THE GLOBAL CRISIS AND THE GOVERNANCE OF POWER IN FINANCE

Author(s): Gary A. Dymski

Source: World Review of Political Economy, Vol. 2, No. 4 (Winter 2011), pp. 581-602
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 THE GLOBAL CRISIS AND THE

GOVERNANCE OF POWER IN FINANCE1

GaryA. Dymski

GaryA. Dymski,Economics LeedsUniversity

Division, Business
School,
University ofEconomics,
ofLeeds,andDepartment University
ofCalifornia, Email:gary.dymski@ucr.edu
Riverside.

Abstract:
Thisarticle examineswhy theglobal financialcrisis
thatbeganin2007hasintensified
policydebateaboutfinancial regulation andgovernance, andbrought abouttheendofpolite
ineconomics.
discourse Coming intothecrisis,
thereceived viewonfinancial
regulation
regarded
power infinance as a matterofmarket concentration alone,andunderstood concentration
andanindication
as stabilizing thatcompetitively fitfirms weredominating themarket. This
article
argues thatthe current
crisis
necessitatesa ofour
reframing understanding regardingthe
not
governance- simply regulation-of finance.
At the core of this must
reframing be a much
multi-dimensional
richer, conceptionofpower anditsimplications infinancial This
systems. article
arguesthatthe locusof powerinfinance hasshifted
with the rise
of the"originate-and-distribute"
modelinthe2000s.Thisshift created newpossibilities
forrent-extractionandspeculation,to
which theexistingmodel ofregulationwasnotprepared toreact. Thesubprimecrisis
emerged
intheviewdeveloped
precisely, here,inthecontext ofthiscrisisinthegovernanceofpower in
finance.
Sorestoring financial
effective regulationwillrequirea deeprethinking
ofwhatfinance
hasbecome, andwhatitshould be.Thechallenge isprofound, forresolving
thenearly
global crisis
offinancial
systems- and,byextension, ofmacroeconomic stagnation-dependsonrecognizing
andresponding totheconsiderable,
multi-dimensional power accumulatedbythevery financial
firmswhosedysfunctionality helped create inthefirst
thatcrisis place.
Keywords: financial financial
regulation; governance;power; bankingconcentration;
megabanks;
subprime crisis;
originate-and-distribute;
speculation

1 Introduction
-
This articlearguesthatresolvingthenearlyglobalcrisisof financialsystems
and,by extension,of macroeconomic -
stagnation dependson recognizing and

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582 GARY
A.DYMSKI

responding totheconsiderable, multi-dimensional poweraccumulated bythevery

financialfirmswhosedysfunctionality helpedcreatethatcrisisin thefirstplace.
The powerof finance,and especiallythatof themega-institutions at theheartof
themodernfinancialsystem, has grownsteadilyinthepast45 years.Muchofthe
celebrated innovation oftheseinstitutionshasinvolvedcapturing moreoperational
leveragebyaccessing more liquidity.In theend, thesuccess of these via
strategies,
competitive globalderegulation and the creationof new methods of risk-shiftingand
risk-taking, endedbycompromising globalliquidity justwhenitwas mostneeded.
The economicandfinancial crisisthatarosenearlyworld-wide in the2007-10
has
period posed such a profound for
challenge policy-makers preciselybecause
it is rootedin the systemfailureof thisbrave new worldof intermediation.
Initiating concretestepstowardre-imagining and re-creating a sociallyefficient
and economically productive financial sector requires, first
of all, acknowledging
thecurrentfinancialsystem'sinordinate, multi-dimensional power.The links
between thisaccretion ofpowerandtheexcessiverisk-taking andincreased financial
that
exploitation triggered the crisismust be better understood. This will permit
a re-engineering ofthefinancialsystemthateliminates thedestructive tendencies
linkedto theaccumulation ofpowerinfinance.
Undertaking this reshaping will notbe easy.The existingrhetoric of financial
regulation among academic and
experts policy insiders evaluates the "efficiency"
and "stability" of thefinancialsystemin narrowterms,and focusesattention on
problemsof mechanismdesign.It is blindto thepresenceand implications of
systemicpower in this system. But unless the debate over financial regulation is
broadened, decades of sub-pargrowth and excessive financial lie
exploitation ahead.
Section2 describeswhythiscrisishas intensified policydebateand brought
abouttheend of politediscoursein economics.Section3 summarizes received
viewson financialregulation, whichinterpret power in finance as stabilizingand
an indicationof competitive fitness.Section4 exploreswhythecurrent crisis
necessitates a reframing ofdebateaboutthegovernance - notsimplyregulation - of
finance.2 Section5 listssomecritical elements forunderstanding real-world financial
systems, including power. Section6 discusses how the locus ofpower in financehas
shifted withtheriseofthe"originate-and-distribute" modelinthe2000s. Section
7 examinestheimplications ofthesubprime crisisforthegovernance ofpowerin
finance; and Section 8 containssome ideas on restoring effectivefinancial regulation.

2 The End of Polite Discourse in Economics

Many,ifnotmost,economists preferdebateswhichare clearlybounded,so that

discussionis invariably
polite.In particular,
thismeansrespectingtheauthority
of thosewithpre-existingclaimsto expertisein givensubject-matter
areas.But

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THEGLOBAL
CRISIS OFPOWER
&THEGOVERNANCE INFINANCE 583

thecurrent crisishas engendereda deep discontent withstatus-quothinking in

economics.Priorto thiscrisis,different theoretical schoolsdevelopedtheirown
explanations for core questions about the economy:Why do banks exist?Is
regulation needed?Does activefiscalpolicyraisewelfare?Each schooldeveloped
itsown answers;themoreinfluential and well-funded theschoolof thought, the
moresettledtheviews.
So whiledifferences ofviewaboutcoreeconomicquestionshavepersisted over
time, in the past threedecades, most economists calledto positionsof economic-
policy leadershiphave portrayedtheirown views as reflectiveof a sensible
consensus.Thissuggested thateconomists' viewsvarywithina narrow band,from
slightly-critical-of-unregulated-markets to suspicious-of-government-regulation.
Regarding financial economists
regulation, haveroutinely celebratedtheimportance
of freemarketsand of reducingburdensomeregulation.The financial-system
flawsmostfrequently mentioned werethemoral-hazard trapsthatariseduetobad
regulatory design, about which pro-market and pro-mild-regulation economists
couldreadilyagree.An examplehereis the"consensusview"orchestrated among
macroeconomists, whether theysubscribed tothenewKeynesianornewClassical
schoolsofthought. Maintaining thisconsensus requiredthatdebatebe polite:limited
to empiricalquestions and to queries about equilibrium modelswithpre-agreed
analytical features.Economists werecertainly freetochallengethepremises ofthis
new-Classical/new-Keynesian consensus in favorof ideas
alternative derived from
overlookedthinkers suchas MinskyandKeynes.Butto challengebasicpremises
was to disagreeimpolitely; and suchchallengescould onlybe freelyexercised
outsidetheinnercirclesofpolicyinfluence.
Nonetheless, as structuralcracksandtensionsbeganto emergeintheeconomy,
several leading academics and policy veteransexpressedtheirunease. John
GeanakoplosofYale,drawingon hisWallStreetexperience, beganwriting papers
about"broken promises" (1996) and"leveragecycles"(2009) infinancial markets-
topicswhichhadgonevirtually unmentioned sincetheefficient-market hypothesis
becamea super-orthodoxy in the 1970s.3In April2005, Paul Volckerwrotean
op-edpiece in theWashington Post, "EconomyOn ThinIce," whichforesawthe
demiseof Wall Street.RaghuramRajan, formerly head of researchat theIMF,
hypothesized thatliberalizingfinancialmarketscould increaserisk-taking and
fragility,not welfare. Paul Krugman, in hispublicdialoguespace at theNew York
Times, shiftedsteadilyto theleft.
Then,afterinnumerable crisesin theglobalSouth,a mega-crisis hittheglobal
North.And thetruceamongeconomistsprovedfragile.Suddenlytherulesof
discoursewavered.The consensusthatcertainthingswerenotto be spokenof
was forgotten. Some economists continued toworkfrom"first principles," urging

