Macroprudential Regulation and the Politics of Delegation in Financial Governance
The scars of the 2007-09 Great Financial Crisis (GFC) are still with us. In the United States, we are in an expansionary period, a long economic recovery that has thus far lasted nearly a decade. In fact, according to economic data from the regional Federal Reserve Bank of St. Louis that maintains the national database tracking business cycles (Federal Reserve Economic Data), the U.S. has enjoyed economic growth since July 2009 (FRED 2019a). After 115 months, that prolonged period of uninterrupted expansion is now the second longest in the country’s history. Nonetheless, the recovery has not affected everyone equally. For instance, according to official Census data, income inequality, measured as the uneven distribution of revenues from wages and salaries among a population, is at its highest level in the last century (inequality.org 2019). The Census also noted the homeownership rate—the proportion of homes in the population owned by their occupants, a measure of wealth and a symbol of the American Dream—is still well below the level of the early 2000s (FRED 2019b). Despite gross domestic product growth overall since 2009, these facts have led commentators to paint a mixed picture of the American economy after the GFC, one in which many middle-class households struggle to pay their bills each month (Quart 2018).
How did we arrive at this situation? Policymakers are still debating appropriate responses to these trends and several proposals are under discussion to address them, including providing all citizens a basic income. This essay examines one specific effort that arose in direct response to the GFC: macroprudential regulation. Macroprudential regulation aims to identify and monitor systemic financial risks (Lombardi and Moschella 2017, 94). It seeks to secure the resilience of the financial system as a whole, rather than gauge the soundness of individual institutions. Scholars and regulators developed this framework in response to the financial complexity of the GFC. Here, I first briefly discuss the characteristics of the recent economic crisis. Thereafter, I explore the political economy of macroprudential regulation and the motives that underpin it. I conclude with a brief discussion of the importance of the politics of financial governance delegation and its significance for democratic accountability.
Great Financial Crisis
The Great Financial Crisis was triggered by a housing market bubble in the United States. But most importantly, as Tooze has argued, it resulted from the interconnectedness of the global financial system (Tooze 2018). Deep integration, in particular between Europe and the United States, meant that financial institutions around the world were affected by events in the U.S. Banks in Europe, Asia and Latin America were trading in United States dollars and difficulties in the American housing market therefore had a snowball effect internationally. With a share of their real estate holdings losing value, banks sought partially to recover their losses. This fact led financial institutions to stop lending money to one another and to all but cease offering credit to households and companies as well. The result was a credit crunch, that was evident first in “an implosion of interbank credit” (Tooze 2018, p. 9). With banks not lending money to each other, the financial system soon was unable to fulfill its intermediary functions, or, in other words, “the core financial system ceased to perform its intended functions for the real economy at a reasonable level of effectiveness” (Duffie 2019, p. 81). Moreover, as this scenario unfolded, another factor was at play: “hidden below the radar and barely discussed in public, [but threatening] the stability of the North Atlantic economy in the fall of 2008 was a huge shortfall in dollar funding for Europe’s oversized banks” (Tooze 2018, p. 8). Indeed, different branches of the U.S. government had to intervene in its economy to avoid its complete collapse. The United States government’s response to the GFC included four main elements:
(1) a stimulus package of approximately 800 billion dollars; 
(2) the de facto nationalization of several financial institutions in or near bankruptcy (AIG, Fanny Mae and Freddy Mac among others) and of some manufacturing companies, perhaps most prominently, the automaker General Motors;
(3) the use of low interest rates and quantitative easing by the Federal Reserve to provide liquidity and to stimulate borrowing;
(4) the development of new laws to protect consumers and depositors, in particular, enactment of the Dodd-Frank Act in 2010, which led to the creation of the Consumer Financial Protection Bureau (CFPB), the Financial Stability Oversight Council (FSOC) and the Office of Financial Research (OFR). The Dodd-Frank Act contained more than 2,000 pages of provisions. Its first title assigned the FSOC and the OFR responsibility to monitor systemic financial risk, a key form of macroprudential regulation.
