The political economy of cross-border financialisation and financial stability: Essays on European experience

This dissertation is an investigation of a number of themes in financialisation and financial stability in a European and cross-border context. Continental European countries are the primary objects of interest, though the US and the UK are also considered given the relationship and similarities between the different regions. The PhD follows a three essay structure but with several unifying threads. Among them are financialisation as a demand-led process (that is, the growth of finance has been driven by factors external to financial markets), comparative and cross-border dynamics, interactions between institutional investors and the banking system, and housing market dynamics. In particular, the thesis examines the transformation and growth of banking activities, the nature and financial stability consequences of the expansion of financial trading generally and also proprietary trading in particular, and the determinants of cross-border debt flows in Europe in the 2000s. From these a number of diverse policy implications emerge. Common among them, and a unifying theme of the PhD, is that financialisation needs to be managed as opposed to reversed. The PhD adds to existing research on financialisation in a number of ways. The chapter on the growth of banking identifies the aggregate growth of investment banking as driven by the increase in scale and scope of modern capital markets. Deregulation and/or disintermediation processes have not been the driving force. The imposition of the first Basel Accord is found to be the largest single factor in the rise of mortgage lending over the past four decades or so. A capital market-led view of investment banking is a novel approach, whereas the invocation of the Basel agreements in this study is one of greater emphasis compared to existing literature. The following chapter finds that in the post-Bretton Woods landscape Europe graduated from recurrent currency crises to repeated credit-based housing crises. Financial trading has recently played a more indirect role in financial instability through the provision of liquidity to the banking system. Proprietary trading is largely dependent on the institutional investor-led increase in trading volume and, while important, has not posed the same threat to stability as housing market dynamics have. These points have not been adequately appreciated in the financialisation literature to date. The final content chapter develops this point further. It finds that institutional investors were the principal driving force in the expansion of debt-based capital flows in Europe in the 2000s. This point has not been appreciated thus far. Position taking by large banking groups was important, but banks largely availed of opportunities for gain as they arose. Institutional investors, in contrast, had a structural need for those instruments that were central to the expansion of flows. This dissertation utilises institutional and historical political economy analysis with frequent use of descriptive statistics. While aspects of the social world occasionally exhibit relatively stable relationships and forms (for example, lognormal distribution of income, Pareto distribution of city size, and so on), this is not the norm. Typically in quantitative social science and economics such forms are assumed a priori, and quantitative techniques such as regression then applied. However, there are reasons to be doubtful of this approach in general, which leads us to favour institutional analysis. For one, free-will imparts on economic agents behaviour that eludes capture by a formal deterministic or stochastic model. A deterministic (or stochastic) view of human agency violates our everyday intuitions that we have control over our actions and lives. The fact that people in general try to influence some outcome in their lives rather than just stay in bed because it has already been determined implies they believe their actions have the capacity to affect their world. Second, the social world is highly complex. Independent of free-will, the conditions under which a deterministic or stochastic model can be applied are highly circumscribed outside of laboratory conditions. Lawson’s (1997) example of a leaf blowing in the wind is a case in point. The problem of complexity applies, writ large, to human action. Further, institutional reasons include distortions arising from model-induced bias reinforcement, publishing bias, and issues surrounding the cleanliness of data. It is for such reasons that quantitative modelling is deemed inappropriate. Institutional and historical analysis also allows the examination of contextual factors which enable interpretation of events, processes, and so on. Some of the dissertation’s findings complement existing research. Others entail a difference in emphasis while others still are minority positions and contrary to a number of presuppositions held in the financialisation literature.