Why international institutions matter in the global credit crisis.

The global dimensions of the credit crisis of 2008 have become increasingly apparent. Bank failures, credit freeze-ups, and sharp stock market declines have spread well beyond the borders of the United States, the original epicenter of the crisis. What role, then, should international regulatory institutions play in addressing the crisis? Much public discussion of the crisis has underestimated the relevance of such international institutions, often assuming that they do not exist, or that they are so weak that we will have to relay to rely on nation-states for any meaningful response.

In contrast, I argue in this article that a relatively well-established set of existing international institutions should and will play a central role in response to the crisis. (1) However, I also argue that policy makers, regulators, and financial elites have displayed too much complacency and self-interest in their attitudes toward these institutions, and these failings need to be corrected with greater public awareness and pressure regarding the role that these institutions can play.

To see the potential of existing international institutions to address the current credit crisis, it is necessary to go beyond the assumption that only states or formal intergovernmental organizations can have influence. Faced with extraordinary complexity, including the need to manage the negative effects of fast-paced global markets, public authorities have increasingly shifted from centralized "command and control" to rely more on hybrid mixes of decentralized public and private regulation, a phenomenon that has been called "regulatory capitalism." (2) A risk in this shift is that policy and regulatory processes will be captured and manipulated by the private sector actors that they are supposed to regulate. However, such capture is not inevitable, especially if mechanisms for asserting the public interest in these processes are strengthened.

Transnational Private Sector Institutions in Global Finance

While the financial products involved in the present crisis are often seen as toxic, mysterious, and chaotic, they also signify an increase in the institutionalization of global financial markets. The current crisis is the first transnational one involving personal credit. There are direct linkages between individual borrowers and global financial markets, in which creditors and investors are much more widely dispersed than previously. Such connections have been enabled by the growth of a variety of now well-established transnational practices, institutions, clearing houses, and networks that transmit information, calculate risk, record contractual commitments, and transfer ownership claims. This institutionalization involves inertia, benefits, and sunk costs for the participants that will make transnational financial practices difficult to abandon. At the same time, this institutionalization can also provide opportunities for public and private authorities to strengthen the governance of global finance.

In the financial sector, as elsewhere, commercial firms may use their trade associations to propose self-regulatory arrangements as an alternative to public regulation. Such practices are very well established domestically and are becoming more evident in global finance as well. For example, the CEOs of leading international banks forestalled effective public regulation of hedge funds at the time of the 1998 Long-Term Capital Management (LTCM) crisis by organizing themselves into the Counterparty Risk Management Policy Group (CRMPG) and creating best practices. Ironically, this group's second major initiative, the CRMPG II report of 2005, predicted a number of the key elements of the current crisis, but evidently without significant effect. The influence of CRMPG I and II was undoubtedly enhanced by the reputation of the chair, E. Gerald Corrigan, managing director at Goldman Sachs and formerly head of the New York Federal Reserve and chair of the Basel Committee on Banking Supervision. He also cochaired CRMPG III, which in August 2008 issued a 176-page report with very extensive recommendations for changes to private sector practices, calling on private sector actors to have "a renewed commitment to collective discipline in the spirit of elevated 'financial statesmanship.'"

The private sector Institute of International Finance (IIF) has greatly expanded its role in global regulatory policy since its formation in 1982 as a group of leading commercial banks seeking to help one another assess the sovereign risks associated with the developing country debt crisis of that day. The IIF was, among other things, influential in shaping the Basel II capital adequacy standards for bank regulation. In July 2008, the IIF issued a lengthy set of "Principles of Conduct and Best Practice Regulations," which expressed the financial industries' preferences for minimizing the severity of the regulatory response, while also acknowledging the need for some substantial changes in public and private governance. The IIF has also recently established a high-level private sector Marketing Monitoring Group, which will monitor systemic risks and interact with international official bodies.