Document Type

Article

Publication Date

1-2010

Abstract

The pattern of regulatory reform in financial services regulation follows a predictable pattern in democratic states. A hyperactive market generates a bubble, the bubble deflates, and much financial pain ensues for those individuals who bought at the top of the market. The financial mess brings the scrutiny of politicians, who vow "Never again!" A political battle ensues, with representatives of the financial services industry fighting a rearguard action to preserve its prerogatives amidst cries for the bankers' scalps. Regulations, carefully crafted to win the last war, are promulgated. Memories fade of the foolish enthusiasm that fed the last bubble. Slowly, greed once again comes to displace fear as the primary motivating influence in the marketplace. And as night follows day, another market run-up occurs, leading to a correction, and another round of calls for retribution against the greedy moneychangers who brought on the crisis. This is a familiar story, not worth belaboring yet again, despite the opportunity afforded by the financial crisis ensuing from the collapse of the market for subprime mortgages. We had our latest bubble, followed by the market deflation, and the politicians are now responding to the calls for vengeance, and perhaps, reform. Instead of focusing narrowly on the latest iteration of this recurring pattern, in this Article I want to compare the political response to this iteration of financial meltdown with last century's response to the stock market crash of October 1929 and the ensuing Great Depression. Comparing the two era's responses affords an opportunity to explore the influence, if any, that international competition in financial services regulation might have on the political thirst for retribution. International competition in financial services was not much of a factor in the 1930s when Franklin Delano Roosevelt pursued his New Deal agenda; American capital markets were relatively independent of financial markets in the rest of the world. Today, however, international competition has the potential to substantially constrain the regulatory decisions that Barack Obama's administration is currently contemplating. The question: Does international competition limit the quest for political retribution? One hypothesis: competition among jurisdictions to attract financial services providers might limit the understandable urge to make the bankers pay for causing the financial crisis. Politicians may trip over each other as they rush to punish the money changers who caused the crisis, but do they want to kill the goose that lays the golden eggs? Exacting a pound of flesh may suit short-term political imperatives, but the financial services industry is an important source of tax revenues, and more importantly, campaign contributions for politicians. Sending the industry offshore would cut into a critical revenue source. And there is no shortage of jurisdictions what would welcome the money changers with open arms. The alternative hypothesis, however, is that the populist anger - particularly when it is fueled by severe economic disruption in the real economy and high unemployment - simply dominates in the political economy of modern democracies. In that scenario, the short term benefits that accrue to political actors from appealing to popular anger over the financial crisis outweigh any potential long term benefits that those actors might reap from protecting the financial sector. Which force - competition or populism - is likely to prevail in the current fight to reform financial regulation? To give away the ending, my money is on populism, not competition. But there are limits to populism's force.

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