Macroprudential paradox

1

Transnational Technocracy and the Macroprudential

Paradox

Andrew Baker

Ongoing efforts to construct functioning macroprudential regulatory regimes throughout the

global political economy are characterized by an unfolding paradox. This paradox is that

macroprudential regulation’s great strength, and one of the principal reasons it rose to

prominence in a short period of time following the financial crash of 2008, is also the

macroprudential regulatory project’s principal potential weakness. This ‘macroprudential

paradox’, reflects the sharp disagreements between commentators, alluded to in the

introductory chapter of this volume, concerning both, the merits or usefulness, and the

shortcomings or uselessness, of informal transnational technocratic regulatory policy

networks (Porter, this volume). As an approach to financial regulation, macroprudential

ideas were well placed institutionally and enjoyed growing credibility with politicians and

other actors, precisely because their principal protagonists were credible ‘technocrats’

operating in transnational networks, often with a good prior analytical track record (Baker,

2012). At the same time, it is this technocratic nature that also places limits and constraints on

the macroprudential project, in both a practical sense in terms of slowing knowledge, policy

and institutional development, and in a normative sense in terms of overlooking questions of

legitimacy and a vision of the future. This last shortcoming restricts the breadth of reach of

the macroprudential project and results in a marked reluctance to connect to a fundamental

vision of the role of finance in the good, just and sustainable economy and society. This

argument is developed in the rest of this chapter in five steps.

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The first step argues that there was an ideational shift towards macroprudential concepts and

thinking following the financial crash of 2008, that has reconfigured the analytical focus and

research capacity of the range of bodies that make up the global financial architecture in a

macroprudential direction (see Porter this volume). A second step makes the case that

macroprudential regulation itself is a technocratic project, authored and initiated by

technocrats, which requires the exercise of a variety of technocratic techniques and the

delegation of increased powers to technocratic regulators, to function. Step three argues that

macroprudential regulation’s technocratic character was a resource, or an asset that was one

of the principal reasons why macropudential regulation rose to prominence so quickly

following the financial crash of 2008, enabling it to become the principal post-crash

interpretative frame informing post crisis regulatory practice. In a fourth step, it is suggested

that in terms of policy development, it is precisely the technocratic nature of macroprudential

regulation that also inhibits and slows the development and implementation of

macroprudential policy and techniques, giving the macroprudential project a very

conservative and incremental dynamic. In a final fifth step, it is argued that the technocratic

nature of macroprudential regulation presents normative challenges for the direction and

social purpose of the entire project, relating to important questions of popular legitimacy, as

well as a technocratic caution or reluctance to use the macroprudential frame to raise

important questions about the correct role and function of the financial system in facilitating

prosperous, stable and harmonious societies. These issues raise questions about the political

sustainability of macroprudential regulation and its capacity to make a difference to the

everyday lived financial experiences of ordinary citizens and communities.

3

The Post 2008 Macroprudential Ideational Shift

Macroprudential regulation (MPR) is a system wide top down approach to regulation and

financial stability that seeks to ‘curb the credit cycle’ through countercyclical regulatory

interventions, by directing the commercial activities of private institutions, in an effort to

restrain extreme movements in asset prices and to deliver relative stability in macro credit

supply. In particular, a macroprudential approach involves treating the financial system as a

whole, viewing risk as a systemic and endogenous property, rather than focusing solely on

the safety and soundness of individual institutions. The aim of macroprudential policy

therefore is to limit the costs of financial distress in terms of macroeconomic output

(Crockett, 2000). In this regard, macroprudential thinking draws on the notion of ‘fallacy of

composition’ – recognizing that individual incentives and the courses of action that flow from

these do not necessarily result in desirable aggregate or systemic outcomes (Borio, 2011).

Similarly, macroprudential thinking recognizes that prices in financial markets can be driven

to extremes by a combination of: procyclicality, when the calculation of risk follows prices,

so that the supply of credit fuelling investment is most plentiful when least needed (when

asset prices are rising) and least plentiful when most needed (when asset prices are falling),

driving asset values to extremes in both directions (Borio, Furfine and Lowe, 2001, Borio and

White, 2004, White, 2006, BIS 2006); and herding, where individuals adopt behaviours close

to the overall mean, deferring to the judgements of others, behaving in a non-rational, or short

term fashion, due to the chemistry of the human brain and the propensities of the limbic

system (Haldane, 2010, 2011). A final macroprudential concept focuses attention on network

externalities and complex systems, as a cross sectional dimension, where relatively small

events can generate all kinds of systemic dislocations due to the complex and unintended

interactions that ensue in complex systems (Haldane, 2010a, Haldane and May, 2011).

4

The term ‘macroprudential’ was first used by the Cooke Committee, (an early version of the

Basel Committee on Banking Supervision BCBS), on 28-29 June 1979, to refer to how

problems with a particular institution could have destabilising systemic implications

(Clement, 2010). Informal usage of the term continued throughout the 1980s and 1990s at the

Basel based Bank for International Settlements (BIS), but it was after the Asian financial

crisis that the research department at the BIS began to develop a fully fledged research

programme and started forwarding macroprudential proposals, including a much clearer

sense of the distinctive features of a macroprudential approach to financial stability (Borio,

Furfine and Lowe, 2001, Borio and White, 2004, White, 2006, BIS 2006, (Borio and

Drehman, 2008). These efforts were also given intellectual energy and credibility by the work

of a number of academic and private sector economists such as Martin Hellwig, Avinash

Persaud, Charles Goodhart, John Eatwell, Hyun Song Shin, Markus Brunnermeir, and

development economists such as Jose Ocampo and Stephanie Griffith-Jones (Hellwig, 1995,

Persaud, 2000, Goodhart, and Segoviano, 2004, Griffith Jones and Ocampo, 2006).

