not have the same professional definition as law;

only slowly are financial advisors being subjected to licensing. The repeal of

Glass-Steagall made it harder to find control points. The right to operate a

commercial bank is one such point, and one U.S. government response has

been to require the other institutions to become such banks if they wantsupport, then to restrict the activities of these banks once againto narrow

banking. This has become the thrust of the Obama administration pro-

posals (Chan and Dash 2010). Another system narrowing proposal is for

structural separations, or living wills, through which banks will be required

to keep their assets and liabilities apart, so that the failing parts can be shut

down without threatening the whole, especially the deposit-taking core.

Perhaps banks should be limited in size overall. In another reference to the

governance of the past, the parts of a bank might be separated on a national

basiscreating subsidiaries, then, rather than branches.There are technical objections to these proposals. How easy is it to distin-

guish core commercial bank functions from more risky activities such as

proprietary trading, running hedge funds, and investment in private equity

funds? Wasnt the problem with lending and borrowing rather than with

these activities? Werent the activities of the investment banks just as great a

threat to the stability of the system? Furthermore, if corporate and state

power are wedded together, who is going to wield the stick of negative

licensing against the top bankers (King 2008)? Who is going to break up or

close down their banks? Rather, the penalty, somehow, has to be the loss ofthe social privileges of such a life, not just an economic practice, but the loss

of the enjoyment of the amenity and affinity of these places. Better still, an

ethos must be established in which such irresponsibility is not an aspiration

and social sanctions such as shame and ostracism apply to discourage it.




14/19

Greater transparency would be a start; many of these transactions are done

remotely or through third parties.

I think this conclusion is logical, yet many will think it optimistic, even

nave, to expect cultural change. If, with the best of intentions, cultural

change is hard enough to obtain, some doubt the potential for reform alto-gether. Urban geographer David Harvey (2006) takes a fundamentally

darker view. He argues it is in the nature of global capitalism for crises

periodically to be provoked (see also Klein 2007). Corporate power is

flexed repeatedly. Consider the destabilizing role the hedge funds played in

the Asian financial crisis. State power comes to the party as well. For

example, the Federal Reserve acted as a catalyst for the crisis, abruptly

putting up interest rates and increasing the attraction of investment back

in the United States, and then, in the lead-up to the GFC, the Federal

Reserve dramatically reversed course. Harvey (2006) claims such disruptionis an opportunity for elites to reassert power. The moment can be used

to clean out rogue traders and recalcitrant officials, buy up weakened

competitors, and dispossess communities of their assets. If this interpreta-

tion is accurate, it might not be possible to expect regulation to prevent

another crisis. If bona fides cannot be assumed, what is to be gained by

trying to encourage the elite networks to think better of the effects of their

activities?

The distinguishing characteristic of the GFC is that it hit hard in the

homelands. When other bubbles inflated, action was taken to burst them. Itseems that Greenspan thought the housing bubble could be managed this

way, as the dot-com bubble had been a decade earlier. Perhaps the situation

was misjudged and the system got out of control. Sometimes, systems theory

is likened to an old theory of sociology, functionalism. Yet, systems theory

understands that systems are not always in equilibrium and that they have

the potential to disintegrate. Harvey (ibid.) says this is true of regional

economies; capitalism moves on. Geopolitical alliances of state and corpo-

ration go into decline, even if they have been strong for a long time. Others

emerge to take their place. Unless Anglo-American elites alter their practices,they might be superseded by other varieties and sites of capitalism (Ferguson

2008). Shifting discussion of international regulation from the G8 to the G20

is some recognition of this prospect.

B. DEMOCRATIC CONTROL OF FINANCE

Finally, the focus shifts away from the power brokers of finance capitalism.

Not all solutions can be found in more sophisticated governance relation-

ships between corporation and state, certainly not in regulation to correct formarket failures. It is vital to reduce dependence on financial markets. If

communities have to rely wholly on it for the supply of essential services, such

as housing, food, health, transport, and energy, the failures of finance

capitalism will be magnified.