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584 GARY
A.DYMSKI

cautionin responsesto thecrisis.Otherssetasidetheoretical nicetiesandjumped

towardpragmatic responsesbased on lookinghardat thenumbers.
The US Treasury'shugebailoutproposalin theheartof a nationalelection
seasonaddedto thedrama,and theglovescame off.Nobel PrizewinnerJoseph
Stiglitz(2009) wrotean articleinForbesentitled Fools";PaulKrugman
"Capitalist
(2009) publiclydisparaged the failure
of macroeconomics, and was savagedinthe
of
weblog Chicago economist John Cochrane (2009). RobertBarbera(2010), a
well-regarded WallStreeteconomist, responded to Cochraneinkind,inan article
entitled "IfThereWerea Fight,TheyWouldHave StoppedIt inNovember2008."
This shiftfrompoliteto impoliteexchangesthatchallengeestablished experts
has been repeatedin othersubstantive areas.The nexttwo sectionsdiscussand
thenchallengetheexpertconsensusregarding financialgovernance, whichhas
overlookedtheproblematic ofmegabanks'power.

3 The Consensus View of Financial Regulation: Power Hidingin Plain

Sight

Expertand academic views on financialregulationhave co-evolvedover the

last 30 years.Bankingderegulation was alreadyon thetablewhentheReagan
Administration tookpower.Soon, close regulationby examinerswas replaced
byderegulation withself-monitoring ofrisks(Dymski1999). However,by 1982,
amidstskyrocketing interest ratesand an oil-pricecollapse,theUS savings-and-
loan systemand commercial banksin "oil patch"statessystematically defaulted.
Savings-and-loans'undue after
risk-taking deregulation, including investmentsin
speculativereal-estateventures, andthefailuretoaccountforrecourserisk,added
to themagnitude of systemfailure.4
The questionthenwas implicitlyposed- was the 1980s crisis of the US
financialsystemduetoinadequate prudentialsupervisionortoill-advisedincentive
mechanismswithinbankingfirms?A set of self-appointed expertstermedthe
"Shadow FinancialRegulatoryCommittee"(Benstonet al. 1986) dominated
discussionaboutthecauses of thesedepository-institution crisesand whatto do
aboutthem.This"Committee" attributed crisistomoralhazardinlending
thethrift
(Kane 1989;Kaufmanand Benston1990): depositinsurance removesdepositors'
incentivesto disciplineintermediaries whose managersor boardstakeundue
risks.The prescription was continued includingmorelimitedbank
deregulation,
regulation;butthekey was toget incentives so
right thatthefinancialsystem could
be self-policing.5
Government interventionwouldonlyleadtomismanagement. As
George Kaufman put itin a 1995 essay:
intheU.S.banking
Themajorsourceof...instability inthe1980s...wasnotthe
system
sector
private butthe or
public government sector.
The first
government createdmany

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THEGLOBAL
CRISIS OFPOWER
& THEGOVERNANCE INFINANCE 585

oftheunderlying causesoftheproblem S&Lsto assumeexcessive

byforcing interest
raterisk and
exposure preventing both S&Lsand banks
from their
minimizing credit
risk
exposurethrough optimal andgeographic
product andthendelayedin
diversification
applyingsolutionsto theproblembygranting for-bearance
to insolvent
economically
Thatis,thebanking
institutions.
ornear-insolvent debaclewasprimarily
anexampleof
government failureratherthanmarket failure. 1995:
(Kaufman 259)
Theperspective oftheCommittee hastwointellectual underpinnings. One,noted
above,is theefficient-markets approachin financial economics;thesecondis the
to
public-choiceapproach public economics. Some membersof thiscommittee
(especiallyBenston, Kane,andKaufman)see regulators notas neutral purveyors of
well-intentionedpolicies,but as advocates fortheir
own interests.Thus, empowering
regulators whilereducingthescope formarketforcescan lead to dysfunctional
outcomes(suchas thesavingsandloancrisisitself)andhugeinefficiencies. Atthe
sametime,financial market forcesareviewedthrough a pragmatic Chicago-School
lensmorethanthrough an efficient-markets hypothesis lens.Committee members
wouldnotagreewiththeconclusionof Fama (1980), based on strictefficient-
markets logic,thatbankshaveno effect onresourceallocation.Butwhileadmitting
thatmarkets maymisbehaveand generaterentsforfirmscapturing monopolistic
power, theircore belief is thatmarket forcesshould be given maximum swayand
government intrusion minimized. In a 2000 paper,Benstonasksthequestionthat
motivates muchShadowCommittee research andpolicydiscussion: "is government
regulation of banksnecessary?"The authoranswersin thenegative.In his view,
onlydepositinsurance, whichleadsbanksto holdinsufficient capital,constitutes
a validrationaleforbankregulation. "Otherwise, banks should be regulatedonly
as areothercorporations" (Benston2000: 185).
For theShadow Committee, then,thefinancialindustry is threatened by an
aggressiveandbullyinggovernment. One wouldneverimaginethatthisbesieged
industry spends millions annually to win friends
andinfluence peopleinCongress
and theAdministration. This manifestation of poweris notdiscussed,though
Committee membersdo worrythatgovernment regulators are influencedby the
of
prospect "goldenparachutes." The Committee's focus is on getting government
policyright, andthismeansmaximum scopeformarket forces:leaveownersfree
to controltheirfirms, andfirms freerto entermarkets.
This experts'panel continuesto function, and is currently sponsoredby the
AmericanEnterprise Institute. Itsmembers havefoundeda newacademicjournal,
theJournalof Financial ServicesResearch, helpingto shape a generationof
research.Morethanhalfitsmembers havebeenmembers ofthisCommittee fromits
founding; severalhave served in appointed governmental positions. The Committee

