The present financial crisis has emerged from aggressive financial innovation combined with regulation that did not address pro-cyclical lending within core OECD economies. The result was heightened uncertainty about the value of assets, from suburban houses to banking houses, that led financial markets to freeze while governments hurriedly encouraged them to keep going with cash injections.
Now that the ‘Great Moderation’ of asset-boom growth is over, proposals for international financial cooperation have emerged in a manner different from the financial crises of the 1990s. Those financial crises were primarily located in Emerging Market Economies, and post-crisis reform placed emphasis on bringing those economies up to the standards of regulation demanded by international regimes, as well as improving surveillance and information exchange via various international institutions.
During this period talk of ‘international financial architecture’ dominated while financial innovations, such as off-balance sheet securitisation and new derivative products, flourished in key OECD economies beyond the line of sight of prudential supervision. The rise of non-bank financial institutions also assisted pro-cyclical lending and empowered a range of actors that were not required to meet the same reserve requirements as banks. At the same time, the amount of investment into OECD debt and securitised assets from states poorly represented in international fora, most notably China, increased.
Given this environment, talk of ‘international financial architecture’ appears out of touch with market realities, blind to differences in how the real economy and international finance are linked, on-representative of new financial powers, and removed from development concerns. To address the current crisis, international financial reform must address all of these aspects. Without doing so, attempts at international financial cooperation will most likely be piecemeal, ignored, and impeded by domestic politics.
The key problem here is not the absence of institutions or fora to discuss financial reform, but a lack of analysis and information on the key obstacles to cooperation, and how best to forge a new international consensus that is inclusive for OECD and Emerging Market Economies alike.