Moreover, the macroprudential ideational shift that followed the financial crash of 2008,

largely involved technocrats from the BIS, together with some of the figures above and some

officials from national central banks, exercising an insiders’ coup d’etat to depose the

simplified efficient markets orthodoxy that had reigned over the previous two decades

(Turner, 2011, Baker, 2012).

In the aftermath of the Global Financial Crisis, the idea of macroprudential regulation rose to

prominence in a remarkably short period of time (Borio, 2011, Baker, 2012). Building

macroprudential regulation has become an accepted policy priority in most major financial

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centres. A critical mass of post-crash reports on the appropriate regulatory response argued

that there was a need to make financial regulation more macroprudential. In the UK, the

Financial Service Authority’s (FSA) principal document, The Turner Review, diagnosed and

set out an action plan for responding to the crisis, within a macroprudential frame, after

Persaud, Goodhart and Eatwell converted Adair Turner, incoming head of the FSA, to the

macroprudential cause in the second half of 2008 (FSA, 2009). Avinash Persaud and Charles

Goodhart also teamed up with Andrew Crockett, former BIS director general, and long time

advocate of macroprudential regulation (MPR), to publish the Geneva Report into the crisis

in July 2009, which again made the case for MPR (Brunnermeir et al, 2009). Through his

participation in the UN Stiglitz Commission, Persaud also ensured MPR featured in their

recommendations (UN, 2009). The De Laroisiere report produced by the EU also identified

the need for a macroprudential approach (De Laroisiere 2009). G30 reports produced by a

combination of public and private sector officials similarly endorsed and explored

macroprudential regulation (G30, 2009, 2010). Naturally as a concept that originated with

and had been pioneered by BIS staff, BIS staff continued to promote and applaud MPR,

publishing their own reports and papers, – further elaborating the case for MPR (Borio, 2009,

Borio, Tasharev and Tsatsronis, 2009,) with the BIS even laying claim to be the principal

institutional owner and intellectual driver of the concept (Clement 2010, Galati and

Moessner, 2011). With so many expert reports advocating MPR and macroprudential

philosophies, an irresistible momentum, or ‘norm cascade’ in favour of a macroprudential

approach to regulation was built and diffused throughout the key policy locations in the

international financial architecture (Finnemore and Sikkink, 1998). Consequently, a new

Basel consensus based on a macroprudential analytical frame took hold in the informal

transnational settings referred to and identified in the introduction to this volume (Porter this

volume, Helleiner, 2010, Baker, 2010, 2012).

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New agencies for the evaluation of systemic risk have now been created in the form of the

Financial Stability Oversight Council (FSOC) in the US, the European Systemic Risk Boar

(ESRB) at the European Central Bank (ECB) in Europe, and the Financial Policy Committee

(FPC) at the Bank of England in the UK. The Basel III agreement has a macroprudential

component involving countercyclical capital buffers and the Financial Stability Board has

been charged with co-ordinating and reporting on macroprudential policy instruments and

reforms, to G20 governments. Concerted efforts are therefore currently underway amongst

the international community of central bankers and regulators to construct functioning

macroprudential policy regimes.

The extent of the diffusion of macroprudential thinking has been captured by the Bank for

International Settlement’s (BIS) Claudio Borio, when he suggested, “we are all

macroprudentialists now” (Borio, 2009, p.1.) However, as Borio has also pointed out, “a

decade ago the term macroprudential was barely used and there was little appetite amongst

policy makers and regulators to even engage with the concept, let alone strengthen

macroprudential regulation” (Borio, 2009, p.32). For example, in several well documented

exchanges at the Jackson Hole, Conference of the Kansas City Federal Reserve in 2003 and

at later meetings of central bankers at the BIS headquarters in Basel, Alan Greenspan was

notoriously dismissive of the macroprudential analysis and arguments of both Borio and his

BIS colleague William White, who were warning of the dangers of an inflating financial

boom. Other central bankers at these meetings largely agreed with Greenspan (Balzil and

Schiessl, 2009). Despite receiving backing from sections of the BIS therefore, MPR

remained relatively unpopular in the lead up to the crisis of 2007-09. From late 2008 through

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to mid 2009 however the popularity of MPR surged. As Borio has pointed out, “this swell of

support [for macroprudential regulation] could not have been anticipated even as recently as a

couple of years ago. The current financial crisis has been instrumental in underpinning it”

(Borio, 2009, p.2). Borio’s comments neatly summarise how macroprudential ideas have

moved from relative obscurity in certain enclaves of the BIS, to the centre of the policy

agenda, dominating and driving the post crisis financial reform debate, in the international

community of central bankers and the transnational governance mechanisms that are the

focus of this volume.