Macroprudential regulation, and the broader concept of macroprudence originated in the late 1970s during the Latin American debt crisis and are characterized by their market-wide perspective in contrast to the micro-prudential perspective, which focuses on individual financial institutions (Clement 2010). A limited circle of policymakers and scholars in the central banking communities of the affected developing nations first adopted the construct. The concept spread to a broader audience in the late 1990s during the Asian financial crisis with emerging nations introducing some form of macroprudential policy instruments from the 1990s onwards (Castillo et al. 2011, p. 7). The term gained its present prominence during the second decade of the 2000s. Indeed, following the GFC, financial regulation took a so-called macroprudential turn (Baker 2013a). In truth, it can be considered an intellectual revolution, because the new framework rejected industry self-regulation; that is the idea that a sound financial system could rely on “financial firms’ own risk models” (Baker 2010, p. 661). In this respect, macroprudence was part of a larger narrative change linked to efforts to describe and explain how and why the GFC occurred. This shift led legislators and public officials to view the financial system as complex and interconnected and to conclude that to avoid the next catastrophe, they could not rely solely on individual firms’ self-regulatory practices, which had proved woefully unsatisfactory in the period leading up to the GFC. In other words, “a growing consensus among policymakers [emerged following the GFC] that a macroprudential approach to regulation and supervision should be adopted” (Galati and Moessner 2018, p. 735).
But what is macroprudential regulation, precisely? As noted above, it is a regulatory framework that aims to strengthen the resilience of the financial system as a whole. The major conclusion policymakers gleaned from studying the dynamics of the advent of the GFC and previous financial crises was that “what is prudent from the perspective of an individual financial intermediary might be imprudent from a macroperspective” (Galati and Moessner 2018, p. 736). This insight made it clear that risk is not exogenous, but rather, endogenous, to the financial system. That is, dynamics within and among institutions are typically responsible for that structure’s instability, rather than external and uncontrollable factors. This was a major change in how regulators approached system strength: overseers now sought to devise policies for its interconnected institutions as a whole.
The macroprudential approach to financial regulation considers risk systemic and endogenous and its designers have identified two main pillars of these: time-series and cross-sectional (Schoenmaker 2014; Kahou & Lehar 2017; Galati and Moessner 2018). The time-series dimension captures the notion that the financial system has a pro-cyclical tendency, or, in other words, in boom times such institutions tend to lend more as asset values grow “and this adds to the economic stimulus. [This relationship between] economic and financial cycles is often known as the ‘financial accelerator’” (Borio et al. 2001, p. 1). Capital buffers can help to reduce this pro-cyclical tendency and are an example of macroprudential instruments.  The cross-sectional dimension of risk in macroprudential regulation refers to the interconnectedness of individual financial institutions and markets. These relationships are what make such systems “complex.” The fact that banks are increasingly interlinked implies that there is a “common exposure to the same risk[s]” (Borio 2003, p. 7). Systemic capital surcharges can help to reduce such cross-sectional risk. 
To date, two scholarly literatures have emerged that address macroprudential regulation. The first has been concerned with the effectiveness of that framework (Lombardi and Siklos 2016; Galati Moesnner 2018; Aikman et al. 2019). Meanwhile, the second literature has investigated the motives and motivations that resulted in this new regulatory framework. If the GFC was the trigger for establishing efforts to achieve financial stability for the system as a whole, scholars in the political economy literature have explored the concerns that led regulators to create a regulatory approach in which they would henceforth assume responsibility for determining appropriate policy instruments to reduce financial risk.
