Shadow Banking: a story of the Doppelgänger (the Double) in science of finance

Ismail Ertürk

Alliance Manchester Business School, The University of Manchester

(ismail.erturk@manchester.ac.uk)

Correponding author:

Ismail Ertürk, Alliance Manchester Business School, The University of Manchester, Booth

Street West, M15 6PB

Email: ismail.erturk@manchester.ac.uk; Phone: 07796 951 788

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Abstract

After the 2007 financial crisis central bank economists in the U.S. produced a map of shadow

banking system, a fragile interconnectedness of regulated and unregulated financial

institutions, to explain why the crisis had happened. This piece of cartographic work in

banking regulation had two aims: a) to represent the economic reality, including the parts that

were not in regulatory sight, with full realism and b) to develop a regulatory surveillance

regime to monitor shadow banking to prevent future crises. This paper problematises the first

aim as a peculiar cognitive response to the knowledge crisis of economics which challenges

the consensus on modern finance as post-modern Baudrilliardian as simulacra. The paper

then introduces a cultural economy perspective to explore the regulatory fear in the second

aim of the shadow banking analysis with references to the theme of the Doppelgänger (the

Double) in the genre of horror stories. Finally the societal consequences of the control

oriented epistemological choices of the shadow banking analysis are problematised by using

Michel Serres’s concepts of foedera natura versus foedera fati.

Keywords: finance; knowledge; banking; culture; financialisation

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Shadow Banking: a story of the Doppelgänger (the Double) in science of finance

“The maps of the financial world being used and developed by regulators today broadly

resemble those used and developed by cartographers in the 15th century. Large parts of the

geographic globe were at that point uncharted territory, a source of fear and foreboding.

Today, large parts of the financial globe are similarly uncharted or cast in shadows. They

too are a source of regulatory fear and foreboding.” (Haldane 2012, p.13)

“The physics of flow, the science of their law, and the Archimedian logic of maximal paths

immediately produce a moral technology. That of balanced level-headedness, of equanimity.

Or of calmed materialism.” (Serres 2000, p.54)

Introduction

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The financial crisis of 2007/2008 invited critical reflection on knowledge in economics in

academic circles and high brow financial media like Financial Times and the Economist.

Regulatory economists working at central banks too joined in this reflection on the

paradigmatic crisis in economics and have produced new analytical frameworks aiming to

guide policy especially in controlling credit creation and systemic risks in financial markets.

This paper will focus on one of these cognitive responses by regulatory economists, the

mapping of shadow banking that also attracted a major academic interest. Unlike the

structural reform initiatives like the Dodd-Frank Act in the U.S., the Vickers Report in the

U.K. and the Liikanen Report in the eurozone the shadow banking regulatory practice has

involved a series of analytical research papers with paradigmatic consequences particularly

by the U.S. Federal Reserve economists. A similar cognitive initiative by regulatory

economists based at the Bank for International Settlement, the international coordinating

body of central bankers, has started a new praxis in collecting theory driven data on financial

cycles (Borio 2010; BIS 2014), inspired primarily by the work of Keynesian economist

Minksy, whose hypothesis of monetary endogenous instability in capitalist economies has

attracted notable critical attention after the crisis. In not so insignificant way the Bank for

International Settlement’s work on financial cycles challenges the idea of external shocks-

driven business cycles as major cause of fluctuations in key macro-economic variables of

growth and employment. The work on shadow banking by the Federal Reserve and IMF

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economists too challenges another orthodox view in financial economics that financial

innovation allocates risk and credit efficiently without systemic risk consequences.

My focus on the rise of the shadow banking paradigm in regulatory economics has a cultural

economy angle. The key original document on shadow banking presents a map that claims to

make visible all institutions and all flows involved in the shadow banking system that were

not previously recorded systematically by the regulators. This is in epistemological sense a

Borgesian map, as I will discuss below, proclaiming a scientific exactness in representing

reality. This example of novel economic knowledge which has influenced the regulatory

thinking on overseeing global financial markets was a response with paradigmatic

consequences to the knowledge crisis in economics that accompanied the financial crisis of

2007. At an epistemic conjuncture where there has been production of significant amount of

influential work and debate on financial reality as problematic creation by performative and

reflexive economic models the regulatory economics of shadow banking poses an anomaly

because it is based on a cognitive practice aiming a mimetic representation of reality that

belongs, in the genealogy of knowledge, to the classical age. This extremely influential post-

crisis regulatory economic model is not a postmodern Baudrillardian hyperreal simulation.