During 2008, as we moved towards the height of the crisis, the existing efficient markets

orthodoxy - a ‘do little’ position remained ascendant in technocratic networks. Indeed, the

initial early centre piece international policy document of the crisis, - a report by the

Financial Stability Forum (FSF 2008), which set out an agenda for responding to early

liquidity problems and stress in securities and derivatives markets, re-iterated “the familiar

trilogy” (Eatwell, 2009). The core message in this report was that greater transparency, more

disclosure and more effective risk management by banks and investment funds were the best

market enhancing light touch response (FSF, 2008). The inadequacy of this thinking became

clear when, the sheer number of financial institutions requiring public financial support

following the collapse of Lehmans in the Autumn of 2008, meant that financial distress took

on a systemic quality. The extreme downward movement in a number of interrelated asset

classes could not be explained by the efficient markets approach. From this perspective

systematic mistakes by markets (as the sum of individual rational decisions), as opposed to

isolated random ones, could not happen, at least when adequate information was available,

because optimising agents would drive prices into equilibrium. In contrast, the

macroprudential approach that emphasized the importance of systemic thinking and

8

highlighted the procyclical and unstable tendencies of financial markets, provided a ready

made conceptual apparatus for explaining the events of Autumn 2008. This conceptual

approach also critiqued the dominance of the existing orthodox and its overreliance on VaR

models, asserting that such an approach was a cause of the crisis and had “further hard wired

procyclicality” into the financial system (FSA, 2009). In this context, the existing orthodoxy

became part of the problem that had to be replaced with new thinking. Macroprudential was

this new thinking.

Regulators, both internationally and domestically are devoting a great deal of energy and

effort to addressing macroprudential policy questions. The most recent joint FSB, IMF, BIS

report on macroprudential policy for the G20, contained references to twenty-two documents

and reports with a macroprudential focus, published by those institutions alone since 2010

(FSB, IMF, BIS, 2011). An extraordinary amount of macroprudential analysis is underway in

the regulatory policy community. In this respect, one of the most important outcomes of the

regulatory reform debates instigated by the G20 leaders after the financial crash of 2008, is

that the global financial architecture, as an analytical and research machinery comprised of a

complex array of institutions and bodies (Porter this volume), has been reconfigured, in such

a way that macroprudential knowledge development has been prioritized. The analytical

focus of this architecture and its research machinery has therefore very definitely shifted in a

macroprudential direction.

As the Bank of England’s Executive Director for Financial Stability, Andrew Haldane has

argued:

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“Macroprudential policy is a new ideology and a big idea. That befits what

is, without question, a big crisis. There are a great many unanswered

questions before this ideology can be put into practice. These questions will

shape the intellectual and public policy debate over the next several

decades, just as the great depression shaped the macroeconomic policy

debate from the 1940s to the early 1970s” (Haldane, 2009, p.1).

The significance of the macroprudential ideational shift that has emerged from transnational

technocratic regulatory networks since 2008, is that it provides a challenges to much pre

crisis regulatory thinking. Fallacy of composition challenges the notion that the rational

incentives of individual actors are sufficient to generate financial stability. Procyclicality

raises the prospect that financial market prices are prone to extreme swings rather than

usually being correct. Herding challenges the notion that individuals have the capacity and

inclination to rationally evaluate all information and draws attention to the myopia and less

than optimum rationality of individual agents (Tucker, 2011), while complex systems

analysis indicates that complex innovative financial systems can be a cause of systemic

instability and fragility rather than enhancing durability, as per the market completion

hypothesis. Consequently, the macroprudential ideational shift has changed the cognitive

filter of many regulators, allowing serious discussion and consideration of a range of

regulatory and policy instruments, that pre crash were barely considered, with the exception

of a few isolated examples. These include: countercyclical capital requirements; dynamic

loan loss provisioning; countercyclical liquidity requirements; administrative caps on

aggregate lending; reserve requirements; limits on leverage in asset purchases; loan to value

ratios for mortgages; loan to income ratios; minimum margins on secured lending; transaction

taxes; constraints on currency mismatches; capital controls; and host country regulation

(Elliot, 2011).

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Macroprudential Regulation as a technocratic Project

As the brief history of the rise to prominence of macroprudential regulation in the previous

section outlined, the principal proponents of this approach were a variety of central bank

officials, the staff of some international and transnational bodies, a small number of academic

economists and market/ private sector analysts who regularly engaged in regulatory and

policy debates. All were well versed in a variety of economic concepts and analytical

techniques. Similarly, all of the figures concerned were professional economists of various

hues, with formal postgraduate economics training, and a professional identity as economists

in either academia, at central banks, various international institutions, or as market or private

sector analysts. Crucially, in the case of national central bank officials who were engaged in

developing macroprudential analysis, they were not simply national officials, but were also

members of wider transnational networks and exposed to repeated and enduring interactions

with their peers at other central banks, and or the staff of institutions such as the BIS, IMF,

and the secretariat of the Basel Committee on Banking Supervision (BCBS) and the Financial

Stability Board (FSB). The technocrats charged with the task of developing macroprudential

analysis, by the G20 governments after the financial crash of 2008, were therefore also

simultaneously transnational technocrats, engaged in various transnational committees and

networks, as well as being national central bank officials.

Martin Marcussen refers to a process of ‘scientization,’ in the central banking world, as a

striking intellectualization of the world, an objectification of things and actions via formal

analysis and mathematical abstraction; a technical mastery via specialized practices and

discourse (Marcusen, 2006). Research departments in central banks have expanded and

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created scientific working paper series, while financing their own scientific journals and

conferences, such as the Kansas City Federal Reserve’s annual Jackson Hole event. In this

context, scientific credentials are becoming effective career enhancing factors for central

bankers. The central bank community is increasingly comprised of figures with doctoral

degrees in economics who engage directly with the scientific community, resulting in

transnational epistemic clan structures. One of the significant consequences of this

scientization is that as epistemic communities, central banks’ organizational boundaries are

blurring, and so are territorial and cultural boundaries, as co-equal central bankers work

closely together from project to project (Marcussen, 2006, p. 10). Existing academic literature

has referred to the phenomenon of econocracy (Self, 1976, Engelen et al, 2010), where

groups of financial regulators and central bankers, claim authority derived from their

technical expertise and academic credentials (Porter, 2003), and debate is led by data sets and

the application of key concepts and analytical techniques drawn from economics, particularly

cost benefit analysis (Self, 1976.)

