Never again financial deregulation… Ten years after the Pittsburgh summit

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A rude awakening to the hazards of financial deregulation

In October 2008, the western world woke up to the realisation that much of its perceived wealth lived in financial bubbles that could suddenly collapse and have real repercussions in our economies, societies, and the everyday life of citizens.

In the following months and years, accompanied by a simultaneous wave of citizens’ manifestations and upheaval, a great public debate started about the desirability of having deregulated financial markets playing such an important role not only in how companies can handle their profits and risks, but also in the budgetary choices that governments make.

Regulation is on the agenda, but market activity is a moving target

Politicians put financial market regulation on their agendas, and at the Pittsburgh Summit in June 2009, the G20 leaders issued a statement wherein they committed to take concrete steps to curb the freedom of global financial firms.

Over the last decade, on both the sides of the Atlantic, important financial reforms have been pushed through in thousands of pages of legislation. This large amount of text is largely due to the infinite amount of technical details that characterise financial markets. The more technology grows, the more financial instruments become complex, with ever more detailed terminology and infinitely higher orders of specification. For example, innovative activities or instruments such as high-frequency-trading, OTC-derivatives, or credit-default-swaps each require specific regulatory arrangements, increasing thereby the complexity of the overall regulatory effort.

Mitigating the real risks of virtual money

A common feature shared across these instruments is that they somehow allow money to be made (or lost) out of money, i.e. through changes in exchange rates, future expected revenues, and so on. Trading in money, in turn, exponentially increases the amount of virtual money circulating around the world, possibly creating bubbles that can suddenly explode. Much of the various regulation introduced over the last decade (e.g. EMIR, MiFID II , Dodd-Frank Act) was aimed specifically at reducing the likelihood of this risk.

For instance, thanks to the new regulatory frameworks, public authorities in Europe and the United States have access to a huge amount of data, covering at least 75% of the daily transactions happening in financial markets. In addition, financial firms now have a much greater obligation to settle their transactions immediately and to ensure the provision of liquidity to markets. As a result, global financial firms today are considerably less free than they were before 2008.

The elephant in the room: do we want this?

Despite citizen activism, despite broad public debate, and despite the massive regulatory efforts seen in the last ten years, the political question regarding financial markets is not part of the current discussion.

The question is whether it is socially, economically and politically desirable to have virtual wealth created out of the trading of money, which is in itself already a virtual construction. No matter how ‘virtual’ the wealth created by financial markets is, it travels back to the real economy through acquisition of tangible wealth, through investments, or through the explosion of bubbles. The virtual creation of wealth thus has severe consequences for the redistribution of tangible wealth in the world. Therefore, it inevitably bears political questions.

In the years of public upheaval following the global financial crisis, these questions were part of the public debate. What happened?

Knowledge is power, and money wins

Although still fundamentally political questions, the level of technical complexity found in financial regulation nowadays is so high that the formulation of answers has been left to those able to understand the language of these markets. And, in the language of these markets, the answer to the question of where financial resources should be allocated generally is ‘investments-with-secure-returns’.

In real life, this answer generally translates into real estate projects. And the more financial markets steer financial resources towards these investments-with-secure-returns, the less these resources are steered towards adventurous enterprises like cleaning the oceans or exploring the potential of alternative energy sources.

Still bubbling under the surface… but for how long?

In short, financial markets are arguably as political as the budgets of national governments. For the time being, however, they are safely sheltered in the technocratic realm of public policy, while the public keeps its focus on a few percentage points of more or less tax, or one or two years of extra pension contributions.

In principle, the separation between politics and the allocation of capital is intrinsic to the coexistence between democracy and capitalism: in order for capitalism to work, investors must be able to allocate their capital as they best see fit, without excessive control or intervention from political authorities. However, when collective action problems become bigger (e.g. climate change) and governments’ redistributive capacity becomes smaller (e.g. austerity), the borderline between investors’ freedom and political responsibility needs inevitably to be rethought.

When linking the question of financial regulation to the collective action problems of our time, thus, the regulatory efforts of the last decade are not to be seen as a point of arrival, but rather as a point of departure.

 

Dr. Johannes Karremans is a political scientist and research associate at the Robert Schuman Centre for Advanced Studies. He also leads a comparative study on Budgetary Discourse in the Eurozone at the University of Salzburg.