Not only did the shadow banking economic model deviate from the current epistemological

trend but its preference to use the trope of “shadow” instead of the accepted technical term

“market-based finance” added an element of intended affect to its rational essence. The term

“shadow” conveys the fear from possible collapse of the financial system as a consequence of

the unregulated shadow activities and institutions in financial territory. The symbolic use of

shadow to signify the unknown and the moral challenge to rational scientific knowledge is a

well-known subject in literature and cinema, especially in the Weimar cinema of the 1920s.

The shadow, the Doppelgänger (the Double) in German expressionist cinema is a signifier of

a science which is out of control and in moral confusion. The shadow banking analysis is,

too, at one level a story about financial innovation, science of finance gone wrong.

The discourse of shadow banking is characterised by a scientific modality driven by a desire

to control the reality, the reality of complex modern financial system. This contrasts with the

kind of problematic, for example in social studies of finance, where the interaction and

ontological hierarchy between economic models and economic reality constitute the research

interest (Muniesa 2014). The post-crisis regulatory economics on shadow banking, on the

other hand, shifts our epistemic frame from one of formatting the economic reality with no

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associations of affect to one of control of the economic reality that lives with its threatening

double (Doppelgänger). This epistemic shift however operates in a field that is not restricted

to policy because the regulatory economics of shadow banking is also about establishing an

academic research intelligibility that assumes a capacity to introduce cognitive order to the

complexity of financial markets and institutions.

An effective regulatory policy requires an intelligence report, a precise map of the terrain. To

achieve this tool the regulatory economics of shadow banking regresses to the epistemic

essence of the classical age where the signifiers precede the signified and consequently

presents an interesting rupture in our critical thinking on modern finance as a simulacra. The

objective of the regulatory economics of shadow banking is to produce scientific knowledge

that would enable the regulators to control the financial reality, to be master of the object they

investigate. The French philosopher Michel Serres (2000) warns against the societal outcome

of such approaches to science where the scientist searches for laws in nature in order to be

able to manipulate them for control. A different approach to science where the knowledge

acknowledges flux in the world and aims to have a pact with its object has a capacity to

project consensual political and social intents. Given the kind of scientific tradition it

belongs to the shadow banking analysis is likely to lead to a financial system that is not

habitable in the long term because the aim of regulatory control overrides a project that leads

to a societal pact with finance. The question of what use the society gets in solving its vital

problems of affordable housing, financial planning for pensions, etc. out of macroprudentially

controlled shadow banking remains unasked let alone answered by regulatory economists.

In the following section I will discuss the mapping of shadow banking as an epistemic shift at

a time when the critical thinking on finance is dominated by debates on performativity. This

then will be followed by an argument that the theme of the Doppelgänger from the genre of

horror stories, where the creation of the scientist becomes an uncontrollable threat to the

society, is also present in the shadow banking analysis. The last section will introduce an

alternative approach to science inspired by the French historian of science Michel Serres that

advocates a knowledge of finance aiming pacts rather than mastery that can lead to a socially

useful finance.

1. The map of shadow banking: a Borgesian fable about the exactitude of science (of

economics)?

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The quotation at the beginning of this paper from Andrew Haldane, senior central banker at

the Bank of England, expresses similarity in scientific methods of the cartographers of the

15th century and the bank regulators in the 21st century. Not only does he affirm the epistemic

affinity between these two temporally and professionally distant knowledge communities he

also acknowledges the shared emotions of fear and foreboding that drive their acts of

reasoning in the face of the unknown. Haldane has emerged as a critically thinking central

banking technocrat after the 2007 crisis on the issue of knowledge of finance and social value

of finance. His frequent erudite multidisciplinary public speeches were taken seriously

enough in the academic community to become the subject of a themed section in the Journal

of Cultural Economy entitled “Engaging Andrew Haldane: Complexity theory, financial

sociability and political arithmetic’ with contributions from Pryke (2011), Cooper (2011),

Ertürk et al. (2011) and Thompson (2011). Therefore in this context Haldane’s observation

in the quotation above about the predicament of the epistemic community he belongs to

carries a justifiable weight. And also significant is his characterisation of the post-crisis

knowledge production by regulatory economists on financial markets because cartographic

knowledge is an anomaly in the context of academic imaginaries that have recently

dominated the thinking on financial markets. Cartographer economists at the world’s major

central banks driven by fear share little similarity with either the kind of calculative traders,

who have become the subject of sociology of finance, engaging in the game of performativity

and simulacra (Haiven 2014; Muniesa 2014) or modernist financial engineers who are

believed, by mainstream financial economists, to find scientific solutions to risk problems in

finance (Finnerty 1992; Merton 1992; Tufano 2003).