Generally, there has been a tendency to overstate the homogeneity of these technocratic

regulatory networks, or at least under estimate their diversity and pluralism during the pre-

crash period (Engelen et al, 2010, Baker, 2009). For example, not all technocrats bought into

the efficient markets orthodoxy and uncritically accepted that financial innovation had made

the financial system more resilient and robust. Macroprudentialists had been critical of

existing practice for some time (Borio and White, 2003, Persuad, 2000), but warnings about

the dangerous combination of conditions brewing in the pre-crash period were largely

ignored by leading central bankers (Balizil and Schiessl, 2009, Baker, 2012).

12

Technocratic macroprudential norm entrepreneurs then effectively used the crash of 2008, to

instigate an insiders coup d’etat, largely deposing the prior efficient markets orthodoxy, as

the previous section established. The staff of the BIS, the central banker’s bank, that hosts

central bankers’ meetings and its headquarters in Basel, pooling data from its various member

banks, to provide analyses of ongoing market and macroeconomic trends and developments,

played a particularly prominent role in promoting macroprudential thinking and analysis, in

developing macroprudential knowledge and in exercising this insiders’ coup, alongside many

of the ‘norm entrepreneurs’ referred to in the previous section. Other key figures in

cementing this shift were the joint chairs of the key G20 working group in the first half of

2009, Tiff Macklem of the Bank of Canada and Rakesh Mokan, of the Reserve Bank of India.

Following the financial crash of 2008 therefore macroprudential was a regulatory project

pioneered, developed and promoted by technocrats operating in transnational networks.

Unsurprisingly, the immediate beneficiaries of the macroprudential project are also

technocrats, who will require an enlargement of their role in the policy process, greater

degrees of autonomy and discretion and will need to be equipped with a wide ranging number

of macroprudential policy instruments, if macroprudential policy is to become operational. In

this sense, the macroprudential project essentially seeks to empower a new cadre of

technocrats and price engineers. For example, the stated objective of macroprudential policy

is to moderate credit supply over the cycle, tightening policy in a boom and lowering it in a

bust (Bank of England, 2011.) The most commonly cited macroprudential policy instrument

is the counter cyclical capital buffer, a variant of which had operated in the Spanish and

Indian banking systems in the pre-crash period. The idea behind a counter cyclical capital

buffer is to lean against the credit cycle based on a reference path of a normalized credit to

GDP ratio. Deviations above the path involve a tightening of capital requirements for private

13

lending institutions, while deviations below that path should involve a loosening of those

requirements (Haldane, 2012). Other potential macroprudential policy instruments include

constraints on bank leverage levels and maximum levels being placed on the levels of bank

asset encumbrance. A functioning macroprudential policy regime therefore clearly requires

regulators who have the capacity and capability to identify normalized paths of credit to GDP

and deviations from that path, based on extrapolations from previous evidence and data.

Further, they would also be required to reach judgements on the precise calibrations of these

macroprudential policy instruments and how they should be scaled up or down to reflect

particular identified phases of the credit cycle. Such a process clearly depends upon the

technical capacity of regulators to reach such calculations, the data sets and data collection

techniques they have to hand and some discretionary powers to reach judgments on how

policy should be adjusted. Empowering regulators to engage in such technical calculations

and judgments is therefore precisely the objective of the macroprudential project. As Andrew

Haldane, Executive Director for Financial Stability at the Bank of England reflects, “if there

were a benign enlightened regulatory planner, able to redirect competitive forces, this could

potentially avert future tragedies of the financial commons. Fortunately there is" (Haldane,

2012a, p.12). One aim of the macroprudential project it has been claimed is ‘technocratic

mastery of financial markets,’ driven by a desire to open new possibilities for control of

complex adaptive financial networks, through mathematized control technologies (Erturk et

al, 2011, Clegg and Moschella this volume). This project of technocratic control involves

proposals to ‘map the financial network’ and to vaccinate interconnected nodes, or

superspreaders through the introduction of Central Counter Parties, as well as some of the

techniques discussed above (Haldane, 2009). It is not the purpose of this chapter to consider

the potential of technocratic macroprudential control technologies (Erturk et al 2011), but

rather to identify that macroprudential regulation both in its inception and execution is a

14

particularly technocratic form of governance that itself raises a whole series of issues and

questions, which will now be discussed in the rest of this chapter.

Macroprudential Regulation’s Technocratic Roots as a Strength

Following the financial crash of 2008 many of the macroprudential norm entrepreneurs

mentioned in this chapter had the strategic advantage of access to the established financial

technocratic research and report writing machinery that politicians called upon to provide

them with diagnoses, answers and proposals. As Tony Porter, indicated in the introductory

chapter to this volume, after 2008, G20 leaders turned to a number of specialist international

bodies and networks to provide a regulatory response (Porter this volume). This included

specialist G20 working groups, the BCBS and the new FSB, which included representatives

from central banks, finance ministries and regulators. In other words, the existing institutional

structures of international and transnational financial governance shaped the subsequent

response and this handed a strategic advantage to macroprudential technocrats who had

membership of these networks. As Walter Mattli and Ngaire Woods have pointed out,

“successful [regulatory] change is made more likely where new ideas provide a way to

regulate that both offers a common ground to a coalition of entrepreneurs pressing for change

and fits well with not-discredited existing institutions.” (Mattli and Woods, 2009, pp.4-5).

