CANALES DE COMUNICACIÓN

the Aftermath of the Financial Crisis

Introduction

Financial markets have been highly innovative over the last two decades. The number of new products and variations on products which have been launched over this period has been immense (see the discussion in Engelen et al., 2010). Newly invented products such as credit default swaps (CDS) and collateralized debt obligations (CDOs) went from zero transactions to transac- tions that were calculated to place billions of dollars at risk, all within the space of a few years. The speed of diffusion of these products across actors, institutions, and countries was dramatic and illustrated a basic problem in law and regulation. As the actors themselves were aware, if all such products had to be subject to regulatory approval or, even worse, had to be explicitly allowed for in law, the speed of innovation would slow to a crawl. This would have a variety of disadvantages to the originators of such products, for example, nobody would be able to accruefirst-mover advantage and the possibility of rapidly establishing scale and reputation for these new products would be more difficult to achieve.

It is important to note that this represents a massive break from the way in which financial markets were conceived and regulated previously. At least since the New Deal, it has been recognized thatfinancial innovation is not an unalloyed benefit to society. On the contrary, during the heyday of the Bretton Woods system, fixed exchange rates, controls on flows of capital, varying levels of state management offiscal and monetary matters, and legal prohibitions on certain forms of activity and organization all inhibited

financial innovation in order to reduce the possibility of volatility, turmoil, andfinancial booms and busts. The collapse of this system as described in numerous accounts of the rise of neoliberalism (e.g., Blyth, 2002; Krippner, 2011) and the gradual establishment of deregulatedfinancial markets, partic- ularly in the United States and the United Kingdom, changed this situation. Much of the literature within political economy concentrates on these macro- processes. However, this broader change still required activities at a more micro-level in terms of particular markets, products, andfirms if the potential was to be realized. The space forfinancial innovation still has to be made and imposed in contexts where there are competing actors with different interests and power capacities. How markets work in practice and with what effects requires attention to the details of those markets and not just the facilitating role which institutional and ideological change plays.

In this respect, thefinancial crisis gives us a useful opportunity to examine the interplay between the macro-level of regulation and government and the micro-level of markets and private actors. It reveals the limits of hegemony, that is, the degree to which the taken-for-granted structures in particular sectors of thefinancial market can be revealed as the outcome of distinctive forms of power and politics. Thefinancial crisis shows starkly who benefits and who loses from a particular structure and then reveals to us how public and private actors struggle to build a new order in a new context.

This chapter focuses on a specific sector of thefinancial markets, which is concerned with Over-the-Counter (OTC) derivative products. What makes this a particularly interesting object of study is that in the run-up to the financial crisis, OTC products grew to a huge extent and were integrally involved with the overall expansion of CDOs, subprime mortgages, and the subsequent balance sheet difficulties encountered by manyfinancial institu- tions. Early analyses of the collapse of 2008 identified OTC derivatives as the fundamental cause of the crash. How these markets operated became subject to more detailed scrutiny and what emerged was a complex interplay of politicians, regulators,financial institutions, and intermediaries struggling to shape and reshape law and regulation by using various resources, theories, and technologies.

The chapter has three parts. In thefirst part, the struggle over the legality of OTC derivatives is discussed and it is shown that in spite of resistance, the combined power of industry insiders and supportive federal officials led the United States to legitimate these products in a way that was particularly advantageous to those trading them. The result was that industry insiders (in the International Swaps and Derivatives Association, known as ISDA) created their own framework for managing these products. In the second part, the products themselves are discussed in more detail to show how and why they were capable of producing the sorts of profits that further

augmented the legitimacy of the market and the power of the institutions which were trading them. In the third part, the impact of thefinancial crisis on this market is discussed and in particular how issues of law and regulation surfaced again. This shows how in spite of the massive delegitimation which had taken place as a result of the crisis, private actors have still been able to limit the degree of legal and regulatory constraint to which they have been subject.

Over-the-Counter Derivatives and the Growth