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586 GARY
A.DYMSKI

metseveraltimesin 2010 and sponsoredpressconferences on proposedtaxeson

bigbanks,SEC regulation ofequitymarkets, andso on.
Leaving aside theShadow Committee itself,theliterature on bankstructure and
regulation has centered in recentyears on the relationshipbetween concentration
andcompetition inbanking. Berger, Demirgc-Kunt, Levine,andHaubrich(2004),
intheirsummary ofthisresearch, argue fortolerance regarding monopoly powerin
banking, for several reasons. older
First, structural tests formarket are
power prone
to estimation error, especiallyselectionbias. Second,theyarguethatmarkets can
be bothcompetitive and concentrated. The presenceof a monopolyor oligopoly
initselfdoesnotimplythatrentsarebeingunfairly takenfromcustomers, inthese
authors'view;markets arecompetitive as longas theyarecontestable. Third,more
concentrated banking markets can be more stable and less Hereagain,
crisis-prone.
financial is in
power hiding plainsight.6
Inthepastdecade,studiesexploring thelinksbetweenmarket structures,stability/
crisis,andregulation haveusedthreequiteseparatemethodologies. One involves
buildingformalbankingmodels.Repullo(2004) showsthatwhenbanksmust
competeforfunds,theywill earnfewerrevenuesper loan,and hencebe more
likelyto makeloansto riskycustomers. In thisevent,capitalrequirements canbe
effective;conversely, when banks face less competition forfunds, theywill choose
saferloans,andcapitalrequirements willbe either unneededorimposedeadweight
losses.In a similarresult,Boyd,De Nicolo,and Smith(2004) findtheprobability
ofa costlybankcrisisis higherundercompetition thanundermonopoly.
Thesecondapproachinvolvesintensive empirical studiesofindividual markets.
Somerecentstudiesusingthisapproachhavecometoless-comforting conclusions
regarding thetreatment ofbankcustomers inconcentrated markets. Carow,Kane,
and Narayanan(2006) showthatborrowers have lostoutin bankmegamergers.
Further, Hale and Santos(2009) examinebankloan dataforborrower firmsthat
eventually floatedIPOs (initialpublicofferings). Theyfindthatbanksdo charge
higherloan ratesforfirmsthathavenotgonepublic;as theauthorsputit,banks
do "pricein" theirinformational monopolyon firmcreditworthiness as longas
they maintain it.
Such "traditional"empiricalstudieshave been joined by a new empirical
approachestablished duringtheAsianfinancial crisis.Hopingtobetter understand
thedeterminants offinancial crises,the IMF and World Bank developedextensive
databaseson financialcrises,macroeconomic conditions, and bankingstructure
and regulation in a largesampleof nations,overa wide swathofhistorical time.
Thismadeitpossibletoutilizeeconometric methods toassessthemacroeconomic,
microeconomic (structural),andregulatory conditions thataccompanied orpreceded
(and thusmayhavecaused)financial crises.So in thesamepanel,1981Mexican
GDP growth might be evaluatedas a determinant ofthe1982Mexicandebtcrisis,

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THEGLOBAL &THEGOVERNANCE
CRISIS OFPOWER
INFINANCE 587

while 1996 KoreanGDP growthwouldbe evaluatedvis--visthe 1997 Korean

meltdown(and so on). Demirgc-Kunt and Detragiache(1998) concludethat
financialliberalization increasestheprobability ofbankingcrisis.
It soon becameclearthatdata structures drawingon globalexperiencesover
broadtimeperiodscouldbe used to considerotherquestions,including thelinks
betweenregulationand banks'marketstructure and behavior.In consequence,
thelarge-scaledatasetapproachis now widelyused in thebroaderliterature on
bankmarket structure andregulation. Thisapproachassumesthatdevelopingand
developednationsarepartof one financial-development continuum, and thatthe
experience ofanyonecountry (e.g. Latvia)shouldbe givenequalweightwithany
other(e.g. theUnitedKingdom).
Thisapproach, whileitoftenleadstocomplexresults, hasyieldeda coherent set
ofpolicyimplications. Demirgc-Kunt and Levine (2004) conclude - based on 150
countries' experience withfinancial crisis,financial structure, anddevelopment -
thatmaintaining outsideinvestors' legalrightsandefficient contract enforcement
will insureeffectivefinancial-sector development.Beck, Demirgc-Kunt and
Levine (2004) argue,using this database,thatfinancial-sector development
reducespoverty. Barth,Caprio,and Levine(2004) used a 107-country studyto
showthatdirectgovernment of
regulation banking markets is not effective,and
leads oftento fragility. Financialdevelopment and stability is betterfostered by
and
empowering properly incentivizing private-sector corporate control of banks.
Beck,Demirgc-Kunt, andLevine(2006) use datafrom69 countries from1980to
1997 to show- aftercontrolling forregulatory andmacroeconomic policies,and
nation-specificshocks - that systematic banking crises are less likelyin countries
withmoreconcentrated bankingsystems.Further, regulatory policiesthatthwart
competition are associated with greater bank fragility.A new studyof 250 banks
in48 countries by Laeven and Levine (2009) shows thatbank risk-taking increases
as bankshareholders' powerrisesin corporate governance.
Takentogether, thesemulti-country, multi-year studiessuggestthatpermitting
bankconcentration torisebyeasingregulations, permitting freer entry intobanking
markets, and relyingon private-market guidancewill lead to continuous, stable
financial-system development - and thus contribute per the expectations the
of
finance-development literature to higherratesofeconomicgrowth. Butinsofaras
market concentration embodiestheaccumulation ofpowerinfinancial markets, this
meansthatthepriceof stability in financialmarkets is megabanks'acquisitionof
market powertherein. Andpotential entryshoulddisciplinemegabanksand limit
theirabuse of customers. Poweris there,butit is principally a markerof some
financialfirms'competitive success; and those firms' incentives are fora "quiet
life"infinancial markets thatarewell-organized andtranquil.

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588 GARY
A.DYMSKI

The peculiarityof thisempiricalapproachis thatit does not evaluatethe

lessonslearnedin moreadvancedfinancialsystemsforless-developedsystems;
itestablishesa meta-outcome thatencompassessimultaneously theexperienceof
themosthumbleand themostadvancedmarkets. Givingswayto marketforces
and restricting government intervention intofinancialsystemswill notcreate
thepanaceaenvisionedin theefficient financialmarketshypothesis;indeed,the
consolidation thathas graduallyoccurredwill hurtsomeborrowers - as a study
co-authored bya ShadowCommittee member(Kane 1989) shows.Butinsofaras
thisapproachassuresa stableandcompetitive systemoffinance,suchlossescount
only as collateraldamage.
This buildsin thepresumption thatsystemicbehaviorconsistssimplyin an
aggregation ofindividual markets, andthatall markets
arecreatedequalforpurposes
ofempirical There
testing. is alsothus ofbanking
one-dimensionalizing - a reduction
ofbankingandfinancial behaviorto a lowest-common-denominator The
activity.
distinction thattheCongressionalinvestigation of GoldmanSachs' role in the
subprime crisishas raised,between megabanks'"fiduciary totheir
responsibility"
depositors and their autonomous role as "market makers"operatingon theirown
behalf(Guerrera andBraithwaite 2010),doesnotarise.Forwhatis commoninthe
Turkishand Bangladeshiand US bankingsystemsis thelender-bank-depositor
relation,the"fiduciary" role.Onlyinthecenteroffinancial powercanonefindthe
outsized"market -
maker"role a rolerepletewithremarkable powertomakeand
breakentiremarkets - thatGoldmanSachs and othermegabankstookon in the
"originate-and-distribute"modelof creditcreation.But anyinvestigation of that
rolecannotbe undertaken withan empirical tooldesignedtoexplainwhatfinancial
crisesaroundtheworldall havein common.

