Abstract
As the title of the book indicates, this volume seeks to identify sources of the 2008 financial meltdown in order to offer policy recommendations. From the perspective of 2019, the crisis not only inflicted economic damage, it also fuelled a populist backlash across much of the industrialized world. Yet such a significant event remains relatively understudied. Did the contributors coalesce around a set of specific findings? Did they deliver clear, applicable policy proposals to protect us from a recurrence?
The editors brought together a balanced mix of perspectives, covering a wide range of topics. Chapter 2, by Laurent Dobuzinskis, addresses the complexity of finance and regulatory schemes to underscore how the gap between practice and our understanding of it leads to regulatory failures. Chapter 3, by Theodore Cohn, effectively describes how private actors have captured regulatory agencies at both the national and international levels. Chapter 4, by Norbert Gaillard and Richard Michalek, explores the role moral hazard played in the crisis. Chapter 5, written by James Busumtwi-Sam, presents the view from Sub-Saharan Africa, a region where financial systems remain underdeveloped. Chapter 6, by Anil Hira, Brian Murata, and Shea Monson, describes how criminals have exploited lax regulatory schemes. In Chapter 7, the editors try to pull these various threads together.
Each chapter has its strengths, but also its weaknesses. Dobuzinskis demonstrates his expertise, focusing on the development of different schools of thought on regulation. I would have appreciated more attention here to the tolerance shown to shadow banking, as well as the increased reliance on market-based methods that individual actors were encouraged to use to reduce risk. Lenders securitized and then sold loans as a way to reduce their exposure to one class of risk; investors purchased various forms of insurance in case problems arose. Rather than limit individual actors’ risks, these practices turned the collapse of the American housing market into a crisis gripping the national (and then international) financial system.
Cohn’s chapter presents several interesting ways to think about regulatory capture, and then tests those ideas against evidence. The material indicates an overdetermined outcome; while the author hints that Republicans and Democrats disagree on important aspects of financial regulation in the United States, that may reflect hope rather than fact. Consideration of financialization might have presented an interesting complementary argument. As more American firms drew income from financial activities, opposition to lobbying by big financial actors surely slackened.
Gaillard and Michalek tackle an extremely important aspect of the events in 2008: the way the United States authorities managed moral hazard. Much has been written about the regulators’ dilemma as a theoretical problem. Practice presents other challenges, and the authors centre on two. Financial innovation usually evades regulation, and, in many systems, private actors become “too big to fail.” Gaillard and Michalek also point out how the credit rating agencies failed to do their job in the early 2000s. They, therefore, generate some of the most useful policy recommendations, suggesting that governments reintroduce vertical and/or horizontal restrictions on financial actors’ activities. This chapter would have benefited from a deeper discussion of regulation itself—it is easy to assume regulation inherently means prohibition. Yet some regulatory efforts concentrate on monitoring. The unfolding of events in 2007–2008 illustrated the difficulties American monetary authorities had in managing moral hazard. They could not evaluate the risk-taking of individual firms, nor could they accurately comprehend the links between individual firms and the broader system. In letting the Lehman Brothers fail, they misjudged the consequences. Regulatory schemes that merely provide information would be helpful.
Busumtwi-Sam’s chapter is especially interesting because it highlights the benefits that effective financial systems deliver at both the domestic and international levels. What should we recommend for Sub-Saharan African states, in terms of striking the right regulatory balance? This underscores the need for more comparison of alternative systems in the volume as a whole. This specific chapter could have addressed the role of capital controls or exchange rate regimes as well, since these also shape the impact of remittances on economic development in this region.
In describing how complex financial regulations create loopholes for criminals to exploit, Hira, Murata, and Monson reveal the scale of the problem. The need for greater harmonization and cooperation should be obvious to policymakers. As with some of the other authors, this chapter could have been strengthened by simply pointing out how much improved regulatory efforts would be if the initial effort was placed on monitoring individuals’ actions.
Although the editors’ introduction argues that the 2008 crisis had deep roots, some of these could have been more clearly drawn out. I have already noted the significance of financialization of the American economy, including the rise of shadow banking. When did this start? Why did it start? How did this process draw in so many participants? A second concerns the role of governments themselves not only as borrowers, but also as actors undermining international regulation. Though addressed in the chapter by Hira, Murata, and Monson, sovereign actors have often contributed to financial crises. A third arises from the role of the American housing market bubble. Domestic political actors—at the federal and state levels—encouraged and abetted sub-prime lending for their own purposes. (For anyone interested in models of regulatory capture, variation in mortgage lending practices at the state level presents a great opportunity for research.)
Most importantly, we miss out on certain aspects of the bigger picture here, since many of the individual chapters’ policy recommendations may not fit together. For example, Chapter 2 points to the Canadian banking system as a positive example. Yet in 2008, Canadian banks had promoted and invested in mortgage-backed securities as much as any others. Some of their initial losses were covered by the bailout of the insurance firm, American International Group (i.e., from United States’ government funds). In truth, stability in Canada rests on the banks’ profitability, that, in turn, relies on limited competition—it would be impossible to implement in the United States and this is not a model other countries would likely follow. At the same time, the small number of banks has enabled Canadians to adopt common technologies in a way that may be attractive to those with underdeveloped financial systems (such as African states). Then again, if Canadian banks are well regulated, why do they appear so prominently in the discussion about money laundering and tax evasion?
Financial regulation has always developed in a “cat and mouse” fashion. Authorities seek to limit risk-taking, but when they do, lenders create new financial instruments or methods outside regulation. We may not be able to ever win this war, but we should try to win the next battle. This edited volume provides some useful insights into what needs to be done now. The book ends with a fitting plea: “Political Economy research and advocacy are needed, now more than ever!” (p. 243) As this volume demonstrates, we have achieved too little on both counts in the decade since the financial crisis of 2008.