In this respect, MPR had not discredited institutional and individual backers that were already

linked into key policy making networks in the form of Claudio Borio’s inner circle of

cognoscenti. As Tony Porter has pointed out if proposals in the field of financial governance

are to appear viable to policy makers, they have to be grounded in prior research, technical

15

reports and have an institutional presence (Porter, 2003). Following the financial implosion of

2008, macroprudential advocates were not starting from scratch. Individuals such as Claudio

Borio and William White, were already recognized and positioned within key policy

networks, with a prior track record of advancing macroprudential ideas for nearly a decade.

They were also able to make intellectual alliances with some of the macroprudential

advocates referred to here. In this respect, the macroprudential perspective had an advantage

in terms of institutional access and a body of prior work that outlined the inadequacies of the

prior efficient markets orthodoxy. Macroprudential norm entrepreneurs’ social status and

professional standing also rose following the financial crisis, meaning that macroprudential

ideas had credible backers whose professional esteem was rising (Baker, 2012). In other

words, Macroprudential’s characteristic as a technocratic project advanced by technocrats,

was one of the great strength’s of macroprudential regulation that aided its rise to

prominence. Crucially, the technocratic nature of financial regulation and its dependence on

expert contributions, also meant that the rise of macroprudential could proceed quite rapidly,

because it was less dependent on building consensus, support and levels of understanding

amongst wider societal and political actors. Consequently, within six months of the crash

G20 communiques were indicating that there was a need to move towards macroprudential

forms of regulation and ‘mitigate procyclicality (G20, 2009).

Technocratic Governance as a Practical Constraint on Macroprudential Policy

Development

While the technocratic roots and character of MPR were one of the key reasons why this

frame rose to prominence in a short period of time following the financial crash of 2008,

these technocratic characteristics have also been constraining the actual development of

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functioning macroprudential policy. By their very nature technocrats like to proceed

cautiously on the basis of data sets and empirical evidence, which take time to accumulate.

Consequently, the task of filling macroprudential regulators’ empty policy arsenal is

proceeding gradually as evidence, data and rationales are compiled and tested (Clegg and

Moschella this volume). For example, in accordance with the pattern identified by Clegg and

Moschella’s contribution to this volume, a recent FSB/ IMF/ BIS report to the G20 on

macroprudential policy (FSB, IMF, BIS 2011) notes that ‘systemic risk identification is a

nascent field, that requires fundamental applied research, so as to inform the collection of

analysis and data, to fill data gaps and to lead to the development of better models’.

Similarly, the private sector has been urging a slow cautious approach to the development of

macroprudential policy. The Institute of International Finance’s (IIF) has argued that ‘the

science’ in this area is at an early stage, while using capital as an instrument of

macrostabilization was ‘unprecedented and untested’, requiring authorities to ‘exercise great

caution ’ (IIF, 2011, p.22). Bank of England officials have been quick to point out that, ‘the

state of macroprudential policy resembles the state of monetary policy just after the second

world war, with patchy data, incomplete theory and negligible experience, meaning that MPR

will be conducted by trial and error’ (Aikman, Haldane, and Nelson, 2011). Macroprudential

authorities will not be able to draw on decades of research and experience. All of this means

that that building functioning macroprudential policy regimes is a slow arduous process as

data sets have to compiled and new policy instruments have to be tested and experimented

with. Technocratic policy prescription is consequently a slow and cautious process. Quite

simply, technocrats are currently wrestling with multiple, intersecting issues concerning

measurement, mapping and devising new practices of intervention.

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The incremental nature of the task of constructing MPR was also evident in the outcomes of

the Basel III agreement. Compared to Basel II which took over five years to negotiate, Basel

III was put together in much shorter period of time, with a first announcement made in

September 2010, following a G20 pledge in 2009. Value at Risk (VaR) models revolving

around price signals have not been jettisoned in Basel III, rather they are now overlain by

macroprudential instruments such as counter cyclical capital buffers. Basel III revises and

adds to Basel II. Existing rules such as the required ratio of equity capital to risk weighted

assets have been adjusted upwards from 2% to 7%, but they also entail substantive (albeit

minimal) changes in risk weights. One reason for this very gradual approach to regulatory

change relates to the internal constitution of macroprudential ideas and how their internal

component parts relate to microprudential ideas (Carstensen, 2011). Microprudential

supervision and regulation can be a constituent part of a macroprudential regime, but it is the

adequacy of microprudential approaches that is disputed by the macroprudential perspective.

Consequently, macroprudential approaches overlay, rather than replace microprudential

approaches in their entirety.

Other technocratic aspects of Basel III included the justification for a more expansive stance

on capital ratios, which drew on macroprudential arguments that capital requirements needed

to be set far above any reasonable estimate of the losses likely to be incurred by an individual

bank, because what mattered was the macro systemic stability of credit supply, not just the

risk of individual failure (Turner, 2011, Miles, Yang, Marcheggiano, 2011.) From this

perspective, Bank of England officials argued that in an ideal world, Basel III capital ratios

would be 15-20% of risk weighted assets, rather than the eventual agreed 7% (Miles, Yang,

Marcheggiano, 2011, Turner, 2011). This objective is however viewed as a long term one,

because while higher equity ratios would not in the long run carry an economic penalty, a

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starting point of sub optimally high leverage means that higher equity ratios could slow

recovery from a crisis induced recession. This argument was accepted even by more

ambitious macroprudentialists such as Adair Turner and the BIS macroeconomic assessment

group, whose analysis informed Basel III design (Turner, 2011). The position of many

macroprudential technocrats therefore is that Basel III is a step in the right direction, but that

the system remains more vulnerable to instability than is ideal and that long term the answer

must be to move towards the 15-20% level (Turner, 2011, Miles, Yang, Marcheggiano). As a

consequence of these arguments, Basel III is to have a slow phase in with many new

requirements not becoming effective until January 2019.

