Lost in temptation of risk: Financial market liberalization, financial market meltdown and regulatory reforms

The current meltdown of the financial markets in the United States, which triggered worldwide financial crisis and staggering declines in global growth rates, challenges the assumptions of fast capital market liberalization (CML). Whereas the discussion in previous years has concentrated on the benefits of financial market liberalization, the focus has now shifted to the cost of fast and excessive financial liberalization.

In contrast to the theory of perfect capital markets, the article starts from the more realistic assumption of imperfect capital markets. We deal with the benefits but also the potential shortcomings of CML. Too-fast liberalized capital markets, with risk assessments solely left to the market, can trigger boom-bust cycles, the busts precipitated by financial instability, entailing contagion effects and strong negative effects on the real side of the economy. The financial meltdown has created not only new challenges for the central banks around the globe, but has also produced initiatives on new financial regulations. We discuss here the most important recommendations put forward by the G20, the United States, United Kingdom and EU policy proposals for the financial market reforms triggered by the recent financial market meltdown.

No final verdict is possible at this time, since the proposals and recommendations issued by the various bodies have to go through the political process. Nevertheless, the regulatory policy fragmentation is already evident between a more liberal position and its tendency to rely more on market modes of coordination and a interventionist position that has more trust in non-market coordination. The challenge for the multilevel governance system of finance is to find a way to regulate without refragmentation both at the European and the global level.