Where does better or worse regulation come from? At a time when financial crises are growing more frequent and more spectacular around the world, this question has only become more important. The quality and efficacy of economic regulation is also something that varies across time and place. Understanding the source of this variation holds important lessons for effective regulatory design for those who are willing to pay attention.
In my recent book, Visions of Financial Order, I offer new insight into the origins of regulatory success and failure by explaining the divergent development of banking regulation in three countries that were supposed to be following the same international regulatory rules—the U.S., Canada, and Spain—in the decades leading up to the 2008 global financial crisis. I show that in each country, banking regulators made different choices in key areas that directly impacted how banks experienced the crisis.
Regulators (and their beliefs) matter
Going straight to the punchline: the divergent regulatory choices of this period were shaped by the different ways banking regulators viewed the causes of prosperity and stability in the economy—what I term principles of order.
Often, we treat financial regulation as something rational—as something that emerges from economic imperatives that demand a certain kind of response. Some scholars have challenged this view by highlighting the political roots of regulation, arguing that it is shaped by the power of regulated institutions to “capture” their regulators and secure industry-friendly policies. It has been much less common, however, to think about financial regulation as something cultural—as something that emerges from different shared beliefs among regulators themselves. If we continue to neglect these cultural influences, I argue that we will miss a very important contributor to regulatory outcomes.
My book shows how in the decades leading up to the 2008 global financial crisis, banking regulators in the U.S., Canada, and Spain were motivated by different regulatory goals. These goals reflected fundamentally different understandings about economic order. In the U.S, regulators were obsessed with enhancing market discipline in banking, while Canadian regulators tried to strike the right balance between prudential and competitive considerations and Spanish regulators focused on enhancing expert oversight and direction to banks. Tracing the finer details of regulatory policymaking across two key domains (regulation of asset securitization and bank loan loss provisioning), I show how these regulatory goals gave rise to different policy choices, producing cross-national regulatory patterns that are otherwise hard to explain.
Where do these beliefs come from?
A natural next question is where did these influential principles of order come from?
For answers, I look to the political and regulatory institutions of each country. Institutions not only shape policymaking by influencing how power is distributed within a society—they also come with meanings attached. They can shape policymaking by influencing what appears “doable, sayable, or thinkable” to actors within countries.
In the case of banking regulation, the distinctive principles of order that shaped U.S., Canadian, and Spanish regulatory policymaking have deep roots in longstanding national political and economic institutions. For example, the U.S. principle of competition was reflected in the design of the earliest American political institutions. In a similar way, the earliest Canadian and Spanish institutions embodied the principle of protecting public rights and state sovereignty, respectively.
However, my institutional argument also features an important twist. Institutional accounts typically emphasize how stable institutions facilitate the creation of new regulatory policies that look a lot like old ones. Yet when we consider the recent history of financial regulation, the defining pattern was not remarkable stability in national regulatory approaches. It was remarkable change.
The changes in regulation that occurred in the U.S., Canada, and Spain in the four decades preceding the crisis offer a case in point. The U.S. entered the 1960s with one of the world’s strictest bank regulatory systems. Over the following decades, U.S. policymakers were also unusually slow to begin dismantling these restrictions. During this period, Canada was among the world leaders in laissez-faire regulation: it not only entered the 1960s with an exceptionally hands-off regulatory system; it was also comparatively quick to deregulate the few restrictions it still had. Spanish banking regulation fell between these regimes.
But by the 1990s and 2000s, things looked very different. In a stark departure from prior regulatory trends, the U.S. developed one of the world’s most permissive regulatory regimes, encouraging banks to enter new, risky markets while making little attempt to ensure they held adequate reserves. In the same period, Canada embraced a more conservative regulatory regime, while Spain adopted a uniquely strict and interventionist regulatory system.
These shifting cross-national regulatory patterns challenge a simple institutional account. How could financial regulatory systems change so dramatically within countries over time, but remain so persistently different across countries at each historical period? Explaining the divergent development of banking regulation requires engaging with both pieces of this puzzle, and the key to solving it lies in a new way of thinking about institutions and their role in shaping policy.
Crisis and Conflict Among Principles of Order
Visions of Financial Order emphasizes that institutions are comprised of multiple principles of order—and that these principles can (and often do) come into conflict with one another. I show how these conflicts shaped the evolution of national regulatory systems by structuring the terms of debate over financial regulation across many historical periods.
Consider the U.S. case. U.S. political institutions don’t just affirm the merits of using competitive forces to organize economic and political life. They also affirm the need to respect the sovereignty of the local community in political and economic affairs. The conflict between these principles repeatedly defined the course of political debates over financial regulation. This conflict featured in the earliest debates between Alexander Hamilton and Thomas Jefferson in the early 1800s; in the clash between Carter Glass and Henry Steagall in the 1930s, and in struggles over financial deregulation in the 1970s. In the late 1980s, the same conflict reappeared to shape the reform debates that followed the Savings and Loan crisis, a conflict that ultimately produced the regulatory regime of the 1990s and 2000s. In Canada and Spain, debates over financial regulation also featured a narrow range of principles of order—but these were not the same principles that dominated in the U.S.
Of course, debates have winners and losers, and how these conflicts were settled carried implications for what happened next. The political dynamics and economic conditions of the historical moment also influenced how specific regulatory conflicts were resolved within countries, and this, too, is crucial for understanding how national financial regulatory systems evolved over time.
But this is the part of the story that has already been told. The part that was missing involves the institutionalized principles of order operating in the background. Looking across more than two centuries of financial regulatory policymaking in comparative perspective, it is striking how often a narrow range of principles of order shaped the arenas in which key national reform battles took place. The story of the regulatory failures that gave rise to the global financial crisis can’t be told without them.
Image: Rafael Saldana via Flickr (CC by 2.0)