The Political Economy of Macroprudence
As briefly discussed above, financial systems are surely complex. During the period immediately following the GFC this view had provided policymakers a rationale to become detached from that structure. In fact, a narrative arguing that the GFC was a product of the financial system’s complexity emerged. That view allowed lawmakers and regulators to escape accountability for the downturn (Datz 2013).  Nonetheless, when confronted with the collapse of the real economy—i.e., with a falling GDP and unemployment skyrocketing—public leaders had to make an explicit political choice: not only it was necessary to devise economic policies that would prevent, or at least diminish the consequences of, the next financial crisis, but it was also imperative to create a regulatory framework that could make a group of officials accountable for such events in the future. As Lombardi and Moschella (2017) have argued, since 2009, policymakers in North America and Europe have deliberately delegated power and authority to new regulatory agencies  and charged them with preventing fresh bouts of severe financial instability. Public leaders have clearly defined the agencies responsible and accountable for direct supervision and macroprudential regulation of the financial sector as a way of reassuring citizens that institutions within it are being held responsible for their activities. The implicit message is that these steps will help to prevent a recurrence of a GFC.
For their part, regulators encouraged legislators to take this step as a result of an “ideational shift” in their own profession (Baker 2013b). As Andrew Haldane of the Bank of England observed in 2009, “Macroprudential policy is a new ideology” (cited in Baker 2013b, p. 127). This frame constituted a radical change of perspective that supplanted previous assumptions about financial instability and redefined the goals of such regulation. As noted above, it represented a move away from assuming that financial institutions could largely regulate themselves to a view that the system is inherently potentially unstable and its whole is intrinsically different than even the sum of its parts. A combination of factors led to this shift, including the existence of professional networks of engaged (and persuasive) intellectuals (ibid.). The process had been gradual, but nonetheless ultimately proved transformative for this area of regulation. Engineered and driven by technocrats, this conversion led to the development of a new financial governance form via a process of “layering, [that is] when new rules are gradually grafted onto old ones” (Baker 2013a, p. 430). In consequence, apart from the legitimizing imprimatur of lawmaker action, macroprudence has thus far been a technocratic endeavor/project (Baker 2013a, p. 426). In sum, macroprudence arose in part from policymakers’ desire to signal their intent “to close the accountability gaps in financial regulation” (Lombardi and Moschella 2017, p. 100). It also resulted from an ideational shift among technocrats concerning how most effectively to diagnose and prevent financial instability.
Discussion: Macroprudential regulation, quo vadis?
All of this said, it is imperative to question the value and effectiveness of macroprudential regulation. A series of recent studies has sought to do just that and have arrived at contrasting conclusions. Baker (2018), for example, has contended that macroprudential regulation lacks a systemic vision of a “good financial and economic system derived from a combination of analytical and normative reasoning” (Baker 2018, p. 296). As a consequence, in Baker’s view, responsible technocrats have also not developed a strategy that adequately communicates their work to the broader public. As a result, macroprudential regulation remains relatively obscure to non-specialists and has not developed a broad political constituency. In this view, the inability to articulate a macro-morality derived from clearly stated social purposes has impaired macroprudential regulator capacity to devise and work to ensure a ‘good economic system’ (ibid.). That fact has also limited the ability of these regulatory agencies to realize political and broader citizenry expectations that they will ensure financial actor accountability and system stability.
As such, the democratic accountability of the technocrats and the regulators in the macroprudential sphere remains opaque. In the United States, lawmakers made a deliberate political choice to provide the Financial Stability Oversight Council, the agency in charge of macroprudential regulation, with limited “ability to respond to financial sector developments outside the commercial banking system” (Aikman et al. 2019, p. 127). The scope of macroprudential regulation is thus restricted to a relatively narrow range of institutions, leaving potential risks in other areas of financial activity unaddressed. Therefore, there is a lack of democratic accountability—the result of a deliberate political choice by lawmakers—in the current structure of macroprudential regulation. This contention challenges a share of Lombardi and Moschella’s (2017) argument that legislators delegated power to specific regulatory agencies after the GFC to allocate supervisory authority clearly. The fact that these entities supervise only a part of the financial system implies that their accountability for that structure as well as for their activities, is also constrained. If, or better, when, something goes awry, it may, therefore, still be difficult to assign clear responsibility for what institution(s) should be addressing it. Hence, it remains essential to understand what powers legislators have delegated, to whom and for what purposes. This understanding is crucial to ensure a reasoned assessment of whom to hold accountable, as well as why and how, when concerns arise. More generally, this argument suggests that the politics of power delegation for macroprudential regulation deserve the continued attention of scholars.