4 MovingfromSettled Theory to a Rethinkingof the Critical

Elements of Finance

The agenda championedby the Shadow Committeeheld sway in the 1990s,

openingthewayforthederegulated 2000s.Depositinsurance was noteliminated,
butrestrictions on bankingandfinancial were.The notionofself-policing
activity
financewas embeddedintheproposedshift forglobalbanking fromBasle
guidance,
I toBasle II. Sincethemid-1980s,Basle I hadimposeduniform asset-basedcapital
requirements on largemultinational
banks.UndertheproposedBasle II rules,ratio
testswouldbe replacedby a requirement thatall largebanksruntheirownstress
testsabouttheirindividualmixtures ofderivatives, futures-market
commitments,
andso on,andwouldsurvivevariousworst-case scenarios.
EvenwhileBasle II was beingfine-tuned, theshifttoa morederegulated regime
continued. Indeed,in the2000s,megabankswereable to createlargevolumesof

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THEGLOBAL OFPOWER
&THEGOVERNANCE
CRISIS INFINANCE 589

collateralized debtobligations inpartbecausetheywerenotcountedincalculating

required capital.TheFinancialServicesModernization (Gramm-Leach-Bliley) Act
of 1999also servedtoblurthelinesbetweencommercial andinvestment banking,
andbetweenvariouslinesoffinancial business.Subprime-loan andsecuritization
volumesexplodedas secondary-market outletsforcreditexpanded.Mostsubprime
loansweremadeby non-bank lenders,sold to megabanks, andthenbundledinto
securities,many of which were insured through credit-defaultswaps(CDS). The
CDS itselfwas invented so thatitsprimary issuer,AIG, couldavoidtheregulatory
oversight that would arise were these underwriting arrangements classifiedas
insurance contracts.
Prudential oversight was clearlylackinginthisasset-price buildupandcrash-
in somesense,by design.The 1999 Act encouragedinstitutional innovation and
line-blurring; Basle II putprudential responsibilityin the hands of the megabanks
themselves; andmegabanks'increasing use ofnon-bank lendersandfundsboosted
theirearnings.Most megabankscreatedstructured investment vehicles(SIVs),
consisting of bundled loans financed by asset-backed commercial paper.Several
megabanks both soldSIVs to generate feesand held them off-balance sheettoboost
theirrevenueflows.Thatthesefundscould be regardedas independent of their
issuing banks' balance sheets - as having been made without recourse - shows how
completely the lessons of the 1980s thriftcrisishad been forgotten.
Thestep-by-step off-loading ofdefault riskontoentities outsideoftheregulatory
scope of the banking authorities came back to haunt US regulators inthesubprime
so
crisis; too did the 1999 elimination ofthe linebetween commercial bankingand
otherfinancialactivity. In theLong TermCapitalManagement (LTCM) crisisof
1998,theFederalReservewas able to call on WallStreetmegabanks - especially
thethen-investment banks- to help restoreorder.These megabankshad been
recruited - strong-armed - intoprovidingtheliquiditythatpermitted LTCM to
unwinditsoversoldposition.Thiswas notpossibleinthesubprime crisis:manyof
thesesamemegabanks werenowthemselves over-exposed inthesubprime market
(and consequentlyundercapitalized).
Whatwas missing?Whydid theShadowCommission'sbelief- reinforced by
boththeoretical modelsand empiricalresults - thatderegulatedfinancialfirms
wouldbe morestableand moreefficient thanrigidlycontrolledmarketsgo so
In
badlywrong? essence, the mistakethe Commission andtheresearchcitedhere
madewas to assumethatthefinancialsystem,once liberated, wouldbehaveas
efficient-market
financialtheory(and specifically, theory)expecteditto behave.
The competition-versus-concentrationdebaterelieson efficientfinancial-market
theoryveryheavily, if in a veiled way. It is assumed thatbankingand finance
consistsofa setofwell-defined -
activities inparticular,theprovisionofcredit(or
ofinsurance)fora setofeconomicagents,whorequirethiscredittoconducttheir

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590 GARY
A.DYMSKI

normaleconomicactivities. Permitting entrybynewsuppliersandthecreationof

newinstruments adaptedtotheuniquerisk-return andothercharacteristicsshould
simply enhance Market
efficiency. powermay exist,butithas no effectivity.
So economists couldrelyon theirsettledviewsaboutwhatbankingis,whatthe
motivesofbankers are,andthebenefits ofcompetitiontounderstand howregulatory
policy should adjust.The reference pointof economic equilibriumprovideda
benchmark forunderstanding whatdistortions
may have arisen.Inacademicsettings,
suchdistortionscouldbe neatlyparsedanddiscussedone at a time.
Figure1 illustratesthisshiftby depictingtheassetsize of the25 largestbank
holdingcompanies(BHCs) in a varietyof years,rangingfromDecember1997
to September2008. Thatis, the25 largestBHCs are shownforeach year;the
populationof banksshiftsfromyearto yearbecause of mergers,failures,etc.
This graphshowsthatfromtheeighthpositionupward,banksize has remained
remarkably constant.But fromone to seven,it's clearthata "super-sizing" has
occurred.Figure2 demonstrates anotherdimension ofdifferencebetweenlargeand
smallbanks:smallbanks'derivatives positionshaveatrophied to nearlynothing;
bycontrast,largebanks'positionsintheseinstruments haveexplodedinsize.Note
thatlargebankshave been approachingderivatives positionsof 2,000 percent;
smallbanks,2 percent.
Butthisapproach - bornofnearly30 yearsofheavilyinfluencing bothdebate
abouttheregulatory agenda and the of
trajectory applied research- wentbadly

Figure1 Assetsizeof25 largest

bankholding December
companies, 1997toSeptember
2008 (figures
inUS$1,000)
Source:
Federal
Financial
Institutions
Examination various
Council, quarters.