The slow pace of macroprudential regulatory reform evident in Basel III is also a function of

the institutional features that the BCBS itself displays as a technocratic institutional

committee, that remains relatively isolated and insulated from wider societal and political

actors, but has close relationships with certain market bodies. Particularly important, in the

BCBS’s functioning is the first mover advantage that accrues to industry bodies such as the

IIF, due to the personal connections leading personnel from the IIF have with members of the

Basel Committee (Lall, 2011). One reason for these connections is the phenomenon of

revolving doors, which results in continuous flows of personnel from regulatory community

to the industry and vice versa, due to similar skill sets (Seabrooke and Tsingou, 2009). It is

also the result of the necessity of sharing information and expertise, as regulators particularly

in the field of finance need to keep abreast of thinking in the private sector and latest market

trends and developments. Initial empirical evidence reveals that industry lobbies, particularly

the IIF were successful in watering down the provisions of Basel III, particularly during

2010, and direct participants in the Basel process have confirmed the role of industry

lobbying in producing a much more minimal form of Basel III than originally envisaged

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(Lall, 2011 Turner, 2011). The Basel Committee’s opaque institutional context has

consequently provided large global banks with first mover advantages of access in successive

regulatory processes, and in the case of Basle III this has resulted in proposals on higher

minimum capital ratios, the international leverage ratio, minimum liquidity ratio, and capital

surcharge on systemically important institutions, all being diluted (Lall, 2011). In the Basel

III case there is substantial evidence for example that French and German banks were able to

shape the French and German delegations’ position in favour of a lower equity capital ratio

and a lower leverage ratio (Mugge and Stellinga, 2011, Hanson, Kashyap and Stein, 2011,

Helleiner, 2012), which again is a reflection of the institutional design of the Basel process

and the question of who has access to BCBS policy networks (Underhill, 1995, Underhill and

Zhang, 2008).

The language surrounding the major macroprudential component of Basel III, - a country by

country counter cyclical capital buffer of between 0 and 2.5 per cent, is also deliberately

ambiguous. The relevant passage reads: “For any given country, this (countercyclical capital)

buffer will only be in effect when there is excess credit growth that is resulting in a system

wide build up of risk.” In other words, a failure to deploy a countercyclical capital buffer can

be justified if system wide credit growth is deemed not to be excessive. The capacity to

implement counter cyclical capital buffers will therefore depend on the capacity, capability

and willingness of domestic regulators to exercise their discretionary judgement, which will

be determined by national institutional arrangements. Crucially, therefore efforts to construct

a technocratic transnational framework of principles for guiding financial regulation, through

initiatives such as the Basel III agreement, do not necessarily imply increasing uniformity and

a shift away from national regulation. This is particularly the case in relation to

macroprudential regulation. Countercyclicality policy needs to respond to national business

20

and credit cycles and is therefore best set by national regulators responding to national

conditions. In this sense, emerging macroprudential practice and the relationship between

transnational regulatory forums such as the BCBS and the FSB and national policy making

reveals the need for scholarship that adopts what Helleiner and Pagliari have called an

integrative approach that is capable of wrestling with regulation based on some degree of

“decentralized coordination” and the complexity that entails, and which is a theme of this

volume (Helleiner and Pagliari, 2011). Rather than simply attempting to demonstrate the

primacy of the interstate arena and diplomacy, the transnational arena and processes, or of

domestic politics and policy making, scholarship should be sensitive to the reality that these

arenas often complement, rather than compete with one another, with subsequent analyses

seeking to examine the complex interactions and inter-relationships between these arenas and

processes.

Technocratic Governance, Legitimacy and Normative Vision

Macroprudential regulation, this chapter has argued, is a technocratic project involving a

technocratic form of governance resting on the exercise of control technologies by

econocrats. The technocratic nature of macroprudential was one of the principal reasons for

its rapid rise to prominence after the financial crash of 2008. However, technocratic

governance is also beset by a number of tensions and problems, that constrain its capacity to

generate socially useful reform and sustainable legitimate forms of governance.

The first problem is that there remains in macroprudential policy formulation and in

technocratic governance more generally, a problematic disconnect between technocrats and

politics that can disempower reform (Engelen et al, 2011, p.189.) By way of clarification it

should be explained that this disconnect is not absolute. For example, the macroprufdential

21

ideational shift could not have proceeded without support from the G20 leaders and finance

ministers. In this respect, the offer of a new more comprehensive regulatory agenda, chimed

with popular sentiment and the rise of populist politics seeking punishment for the banking

sector following the financial crash of 2008 (Thirkell-White, 2009). This climate of opinion

created incentives for politicians to open debates about financial regulation to include broader

social externalities (Thirkell-White, 2009). Macroprudential regulation provided a route map

for making such a link because it has ostensibly motivated by a normative stance that

regulation should be driven by an effort to ensure that the costs to society as a whole are less

than the private costs incurred by private sector institutions (Persaud, 2009, Alessandri and

Haldane, 2009, Turner, 2011). In this respect, some scholars have argued that intellectual

debates have emotional or affective contexts and that deeper affective values prefigure more

refined cognitive attachments –in ways that can help to enable the rise of specific norm

entrepreneurs (Crawford, 2000, Seabrooke 2006, Ross, 2006). Certainly, the macroprudential

ideational shift, benefitted from a change in the popular mood that favoured increasing

financial regulation immediately following the financial crash of 2008.