Overall, the lack of clearly stated social purposes and scope for macroprudential regulation impairs its relative effectiveness as well. Ten years after the GFC, the financial system is certainly more resilient than it was prior to that crisis, as regulators have introduced more stringent banking regulations and prohibited many unsafe practices (Duffie 2019).  However, the condition of large parts of the U.S. economy remain precarious, leading many analysts to question the implications of macroprudential regulation as currently practiced. Macroprudential regulation might bring stability and establish a regulatory framework that helps to limit the potential effects of a future financial crisis. However, if the link between financial regulation and the real economy is not clarified, it will be difficult to give credit (or indeed take issue with them either) to the technocrats and regulators for any such actions. In sum, the character and sufficiency of the powers currently delegated to the regulatory bodies created following the GFC remains an open issue. First, it is not clear whether it will be possible to hold them accountable for future instabilities because of their limited reach in practice. Second, the linkage between macroprudential regulation and the real economy remains unclear. As a result, financial actors could perhaps still take steps resulting in economic difficulties and regulators might still be able to argue, and rightly, that their remit did not reach the causes of that turn. In other words, it is theoretically possible that regulators, with the limited authority that they have been granted by lawmakers, will not be able to prevent future financial crises. The challenge of creating democratically accountable supervisors for the financial system remains an unfinished task. Scholars should continue to give this vital concern their attention
A recent study found that the nation’s central bankers are increasingly preoccupied by different topics, “broader than the traditional scholarly focus on inflation-related variables” (Moschella and Pinto 2018, p. 14). Political scientists and public administration scholars should cooperate with those officials as they work to develop an encompassing financial regulatory framework that is also democratically accountable. In this way, regulators can demonstrate the value of macroprudence, while also ensuring that their efforts to realize its tenets are transparent and democratically responsible.
1This stimulus package was approved by the U.S. Congress and is known as the “American Recovery and Reinvestment Act of 2009” which entailed spending in welfare, education, energy, infrastructure and so forth.
2 A countercyclical capital buffer is a condition imposed on a financial institution to augment the ratio it maintains between the amount of credit lent versus capital retained. This requirement leads banks to “cut excessive lending” (Kaohu and Lehar 2017, p. 100). This is fundamentally a loan-to-value (LTV) ratio.
3 A systemic capital surcharge is a different capital requirement for systemically important financial institutions (SIFI) that reduces the need for a ‘too-big-to-fail’ subsidy in the event of a crisis (Schoenmaker 2014, p. 6).
4 According to Datz: “Attributing the magnitude of the crisis to financial complexity presented a new twist within an old practice. A common impulse as corporate scandals, fraud and financial crises occur is to single out villains. […] In contrast, narratives about the crisis that emphasize the role of complexity in feeding financial turmoil focus on the system as the primary scale of analysis and often obscure agency. Many such accounts subjectified complexity; it was complexity that ‘acted’ often producing bewildering outcomes” (Datz 2013, pp. 466-7).
5 In the U.S. case, in particular the FSOC.
6 Other accounts are more dubious of the successes of the new regulatory framework. See for instance Tarullo (2019).
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Simone Franzi is a doctoral student in Planning, Governance, and Globalization. His current research project focus on the politics of financial regulation. Other research interests include the financial regulation of blockchain technology; the impacts of trade agreements to different dimensions of democracy; and the restructuring of democratic governance in light of the growth of global cities. Prior to coming to Virginia Tech, Simone received a Bachelor’s and a Master’s degree in Political Science and Geography at the University of Bern, Switzerland. He completed his undergraduate degree with a thesis on the conceptualization of trust in the social sciences. For his master’s degree, he studied the implications of commodity trading for sustainable development and he wrote a thesis on the relation between commodity abundance and international cooperation. Website: https://franzisimone.github.io.
February 7, 2019