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THEGLOBAL
CRISIS OFPOWER
&THEGOVERNANCE INFINANCE 591

2 Derivatives
Figure ofassets,1992-2008:banksoverandunder
as percentage
inassets
$1billion

wrong.Theone-size-fits-all approachtoevaluating banking-system behavior

which
developed amidst theAsian crisisdesensitized researchersto the remarkableshift
in thesize-orderingandscale ofthemostgiganticfinancial firms.
As Bookstaber(2007) and Sorkin(2009) demonstrated in verydifferentways,
thisdifferenceinthescaleofsomefinancial firms impliedexplosivegrowth these
in
firms' intheposition-taking
activities: thatlinkedtheseactivities,inthederivatives
positionsthathedgedorbeton theseactivities, in thechallengeofunderstanding
(muchless controlling) theirexposuresto risk,andultimately in thechallengeof
defining whether theirinterestlay more fundamentallyservingor in exploiting
in
theircustomers.
Not surprisingly, then,whenthedizzyinglycomplexfirmsat thetopof Wall
Street'spyramid beganto failin 2007,as didmanyofthesmallerfirms andfunds
enmeshedin (or createdby) thesefirms'octopusarms,settledtheoryseemed
inadequatetothetask.The size andspeedofsystemfailureperceivedbyTreasury
and Fed policyinsiders,alongwiththesize and speedof theTARPbailoutthey
orchestrated,lefttheacademicliterature on howbanksfailfarbehind.The weak
resultsof thatbailouthaveresultedin a sustainedreform effort,aboutwhichthe
finance-and-development literature'ssimplelineardistinction betweentheabsence
andpresenceofadequatefinancial intermediation hasnothing to say.Shouldover-
the-counter trading be reined in? Should a "Volcker rule" forbid "banks"from
tradingontheirownaccount?Shouldbanksfundtheirownbailoutfund?Notonly
havetheseissuesnotbeenresearched; no economist imaginedthatthedebateabout

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592 GARY
A.DYMSKI

suchreforms wouldoccuronlyafter$700 billionhadbeenchanneledto financial

halfto thelargestmegabanks.
institutions,
Whathasemergedinthiscrisisis an entirearchitecture offinancial dysfunction-
which
alities, range from theexploitation of the vulnerable totheextraction ofrents
fromtheunwary totheabilityofwell-positioned playerstopassrisksoffontoother
-
parties ultimately, onto thepublic. There are so manymoral-hazard andadverse-
selectiondimensions tothiscrisisthateconomists prepared analyzesecond-best
to
Nashequilibria caneasilyidentify oneoranother incomplete-market problem whose
can
malfunctioning readily be seen. What is not so easy is to identify the ways
in whichthedysfunctionalities and second-best equilibria interact- the broader
architectureof systemfailure.The problemis thatfixinganyone maladywithout
payingattention to thisarchitecture insuresthattheprocessof flyingblindwill
continue.Forexample,TBTF ("too-big-to-fail") is certainly oneflaweddimension
oftheUS financial system. But"ending"TBTF ontheassumption thatmarket forces
canhandlethefall-out fromthecrashofanyfinancial institution- fromthesmallest
to thebiggest- makesassumptions abouttheresilience, stability,andscale ofthe
requisitemoney, and
bond,derivatives, equity markets that must be evaluated.The
structured complexity of thefinancialsystemincludesnotjust spot,futures, and
state-contingent transactionsmarkets, but also multiple of
layers spatial interaction
(global[cross-border] markets, regional/common-zone markets, nationalmarkets,
and local markets). Thereare agentsplayingthemarketsin each "location,"and
authoritiesat eachnexus.
Economists, confronted withthissituation, havea choice.Theycan regardthis
crisisof financeas continuouswiththoseprecedingit,and continueto relyon
insightsand empiricalresultsderivedfromsettledapproaches - thatis, theycan
relyon thesortof theoretical and empiricalresultssetoutin section2 to inform
theirreactionsto thecurrent situation. Alternatively, theycan see thiscrisisas
requiringthattheoretical understandings andpolicyresponses basedontheanalytics
ofimaginedequilibrium statesbe setasideor,at theveryleast,supplemented.
The latterseemstheonlycoherent path.The ShadowCommittee has painted
itselfintoa corner.The market-equilibrium view thatconstitutes itsfoundation
hasbeenknockedasunder, as hasthenotionthatprivateownership is a sufficiently
stronginterest to lookafterthelong-term welfareoflargefinancial firms. Indeed,
theverydefinition of theterm"competitive financialmarket"is unclear,afterit
was systematically weakenedin defenseofmegafirms' rightto takelargershares
in evermoremarkets.
Challengingtheimplicitly efficient-market view of mostsettledresearchon
financialregulation andstructure risksa plungeintoan intellectual abyss:forwhat
can replacetheefficient-markets view?At thisstageof events,thereis no new
imagined idealsystem thatcan serve as an alternate system-design reference point.

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THEGLOBAL
CRISIS OFPOWER
&THEGOVERNANCE INFINANCE 593

Theideainsteadis toconfront thereal-world

systemoffinance
as itis,tounderstand
itsreal-world impactson diversefirms andtoexaminehowtoturn
andindividuals,
itto sociallyefficient
andeconomically productive
purposes.

5 Core Elements of Finance for Re-establishingCoherent

Governance

Fouranalytical elementsthataremissinginefficient-market-based thinkingabout

financialgovernanceare readilyidentified.7 The firstis systemcomplexity and
structuralinteraction.A seconddimension, invariably overlooked in analyses that
focuson mechanism designandbreakdown, is power.It's clearthatsomeplayers
in thismatrixof financialinteractions have theabilityto forceactionby others,
or to extractrentsfromothers,or to relyon theinability of systemlogicsto find
alternativeoutcomes.In thiscase, powerhas payoffs. Again,poweroperatesin
differentwaysandatdifferent levelsofthefinancial system. Thewayinwhichthe
exerciseofpowerhascreatedsystemic dysfunctionalities, distortedincentives,and
affected crisis-resolutionpathways deserves careful study.
The verycomplexityof interactions - the structuraldisplacementof the
borrower-lender-depositor relationship fromthecenterof thefinancialcircuitto
itsperiphery - meansthatinformation and itscontrolor absencebecomesa key
featureof thecrisisscenario.Information problemshereinvolvemorethanthe
problemof asymmetric information withinpair-wisetransactions in thecredit
market: theinability ofonepartyinthistransaction toknowthetrue"state"ofthe
otherparty'scondition.Instead,information problemsinvolveopacity,secrecy
andprivatearrangements, privilegedtechnicalinformation (thatoftenrunsahead
of regulators' oversight capability),and so on. Indeed,theverylack of opacity
in theemerging setof securitized financialrelationswas interpreted by someas
equivalent tothecreation of newtype banking(see Dymski2010). Butopacity
a of
defeatsoversight. In thecurrent effortsatfinancial reform, thedebateoverwhether
derivatives shouldbe exchange-traded involves,inpart,theissueofwhether a set
ofregulators oroverseers (the"exchange") willhave real-timeinformation on open
derivatives positionsandevolvingtermsandconditions inmarkets.
Afinalcoreelement ofthesystem as itis,then,consistsofthebeliefs,confidence,
andcredibility- thatis,whatAkerlof andShiller(2009) termthe"animalspirits" -
of theagentsinteracting in financialmarkets.These authorsarguethatmarket
outcomes aresystematically bythefactthattheagentsinteracting
affected inmarkets
oftenmisinterpret information, havedistorted perceptions, orevenreactemotionally
rather thanrationally.So theseelements matter, as gapscanreadilyemergebetween
whatsystemarchitects and playersintendothersto understand and do, and how
thoseothersactuallysee thingsand react.These problemscan be interpreted as