The problem however is that technocratic governance is particularly prone to disconnecting

from politics and popular sentiments, despite the fact technocrats frequently owe their initial

empowerment to changes in popular moods and sentiments. This is precisely due to the basis

of and claims to technocratic authority, which rest on claims to technical expertise and the

scientific status of the knowledge derived from sub disciplines such as finance economics,

which are closely linked to the practice of finance (Mackenzie, 2006), but also claim to be

outside of, above and separated from partisan politics. Unfortunately, such claims are riddled

with tensions that make technocratic governance a perilous and fragile exercise.

22

Econocracy as described in this chapter, has its limits, but it also has some strengths.

This chapter has provided an account of how econocrats have a commitment to evidence and

debate as a foundation for policy prescription, as well as a reflexive capacity.

Macroprudential norm entrepreneurs were able to reflect on the crash of 2008, revising their

own view of the world, while others who had long been privately and publicly sceptical of

the prevailing efficient markets approach to regulation in the pre-crash period, became much

more prominent and vocal after the events of 2008 sparked serious regulatory reform debates.

In this respect, macroprudential technocrats framed the financial crisis in terms of the

intellectual failures of the efficient markets position and a failure to understand systemic

dynamics. In this way they forced open the argument about the re-regulation of finance

through carefully assembled arguments and persuasion. As Engelen et al note, econocrats

took the primary role in ‘troublemaking’ (Engelen et al, 2011, p.199), and they primarily did

so through the macroprudential frame. The macroprudential response to the crash of 2008 has

placed a value on more and better forms of knowledge, and the belief that technical solutions

can be found to complex policy problems.

A fundamental problem faced by technocratic governance is that there is often a disconnect

between intellectual radicalism and actually policy output and delivery. This has been

particularly evident in the case of macroprudential regulation. The interventions of Haldane,

Turner and Borio as macroprudential intellectuals have been relatively radical in intellectual

terms, at least when counterposed against the prior efficient markets orthodoxy, but they have

also been relatively timid in their policy prescriptions to date, which have not gone much

beyond advocating increased capital requirements, particularly of a countercyclical variant,

some enhanced leverage limits and some exploratory thoughts about simplifying and

separating or modularising the financial system (Turner, 2011, Aikman, Haldane and Nelson,

23

2011, Borio, 2011). Some of the reasons for this were touched upon in the previous section,

concerning technocrats’ preference for evidence based policy making derived from the

compilation of extensive data sets. In this sense, the movement towards technocratic

macroprudential regulatory interventions proposed by radical technocrats such as Andrew

Haldane, based on borrowing concepts from epidemiology and ecology (Haldane and May,

2012), and efforts to map and reconstruct the financial system, are susceptible to criticisms

that they replace one failed mathematization (efficient markets derived risk management and

modelling), with another (Engelen et al, 2011, Erturk et al, 2011). Moreover, expert led

banking reform has remained insulated from democratic politics, as these radical technocrats

have not connected to democratic politics, primarily because their technocratic authority has

rested on a demonstration of technocratic impartiality. Unfortunately, this simultaneously

places a very restrictive break on the process of financial regulatory reform and restricts

serious debate to a narrow technical form. Apart from some utterances about “socially useless

finance,” from Adair Turner, there has been a singular reluctance in the technocratic

macroprudential community to connect to wider questions concerning the social purpose of

finance. Andrew Haldane’s work on banking on the state has expressed hostility to the notion

of socializing private banking losses (Alessandri and Haldane, 2009), but questions of the

objective of financial reform, beyond making finance safer have hardly been actively

pursued. Macroprudentialists have displayed a conspicuous reluctance to ask questions about

what banking and credit could and should do for the economy. This reluctance has

consequently narrowed the debate and ensured that the macroprudential project has remained

largely divorced from the vast majority of ordinary people’s lived every day financial

experiences. Therefore, while the technocratic character of macroprudential regulation has

had strengths, it has also been simultaneously restricted and weakened by a similar

24

technocratic reluctance to link to the concerns of mass publics and place financial reform into

a wider social and political context.

A second potential difficulty associated with technocratic governance, is that the historical

record reveals that there is a long standing tension between technocracy and popular

legitimacy. Technocratic governance has a tendency to sow the seeds of its own downfall,

when technocrats shut themselves off from mass publics and behave in ways that limit the

resonance and appeal of their ideas with mass publics. Current macroprudential debates are

for example foreshadowed by the arguments Thorstein Veblen and John Kenneth Galbraith in

favour of technocratic interventions to correct market pathologies that derive from extreme

destabilising price changes generating unacceptable social costs. In Institutionalist debates,

Veblen and Galbraith initially highlighted an array of policy possibilities, providing

justifications for Progressive-era regulation and the postwar Keynesian regulatory-

macroeconomic policy mix. Yet, each eventually failed to recognize the limits to their own

claims for governance by “engineers” and a broader “technostructure” (Baker and Widmaier,