15/19

Such a critique is not revolutionary. It does not dispense with capitalism,

for financial markets and institutions clearly have their uses. Venture capital

helps start up innovative businesses; hedges can be a safeguard for food

producers; bankruptcies restart moribund businesses. Still, crucial social

questions should always be asked whenever markets are being constructed(Bordieu 2006). For example, we might ask, to what extent is the creation of

secondary markets socially desirable? If water rights are to be traded, should

purchase be confined to those who actually use water? Though there were

other reasons, one reason for the rapid rise in food and energy prices during

2008 was the role of speculators in the markets (UNCTAD 2009; Cable

2009).

It has to be an exaggeration to say everyone benefits from financialization.

If the claim was that the new finance technologies would eliminate risk

altogether, a more conventional interpretation is that risks were beingshifted. Such risk shifting seems a feature of post-Fordist capitalism. For

instance, employment is once again placed on an insecure casual basis or

outsourced to contractors. Most pointedly, members of pension and super-

annuation funds are moved from defined benefits to benefits that fluctuate

with markets, and other workers are required to fund their own retirement. If

aspiration or greed attracted some households to the new financial products,

to become minicapitalists (Marazzi 2008), others also made such moves

because their wages declined and they saw no public or civil sector alternative

for securing housing or retirement (Panitch and Konings 2009). Further-more, when the crisis pervaded the system, it penalized many who were not

represented in the foolhardy financial transactionsworkers and businesses

in the real economybecause the financiers were no longer extending credit

or were only doing so on prohibitive terms.

A longer-term solution would find a better balance between finance and

industry, between private and public service provision. It would seek a

political settlement, not just an economic shift. Democratic capitalism relies

on a certain empathy and cooperation between the social partners. Missing

from the corporate-state equation are small producers, workers, unions,local communities, consumer groups, nongovernment organizations, and

philanthropies. Yet, they figure in law and society studies (Morgan 2005;

Kelsey 2008) and in the inspiring examples Santos and Rodriguez-Garavito

(2005) bring together in studies of globalization from below.

To reembed markets (after Polanyi 1957) and to reconfigure essential

services as public goods requires very locally focused, yet at the same time

globally coordinated, action. Partly, it is the return of the public sector, for

example banks in public hands. Moreover, it depends on public-private

partnerships being formed to work on food, health, and environmental chal-lenges. And these partnerships benefit from a supportive legal framework.

Thus, work is being done to fashion treaties that civilize trade and invest-

ment. Such treaties raise the status of public goods like social security and

environment sustainability relative to the freedoms and rights that traders




16/19

and investors have obtained (Drahos 2005). They attach requirements that

traders and investors pay respect to more conventional forms of regulation,

such as the requirements for prudential financing and corporate social

responsibility (Picciotto 2009).

Perhaps one final note can underline the point. The world is responding toa bigger challenge than the GFC, the destruction of the natural environment,

with the creation of another financial market, the carbon emissions trading

system (Taibbi 2009b). Again, our fate is tied to financial instruments,

trading for profit and risk shifting. Yet, it is an enterprise in which we are all

truly implicated; eventually no one can escape the consequences of global

warming. If market mechanisms have their part to play, it is necessary to be

thinking also of clean regulatory technologies such as a tax regime. Better

still, rather than rely on financial incentives proving effective, we must try to

alter production and consumption practices to minimize emissions alto-gether. Zizek (2009) cites the modesty of Buddhism, culture again. Buddhism

might also reduce the demand for financial credit.

NOTES

1. This piece stems from a miniplenary at the 2009 Law and Society AssociationMeeting. We were asked to reflect on the distribution of power between corpora-

tion and state in the wake of the GFC: In the wake of scandals such as Enronsand the collapsed market of secondary mortgages, the Mini-Plenary will ask aboutthe emergence of self and private regulation, the accountability deficit, theadequacy of new governance as providing solutions to crisis of citizenship,democracy and growing inequality (Law and Society Association 2009, 75).

2. In April 2010, the SEC launched a civil fraud suit against Goldman Sachs forrecommending products to clients while it and another of its clients were shortselling them (betting against them).

3. Of course, these plans do not exhaust the proposals that have been made. Propos-als have come from all directions, and one issue is why some (the United Nations,for example) seem to have been sidelined.

4. Thus, the creation of secondary markets distances the financiers from responsibil-ity for the success of the mortgages they have generated, unlike the bank managerMr. Deeds, who is embedded in his local community.

5. Including Greenwich, Connecticut.

christopher arup is Professor in the Faculty of Business and Economics, MonashUniversity, Melbourne, Australia.

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