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594 A.DYMSKI
GARY

arisingin one of twoways: theycould be rootedin perceptualerrorslinkedto

psychologicalprocesses(as Tverskyand Kahneman1981 see it); or theycould
representreactions to fundamentaluncertainty aboutthetruestateoftheworld(as
Minsky1986 sees it).
Onlyan analytical approachthattakesintoaccount,then,system complexity and
structuralinteraction, power,problems of information, and the problems created
by agents'reactionsto uncertainty, can comprehend how thefinancialsystemis
structured,andhowithas brokendownandmalfunctioned.
We leave as an openquestionwhether a subsetofthesefourelements, or only
all fourtogether, can sufficefora coherentpost-efficient-markets understanding.
Two recentvolumeshave largelyfocusedon thefourth element - thefragility of
agents'beliefs and confidence.Akerlofand Shiller (2009) make thisthe centerpiece
oftheirdefenseoftheroleofgovernment intheeconomy:theyarguethatcentral
banks'powerresidesintheirability tostabilize"animalspirits" infinancialmarkets,
thusoccasionally - andcrucially- stabilizingmarket forcesthatwouldotherwise
sometimes cascadeoutofcontrol. Theyarguethatthecurrent crisisrequiresstronger
-
interventiondirectcreditinjections, as perTARP.Reinhart andRogoff(2009) are
morecircumspect; theystraddlethechoicepositedinsection4. Theyarguethatthe
present crisisis continuouswithpreviouscrises.However,theyomitanyreference
toefficientfinancial-markettheory,andaffirm- without elaboration- the"concept
offinancial fragilityineconomieswithmassiveindebtedness" (292). Theylargely
concurwithAkerlofand Shillerthatbreakdowns in beliefsand confidence are at
therootofthecrisis.Buttheydo notmention, as Akerlofand Shillerdo,8thatthis
alreadyplacesthemat somedistancefromequilibrium theorizing.

6 The Nature of Power in Finance

We elaboratein theremainder of thisarticleon thesecondof thefourelements

identifiedabove,one mostoverlookedin discussionsof financialregulation: the
of
problem power infinance.
As seen is
above,power invisibly in
present analyses
ofbankingconcentration, itspossibleimpactfrequently discounted. Buthowdoes
powerenterintosystemsoffinance?Is itlimitedtomarket concentration, ordoes
ittakeotherforms?
The literature reviewedin section3 presumesthattheanswerto thesecond
questionis "yes"; and becausefinancialmarketsare assumedto be contestable,
poweris notimportant infinancialdynamics. Herewe attempt to differentiate
the
loci and formsof powerthatarisein finance,and developa widerview of how
powercan affect processesandoutcomes.9
financial
One locus of poweroccursin some relationswithina time-using economic
process,suchas a borrower-creditor
contract.
Another locusofpower is transactional,

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THEGLOBAL
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&THEGOVERNANCE INFINANCE
OFPOWER 595

involving onlythemoment ofexchange. A third locusofpoweris structural. Itarises

whentheoutcomesofagents'interactions, whether transactional ortime-using, are
forcedorpredetermined by a setof determining parameters.
Thereare,in turn,severalformsof power.Hirschman(1970) suggestedone:
exit-power. This ariseswhenone agentin a relationship (a creditcontract, for
example) can leave it without damaging one's net revenue streams, but the other
agentin therelationship will indeedsuffer an expectedloss fromsucha break.A
secondformofpowerariseswhenoneagentina transaction hasprivate knowledge
relevanttothetermsandconditions ofthattransaction, buttheotheragentdoesnot.
A thirdformofpowerariseswhenone agentin a relationship is more- or more
-
powerfullynetworked or interconnected withexternal partners or activitiesthat
are economically valuable.In thisevent,theless powerful agentcannotdissolve
his/herrelationship withthemorenetworked agentwithout suffering fromreduced
access,directly orindirectly, toothervaluedcontacts.Finally,thereis asymmetric
resilience,whichariseswhenone agentin a relationship has a greaterabilityto
sufferlossesorto renewresources. Thisagentcan then"outlast"theotherin any
warofattrition.
Thelociandforms ofpowerinteract. In a time-using locus,positional powercan
arise,as one agentcan bargainharder(extractmorerent)thantheother, knowing
thelatterhas no exitoption.In a purelytransactional frame,arbitrage powercan
arise,due to thefactthatone agentis interconnected witha network thathas the
to
capacity exploit a price differential,while another, less-networked agentlacks
thatcapacity. Further, theforms of power can often offsetone another. For example,
ina subprime loancontract, theborrower mayhaveinformational powervis--vis
herowncreditworthiness; butthelendermayhaveexit-power inthattheborrower
is sociallyisolatedandcan identify no otherlenderoptions.
Inreceivedversions offinancial theory,poweris seldomifeverdiscusseddirectly.
The powerproblematic thatis discussedinvolvestheborrower-lender relation.
it is
Typically, hypothesized that both lender and borrower may have exit options,
buttheborrowerimplicitly has positionalpowerbecause of an informational
advantage.This advantagemayarise due eitherto borrowerintentions (moral
hazard)orcapacity(adverseselection).Moralhazardmayalso arisewhena bank
is willingto takemorerisksthanitsdepositorswouldbe comfortable with,but
deposit insurance has made those depositors risk-indifferent.Much, if notmost,
discussionsofregulatory reform - say,bytheShadowCommittee - centeron the
needto structure regulations so thatowners'interests in maximizing thevalueof
theirbanking firm (its assetprice)- and not governmental decrees orimperatives -
can guidefinancialinstitution creditand resourceallocation.These
to efficient
discussionshaveled to policychange.Activityderegulationforbanksandthrifts
inthe1980sand 1990s,forexample,shouldhaveprovidedfinancial owners
firms'