2013). In this way, intellectual consensus which enjoys popular legitimacy can fall prey to

overconfidence, and presage crises that spur a reassertion of popular debate. Technocratic

agents are prone to engaging in the unconscious “intellectual repression” of everyday values,

and so fail to modify their beliefs in response to shifts in market developments or political

legitimacy. Arguments about the usefulness of a technocratic cadre of officials, modifying

extreme price movements, so as to enhance the durability of capitalism, to minimize social

harm and to deliver a public interest, are in this respect not new, but these claims are at the

core and very intellectual foundation of the macroprudential case. Macroprudential, although

proceeding slowly and incrementally, (Baker, 2013,) is nevertheless a technocratic growth

25

industry, which potentially creates and empowers a new technocratic cadre of price

engineers. In the case of both Veblen and Galbraith, over time, each strove to develop ever-

more refined, unidirectional models to support their specific policy preferences, but they

overrated the autonomy of “engineers” and the “technostructure” in ways that proved at odds

with everyday ideas. In this way, they each failed to recognize the tensions between

technocratic refinement and policy legitimacy.

Legitimacy gaps occur when the claims made to legitimacy by an institution, or organization,

with a specific policy function and mandate, are rejected in the expressive practices of those

being governed, resulting in a widening gap between claims and acts (Seabrooke, 2007,

p.258.) By contrast when those claims are conferred by mass publics, legitimacy gaps

narrow. As we have seen in the macroprudential case, technocratic forms of governance

usually come into being when the gap between the claims of particular groups of regulators

and the expressive practices of the wider public narrow quite dramatically. Over time,

however, we have also seen that, that gap is prone to grow, because insulated technocrats

become convinced of the correctness of their own prescriptions (over confidence) and can

become divorced from popular sentiments, which can simultaneously undermine the

effectiveness of their technical policy prescriptions and the political will that granted them

regulatory responsibilities in the first place. This is a trap that all forms of technocratic

economic governance are prone to. Avoiding such pitfalls requires constant vigilance on the

behalf of technocratic regulators in relation to how their policies map onto wider public

moods and concerns. Consequently, contemporary macroprudentialists need to be aware that

technocratic projects can only survive and be sustained for as long as they chime with wider

public sentiments. Without this a “legitimacy gap” (Seabrooke, 2007) is liable to open up

between technocratic pretensions and public moods and tolerance, as occurred in the cases of

26

Veblen and Galbraith’s technocratic projects after the first world war and in the 1970s

respectively, which could in turn eventually undermine the very political foundations of

maroprudential regulation (MPR).

Conclusion

This chapter has argued that the financial crash of 2008 was the catalyst for an ideational shift

towards a macroprudential regulatory perspective in transnational regulatory networks.

Macroprudential itself is a technocratic project that potential empowers a new cadre of price

engineers. The technocratic roots of macroprudential were an initial strength, that enabled the

macroprudential regulatory frame to rise to prominence in a period of just over six months.

Moreover, macroprudential technocrats have mounted the most coherent, effective, enduring

and radical intellectual critique of prior regulatory practices derived from simplified versions

of the efficient markets hypothesis (Turner, 2011). Despite this actual functioning

macroprudential regulation has been proceeding slowly and is currently in a technocratic

experimental phase of trial and error. Furthermore, macroprudential technocrats have

displayed a reluctance to connect to broader political groupings and wider debates about

finance, possibly for fear of undermining the very independent technocratic authority that the

macroprudential project has relied upon to date. Unfortunately, this kind of stance is also a

key weakness of the macroprudential project that limits the supportive political coalitions that

can form behind it. This reluctance to move outside a narrow technocratic mode of operation

has also revealed itself in the unwillingness of macroprudentialists to ask questions about the

social and economic purpose of finance, and this has simultaneously narrowed the

macroprudential regulatory reform debate, to how to set and operate a range of narrow

technical policy instruments such as capital requirements, counter cyclical capital buffers and

27

leverage limits. The role of finance in the economy more broadly as part of a wider societal

vision, has largely remained outside of the purview of contemporary macroprudentialists.

Finally, previous experience with technocratic governance designed to limit extreme and

unwarranted price movements, has revealed that a particular Achilles heel, is that

technocratic protagonists can suffer from over confidence and become divorced and isolated

from more populist concerns and sentiments, resulting in declining effectiveness and growing

legitimacy deficits. In the light of this analysis in the final section of the chapter, it may be

necessary for a working out of popular narratives, such as from “Occupy,” before any truly

legitimate intellectual regulatory framework can be constructed and implemented. Moreover,

this suggests that advocates of stronger macroprudential positions will not themselves

ultimately triumph unless they are able to reconcile claims for technocratic expertise with

those for popular legitimacy. This is an extremely difficult tension to resolve, because

technocratic expertise as a source of authority relies on evidence based policy making that

claims to be outside of politics, yet simultaneously needs to be empowered by and reflect

prevailing political sentiment. This is the very essence of the macroprudential paradox.

Interestingly, there are early signs that some of the strongest advocates of macroprudential

regulation appreciate this dynamic. Andrew Haldane has not only argued that we are in the

early stages of a reformation of finance that the Occupy Movement has “helped stir” by

making arguments that “have helped win the debate”, but he has also recognized that as a

technocratic policy maker he will need their “continuing support in delivering radical

change” (Haldane, 2012b, p.101.) Such a recognition is important because it is crucial in

resolving the macroprudential paradox sketched in this chapter.

1 Incoming Bank of England governor Mark Carney, and current Bank of Canada governor has similarly cited

the importance of Occupy in influencing regulatory debates.

28

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