banking. After an initial period of capital scarcity and accompanying economic stagnation, thishad the effect of supercharging the development of the securities markets, as specializedinvestment banks had strong incentives to foster financial innovation in securities. Interest-ratecontrols enacted in 1966 accelerated this process and caused the banks to lose business tomoney-market mutual funds and other direct investments. The competitive pressure caused largecommercial banks to take greater and greater r isks to maintain profits and to circumvent Glass-Steagall restrictions, culminating in the passage of the Gramm-Leach-Bliley Act of 1999(GLBA), which repealed the provisions of Glass-Steagall preventing commercial banks from participating in investment banking. Ultimately, however, banks are becoming increasinglyobsolete, and the damage caused to the financial system by their behavior is only made worse by protective subsidies and preferential regulation by the government and the Federal Reserve.
This paper takes inspiration from Hall and Soskice’s (2001) theory of
. The authors argue that specific types of economic institutions will becomemutually reinforcing and lead to very different patterns of behavior.
Liberal market economies
will tend to encourage interaction between firms based on supply and demand, and arm’s-lengthtransactions.
Coordinated market economies
, on the other hand, encourage interaction based onstrategic bargaining and large-scale coordination between actors. While these are ideal types and both styles of behavior can be found in any economy, the tone will be predominantly set by oneof these logics. “In any national economy, firms will gravitate toward the mode of coordinationfor which there is institutional support” (Hall/Soskice 2001:9; cf. Baliga/Polak 2004, Monnet/Quintin 2007). In particular, access to capital in a liberal market economy is granted most oftenthrough the capital markets; in coordinated market economies, capital is accessed via long-termrelationships with powerful banks (Hall/Soskice 2001:28). The United States is considered the
ne plus ultra
of liberal economies, while Germany is a good example of a coordinated economy.A given pattern of institutions constrains future development of the system, by making somechanges more attractive than others in the short-term—even when other changes might have better effects in the long-term (North 1990:7). Institutions will also guide the behavior of actorsoperating within them, by encouraging particular kinds of behavior, skills, and learning over other kinds (North 1990:74). Consequently, the constellation of actors and institutions willconstrain each other’s development over time, causing the system as a whole to move accordingto an inherent logic guided by past history (North 1990:99). This is often called
. Path-dependency effects are immensely powerful in the financial industry, in particular when considering the interaction between two components: the banking sector and thesecurities markets.Firms trying to raise capital from investors
need two related things:
.Investors must be able to tell whether a given firm is a good investment; additionally, they must
Firms have two means of raising capital:
. Borrowing money, either in a straight loan from a bank or by issuing bonds, imposes a fixed payment obligation on the firm. Issuing equity, i.e. stock, carries no fixedobligations, but rather a proportional claim on the profits of the firm. Equity is thus riskier but potentially morelucrative for investors.