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596 A.DYMSKI
GARY

withthemeansto disciplinetheirbankingfirms'activitiesby subjecting themto

competition (thehighest-return activities
growmost).
Butderegulation didnotleadtothisoutcome.Onereasonis thatlargebanks'links
totheborrower-lender relationshipunderwent a complete transformation. Oncethis
happened, effortstoreducetheadverseimpactofmoralhazardwithin theborrower-
lenderrelation per se were and
superseded displaced toother loci that wereoutside
ofbankregulators' In
purview. particular, the riseof the "originate-and-distribute"
lendingmodelrepositioned themegabanksthatbundledand sold collateralized-
debtobligations vis--vistheborrower-lender relation.Thesemegabanks wereno
longer in the of
position "lender";instead,they were in the of
position facilitating
theactivityof loan networksin whichtheywerenotpositionedas theultimate
lenderto borrowers approvedforcredit.
Two formsof network-based powerarose in thisnew lendingmodel. One
involvedpositionalpowerwithinthenetworks thatrecruited and thenultimately
funded(ordenied)borrowers. Thispositionalpoweroccurred attwochokepoints.
One involvedthelinkbetweentheloan brokers, finance-company workers, and
loanofficers whoproposedloanpackagestoprospective borrowers. Insofar as these
borrowers weresavvyandwell-capitalized, theycouldobtainfairloanoffers. But
borrowers wholackedcapital,and/or werefrompopulations orareasthathadbeen
historicallydeniedaccesstofair-market credit,couldbe offered exploitative terms
andconditions. A secondchokepointarosebecausemegabankscontrolled access
tosecondary markets forthelendersandloanbrokers thatoffered themloans.This
was underlined bymegabanks'informational advantagesaboutunderwriters' and
loandistributors' risk-tolerancelevels.
In turn,megabanks'powerwithinthe lendingnetworkalso facilitatedtwo
typesof transactions-based arbitrage power.First,theycould sharein therents
thatlendersextractedfromborrowersby charginghigh fees forproviding
securitization,underwriting, and/orservicingfortheseloans.Second,theycould
exploitinterest-rate differences locales at thesamepointin time,so
in different
as to earnarbitrage-based income.In effect,thecreationof structured investment
vehiclesfacilitated theexerciseofnetwork powerinvolving access to investorsand
insurers, access to liquidity,and tradingcapacity.In effect, thisarbitrage power
resultedfrommegabanks'positionalpowerwithinthelendingnetwork. Notethat
thisis also a wayofcharacterizing thecarrytrade.
Of course,GoldmanSachsandotherinvestment bankscameup witharbitrage-
and positional-power strategiesforrevenue-making thatwerefarmorecomplex
thanthisbaselinescenario.Sufficeitto say thattheimpactof the"originate and
distribute"modelwas,amongotherthings, tocreatenewpotential sourcesofpower
formegabankswithaccess to thedistribution and othernetworks required.This
power could generate substantialrevenueswhen asymmetries of information or

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THEGLOBAL
CRISIS
&THEGOVERNANCE INFINANCE
OFPOWER 597

werethereto be exploited.Andit shouldnotbe forgotten

exit-options thatat the
heartof thesubprimelendingboomwas thesystematic financialexploitationof
individuals
socially-excluded andcommunities Reinvestment
(California Coalition
2010; Dymski2010).

7 The Governance of Power in Finance afterthe Subprime Crisis:

Some Considerations

(2010) defines
Stiglitz thefactors thatgovernregulation inanysetofmarkets: market
failure,market irrationality, and distributivejustice. The positionof the Shadow
Committee vis--visreform offinancial regulation is thattheseconsiderations are
largelyirrelevant inresolving thecrisisofhousingfinance andbanking. TheShadow
Committee participated in the2010 Congressional debates on thepossiblereform
of financialregulation; itweighedin againsttheimposition of furtherregulatory
constraints or feeson financialinstitutions, especiallymegabanks.10 Individual
membersof theShadowCommittee have gonefurther and arguedthatexcessive
governmental regulations and intrusionsinto financial markets weretherootcause
ofthesubprime crisis(Dymski2010).
Thisviewis rejectedhere,basedon an evaluationoftherelevanceofeachofthe
criteriacitedby Stiglitz.The absenceofadequatecontrolsovernon-bank lending
and overthesecuritization of credit,forexample,clearlypermitted a virus-like
transmission of marketirrationality, resulting bothin thehousingbubbleand in
thehugestockof zero-down-payment and negative-cash-flow mortgageloans.
In addition,distributive justice would have been furthered had theCommunity
Reinvestment Actbeenusedto stemtheflowofexploitative subprime loans.11
But thecriterion thatdeservesspecial attention in thewake of thesubprime
crisisis thefirstcitedbyStiglitz - market failure.Marketfailurearises,ofcourse,
whenall thebenefits of a good are notcapturedin a private-market transaction,
or whensomeof thecostsof a good's production arenotbornebythepartiesto
thetransaction. ElinorOstrom(1990) wonthe2009 NobelPrizeinEconomicsfor
pointing outthat "tragedy ofthecommons"situations, whereinagentsoverusean
unpriced assetuntilitis depleted, canbe overcomethrough appropriategovernance.
Arguably,one of theproblemsthatgave rise to thesubprimecrisiswas the
failureof thesystemof financialgovernanceto adequatelyregulatetheexercise
of powerin finance,and to preventa "tragedyof thecommons"abuse of a key
public-good resourceinthefinancial sector.Theresourceinquestionis liquidity -
accesstoready, short-term funding ata dependable priceinthefinancial market. The
model
"originate-and-distribute" operates byoffloading debt
securitized from banks'
balancesheets - wherethisdebtis at leastpartially financed bydepositors - tothe
openfinancial market, whereitis financed byshort-term borrowing. As notedabove,

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598 GARY
A.DYMSKI

theasset-backed commercial papermarketwas a dominant sourceof financefor

securitized mortgage debt(untilthatmarket crashedin September 2007).
In principle,ifthesame volumeof loans werefinancedby depositorsin one
financialsystemand by short-term commercial paperin another, theremightbe
littleto choosebetweenthetwo.Buttheaccrualofarbitrage-power bymegabanks
inthenetwork ofmarkets thatsupported the"originate-and-distribute" model- and
inparticular, thelackofrecourseon thepartofborrowers andlenderswhowanted
-
accesstothatmodel ledtoa situation inwhichall theincentives weretoincrease
fee-based incomebygenerating evermorecredit throughthismechanism. A housing
bubblearoseas evermorepeoplewereluredintoacceptingpotentially ruinous
mortgage loansso as to buyhomes. And debt-to-income ratios rose precipitously
throughout theeconomy,as thenetworkservicingthe securitization machine
accommodated theinclusionof evermoretypesof householdand businessdebt.
Accompanying thegrowthof theseout-of-control spot-market transactions, of
course,was anevengreater explosionofoff-balance sheetderivatives activities
(see
Figure 2 above), which further increased the drainon available liquidity.Needless
tosay,hyper-leverage ofthemegabanks - especiallythelargeinvestment banksand
-
hedgefunds necessitated thesefirms'excessiverelianceon availableliquidity.12
In effect,thebravenewsystemoffinancedisplacedandmultiplied moralhazard
problems, whiledecentering credit creation ina waythat this
put multiplying moral
hazardoutsidethereachof established - bank-centered - channels of financial
regulation. Firmsparticipating in "originate-and-distribute" networks engagedin
arbitrage-based activities
that offloaded substantialamounts of risk.Risk-tolerant
megabanksstakedout positionsin thisnew systemby drawingso heavilyon
markets with"commons"characteristics as to abusetheirlimits.Andall thiswas
underwritten by insurers- notably AIG - thatmade insurance"bets"based on
theassumption thattherewas a stabledistribution of riskin theseevolvingand
ever-more In
stressedmarkets. effect, the"originate-and-distribute" modelgave
risetoa cascadeofinterlinked, hierarchically-distributed principal-agent problems
whichlargelyescapedregulatory notice,muchlesscontrol. Excessiveleverageand
greedbythemegabanks attheheartofthenewcreditnetwork eventually erodedthe
resilience oftheliquidmarkets onwhichtheydepended, evenwhilestripping away
thetoleranceforriskand willingness to "go long"and "believein theborrower"
thatmakecreditmarkets work.
Thesedynamics pushedpeopleon bothsidesoftheborrower-lender relation,in
waysquitedifferent thananticipated inthesimpletheory offinancial intermediation
thatmostpolicyanalystsandempiricalworkin thisareaclingsto.The endresult
is a deteriorationofthewillingness and abilityofthefinancialsystemto provide
anyrealfunctionality totherealeconomy, evenwhileitsactivities anditsrevenues
consumeevermoreofnationalincome.

