The Global Financial Crisis: Learning from Regulatory and Governance Studies

CHRISTOPHER ARUP

Regulatory and governance studies help locate power and responsibility in the global 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 spread around the world. In the response to the crisis, responsibility for regulation will remain largely systems-based rather than centrally directed. However, those systems should be located in the culture of the elites, which are socially and spatially 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 democratic control of finance and less dependence on finance capitalism for essential services, social security, and environment protection.
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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 Business and Economics, Monash University, PO Box 197, Caulfield East, Victoria, Australia 3145. Telephone: +61 3 9903 1026; E-mail: christopher.arup@buseco.monash.edu.au. LAW & POLICY, Vol. 32, No. 3, July 2010 © 2010 The Author Journal compilation © 2010 The University of Denver/Colorado Seminary ISSN 0265–8240

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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 the tools 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 for the global financial crisis, including bankers, fund managers, investors, sellers, advisors, householders, consumers, economists, journalists, politicians, and government officials. Regulatory studies has been especially enlightening in showing how private actors regulate along with public agencies, 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 sense of pluralism does not necessarily tell us a lot about the distribution of power among the relevant actors and relationships. When the framework is accommodating 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 so—where 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 progressive in its expectations. Influence is attributed to agency and action—the power of ideas and conversations—so 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 of the 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
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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 regulation really offer such potential (Santos and Rodriguez-Garavito 2005)? Some people 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 commentators 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 the interests 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. Provocatively, Panitch and Konings (2009) describe this as a myth—part 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 a sympathetic 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 recognizes 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 regulation 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.
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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 between markets, hugely increasing volatility and magnifying risk. This led to regulated 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 dramatically. 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, derivatives greatly expanded—notably 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 dramatically 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 agencies also had the capacity to scrutinize the newer instruments. Crucial decisions 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 Commodity 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 conversations. 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 collaboration during the incubation period as well. One such collaboration was the decision 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 financial institutions 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 government’s complaisance 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 innovations (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 regulators. Perhaps one reason was the belief they were not needed—efficient 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. This practice 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 decades—on consolidated accounts, for example—has 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 Pacific Island 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© 2010 The Author Journal compilation © 2010 The University of Denver/Colorado Seminary

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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 maintained an ambivalent relationship with offshore jurisdictions (Kochan 2006); some of the most popular locations include British dependencies, the Channel Islands, and the Caribbean islands—Antigua, 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 the Cayman 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 (Krugman 2009). 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 expansive definition of investment that runs beyond foreign direct investment to take in speculative trade (Schneiderman 2008). Like BITs, such FTAs provide protections once investments have been made—guarantees of fair and equitable treatment and protection from indirect expropriation. Some go further now and grant preestablishment rights too—that is, rights of entry or access to the host country’s 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 response to an earlier debt crisis. Arbitration tribunals are developing jurisprudence governing the extent to which these investor rights and protections can be squared with the state’s 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 investment 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 right—they are both intermediaries 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 countries, 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 takeover 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 committee was 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 crisis—that 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 legitimacy 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 procedures 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 measures. After two years, executives and legislators are still talking. The Bush administration’s first aim was to save the big banks. It bears repeating that hundreds of billions of dollars were involved. Officials negotiated 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 the markets, 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. Nonetheless, 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. For example, 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 conditions. 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 efforts to regulate derivates illustrates. Industry quickly warned that reform should not stifle innovation and undermine the sector’s advantages for the national economy. Core industry groups such as the International Swaps and Derivatives 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 derivatives from those characterized as privately negotiated and customized. Standard derivatives would be traded on public and transparent exchanges; they would be subject to clearance requirements to manage their impact. Private derivatives, on the other hand, would bear only some recording and reporting requirements. Frank Partnoy (2009) has argued that such a distinction would create an enormous loophole—an 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 2009 communiqué, 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. Meanwhile, the Obama administration has taken another tack, focusing on restricting the activities of the deposit taking government guaranteed commercial 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. Tax avoidance was one reason financial funds went off balance and off shore. The Bush administration had put a stop to U.S. cooperation with the OECD’s 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 G20’s 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 Madoff’s 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 UBS’s 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 be effective, regulation must enlist the cooperation of those with power. Experienced 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 local investors, 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 managers 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 maximize returns 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 reinforcing reflexive 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 searching, 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, speedup, 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 attachment 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 vandalism—Jean-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 journalists gravitate towards these interpretations. One of the best, by Financial Times 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 conditions, capitalist elites tend to wield power without taking responsibility for the people and communities they affect.4 In his response to the GFC, President 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 cultural—to 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 pervaded 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 taken onshore 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 New York.5 New York and London are physical proximities, desirable places to live and congregate, where regulation is governed face to face. Even technological 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 restorative justice to the elite firms. Reasserting personal liability might encourage more responsibility, too (Picciotto 2009). It might also be necessary to look beyond the firms—for often this is too late—to the formative cultural influences on the financial elites: to private schools, graduate business programs, professional associations, research centers, arts and philanthropic foundations, style and opinion leaders, and finance media, perhaps even to gentlemen’s clubs, where people congregate and socialize and which they respect as their points of reference. If this sounds old-fashioned, consider a related sector—the Warhol economy in New York. To understand how this operates, 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 financiers’ 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 want support, then to restrict the activities of these banks once again—to “narrow banking.” This has become the thrust of the Obama administration proposals (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 basis—creating subsidiaries, then, rather than branches. There are technical objections to these proposals. How easy is it to distinguish core commercial bank functions from more risky activities such as proprietary trading, running hedge funds, and investment in private equity funds? Wasn’t the problem with lending and borrowing rather than with these activities? Weren’t 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 of the 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.
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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 naïve, to expect cultural change. If, with the best of intentions, cultural change is hard enough to obtain, some doubt the potential for reform altogether. 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 disruption is 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 interpretation 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. It seems 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 corporation 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 relationships between corporation and state, certainly not in regulation to correct for market 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.
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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 being shifted. 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 superannuation 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). Furthermore, when the crisis pervaded the system, it penalized many who were not represented in the foolhardy financial transactions—workers and businesses in the real economy—because 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 challenges. And these partnerships benefit from a supportive legal framework. Thus, work is being done to fashion treaties that civilize trade and investment. Such treaties raise the status of public goods like social security and environment sustainability relative to the freedoms and rights that traders
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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 to a 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 altogether. 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 Association Meeting. We were asked to reflect on the distribution of power between corporation and state in the wake of the GFC: “In the wake of scandals such as Enron’s and the collapsed market of secondary mortgages, the Mini-Plenary will ask about the emergence of self and private regulation, the accountability deficit, the adequacy 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 for recommending products to clients while it and another of its clients were short selling them (betting against them). 3. Of course, these plans do not exhaust the proposals that have been made. Proposals 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 responsibility for the success of the mortgages they have generated, unlike the bank manager Mr. Deeds, who is embedded in his local community. 5. Including Greenwich, Connecticut.

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

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