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THEGLOBAL
CRISIS
&THEGOVERNANCE
OFPOWER
INFINANCE 599

8 RestoringEffectiveRegulation

As was seeninthediscussionin section2, regulators havenotregarded eitherthe

of
governance power in finance or the protection of thepublic-good character of
liquidityas within theirareasofresponsibility. Thelanguageoffinancial regulation
hasbeenformulated veryclosetotheidealizedmodelofefficient financialmarkets,
withouttakingintoconsideration thecharacteristics of thereal-worldmodelof
financethatcame intomaturity in theearly2000s and thencrashedin thelate
2000s.Thismustnowchange.Theterm"concentration" canno longerstandinfor
"power"; and the of
governance power infinance has to become anexplicitobjective
offinancial Ifthe
regulation. megabanks arenot forced byAct ofCongresstoshrink
toa manageablesize,thenthelinksbetweenindividual megabanks' network power
and theactualnetworks thatlie at theheartof financialmarkets willbe too tight
to unwind.In thisevent,"too big to fail"is a reality.The ShadowCommittee's
unconvincing distinctionbetweenconcentration andcompetition inbanking markets
servesonlytoillustrate howlittlestomachitsmembers haveforpoliciesthatwould
indeedinsurethatno banksaretoobigto fail.
The onlythingthatwillinsurea sociallyefficient andeconomically productive
financialsystemis dedicatedregulation thattakespowerasymmetries, "commons"
dimensions offinancial markets, and socialjusticecriteria intofullconsideration.
This is a hugechallenge,especiallybecause theUS's privilegedpositionin the
neoliberalorder - itssteadysurpluson capitalaccountcombinedwiththedollar's
privilegedstatusas a reservecurrency - dissuadedregulators frominsisting too
muchon prudential behaviorby thebankstheywerechargedwithoverseeing.13
Theneoliberal erahasgivenrisetomanystructural imbalances, whichinturnhave
been exploitedby firmswitharbitrage power.Giventhatstructural imbalances
cannotbe wishedaway,thearbitrage that
activity feeds on these imbalances must
be reduced.14 A further possiblecomplication is that regulatory actions aimed at
reiningin financialinstitutions' risk-taking will in manycases have implications
fortheoverallpace ofmacroeconomic insofaras theseactionsmayslow
activity,
orquickenthepace ofloan-making.
But it is one thingto havea dysfunctional financialsystem,and quiteanother
tohavea substitute systemreadyto do better whatwas notdonewellbefore.This
does notmeanlayingdownarmsbeforetheexecutiveofficers ofmegabanks who
see itas theirrightto operateas "principals" on theirownbehalfwhileaccepting
publicsubsidiesandguarantees reservedfor"intermediaries" operating on behalf
oftheirdepositors. Itwill,however, a
require reframing of theterms and conditions
of financialregulation. It is hightimeto displacetheefficient-markets ideal as a
guideto whatitis aboutthefinancial systemthatmustbe controlled or overseen;
itis timetorecognizethedeepimplications ofunchecked powerinfinance. Andit

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600 A.DYMSKI
GARY

is morethantimetorestorethetermsandconditionsofpublicgovernance so as to
renewtheeconomicfunctionalityandsocialefficiencyofthesystemoffinance.
An
debate
energetic about how togovernfinancehasbeen and
initiated, must continue.
Thiscannotbe a politeconversation:
itmustbe real.

Notes

1. Thisarticle appeared asChapter 4 ("TheGlobal Crisis

andtheGovernance ofPower inFinance")
inthevolume TheFinancial Crisis,edited byPhilipArestis,
Rogrio SobreiraandJos LuisOreiro
(Palgrave Macmillan, 2011). Itwaspresented attheconference "Central
Banking aftertheCrisis/La
Banque Centrale aprslaCrise," Toronto, May21-22, 2010.Theauthor thanks Frederico Gonzalo
Jayme Junior, Louis-Philippe Rochon, Philip andRogrio
Arestis, Sobreiraforcomments onan
earlier
version ofthisarticle.
2. Theterm "financial governance" often referstoshareholders' guidance offinancial firms.Here
thisterm refers tothepublic governance offinancial
institutionsandmarkets.
3. Fox(2009)describes howtheefficient-markets came
hypothesis todominate research onfinancial
markets.
4. Recourse risk ariseswhen a lender sellsa loan(orotherasset)ithasmadeorbought toa third
partytowhom a minimum rate ofreturn hasbeenpromised. Iftheassetunderperforms, thethird
partyholding ithasrecourse tothelender tobemade whole onitscontract. SeeWall(1991).
5. Similarly,analyses oftheLatin American debt crisis
attributed non-payment toinadequate debtor
"effort,"thatis,tomoral hazard factors- notto"type." See,forexample, Eaton, Gersovitz,and
(1986).
Stiglitz
6. Inthe1980s, thelatter viewwonoutover theformerintheFederal Reserve andother regulatory
agencies (Dymski 1999).
7. These four themes havemany intellectual inclassical
forebears political
economy, NewandPost
Keynesian economics, andneo-Marxian andpost-Walrasianapproaches;space constraintspreclude
a discussion ofthese lineages here.
8. Seefootnote 6 tothe"Introduction" toReinhart andRogoff (2009).
9. Thisanalysis isindebted tothepioneering work ofGreider (2010)andEpstein ( 1992)ontherole
ofpower infinance.
10. Oneexample among many isShadow Financial RegulatoryCommittee (2010).
11. Dymski (2010)summarizes studies thatcounter thenotionthat theCommunity Reinvestment Act
wasamong thecauses ofthesubprime crisis.
12. Torecognize limitstoliquidity is notanassertion thatliquidity hasanabsolute bound. Like
Minsky (1986), wecanconsider liquidity asvariable,
subject tothebeliefs andfears throughout
thefinancial system.
13. Thisargument ismade inDymski (2009).
14. Consider thecarry trade.Thevery presence ofanuneven global mapofeconomic - some
crisis
countrieswhose lowinterestratesreflecta desperation
for
stimulus, andother countries
whose crises
haveforced them torestrict
credit andraise - encourages
rates theparasitic
growth ofarbitrageurs
whofeed onboth sidesofthis macroeconomic misery.

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