These regulatory economists travelled back in the history of sciences to the kind of

representation that according to Foucault (1970) characterised the Classical age, the age that

Haldane refers to too as the age of cartographers, and is memorably fictionalised in Borges’s

fable of “Of Exactitude in Science” (Borges 1981). In this kind of epistemological world the

scientist’s work mirrors the real world: “And representation – whether in the service of

pleasure or of knowledge – was posited as a form of repetition: the theatre of life or the

mirror of nature, that was the claim made by all language, its manner of declaring its

existence and of formulating its right of speech.” (Foucault 1970, p.19). The regulatory

economists that Haldane refers to regressed not only in method but also in theory and framed

their mapping of the financial system by using the textbook understanding of what banking is

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for. In this textbook version of banking mainstream economists imagine banks as

intermediaries between savers and borrowers in the economy and almost exclusively

concentrate on their credit creation function. But this view of banks has already been largely

abandoned by the mainstream finance literature that declared way back in the 1990s that

securitisation and derivatives have transformed the role of banks from one of intermediation

between savers and borrowers to one of transforming risk in the economy (Allen and

Santomero 1998 and 2001; Ertürk and Solari 2007; Merton and Bodie 1995). Just like in

almost all mainstream economics the regulatory economists writing on shadow banking carry

out their analyses without a critical engagement with either the history of economics or the

history of economic thought. Defined by this kind of wilful amnesia the economics of

regulatory economists led to the creation of a map, the map of shadow banking (see Figure

1), which launched a new post-crisis project of regulatory panoptic located at the Financial

Stability Board -a group of finance ministers, central bankers and financial institutions that

monitors and makes recommendations about the global financial system- and is integrated

into the broader post-crisis regulatory surveillance known as macroprudential risk

management. The aim of this proto panoptic surveillance based on the shadow banking

framework is to address the fear of experiencing in the future another catastrophic systemic

risk in the global financial system (Benigno et al. 2013; Claessens et al. 2013). When the

debates among the academic economists in the aftermath of the crisis on the failure of the

science of economics were calling for a new theoretical paradigm to explain and predict the

economic phenomenon the regulatory economists have followed a different cognitive path to

sharpen their analytical tools to accurately map the constellation of the financial system.

[insert Figure 1 about here]

In the aftermath of the 2007 financial crisis there was a widespread agitation in academia,

media and in some sections of the society to deliberate on knowledge failure in economics. In

this context the sentiments of the Queen in the U.K., expressed at her visit to the London

School of Economics in 2008, asking the eminent members of the economics discipline

something along the lines “how come you could not see the crisis coming if it was so big”

have become both ubiquitous and efficacious in describing this interest. The Economist (18

July 2009, p. 72), another icon of the establishment, was more emphatic and expectedly brash

in its views and declared that “macroeconomists ... must write off many of their past

intellectual investments.” These establishment names were joined by the Keynesian

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economists in the criticism of neo-classical economics. Nobel laureate Krugman (September

2, 2009), who described Chicago economists as “product of a Dark Age of macroeconomics”,

and another Keynesian economist Jeffrey Sachs (2009, p.1), who called for “basic reforms

in... macroeconomic science” shared similar sentiments as the Economist. For Caballero

(2010) such reforms should be based on, in the first place, admitting the knowledge pretence

in macroeconomics that Cooper (2011) traced historically in neoliberal thinking back to the

debates between the two towering figures of Hayek and Friedman who differed

fundamentally in their views of economics as a science. Among all this sound and fury

regarding the knowledge failure in economics Financial Times columnist Gillian Tett

(March 9, 2009) announced the urgent need for an intellectual compass: “[crisis] has left

everyone from finance minister or central banker to small investor or pension holder bereft of

an intellectual compass, dazed and confused.” Instead of a compass, a year later in 2010 the

economists at the Federal Reserve Bank of New York (Pozsar et al. 2010) came up with a

map, the kind of cartography that Haldane above refers to, that prioritised the cartographic

knowledge of the financial terrain of which a substantial part was in shadows for the

regulators. A compass without a reliable map would be no use in navigating safely and

purposefully in complex world of finance.

Pozsar et al. (2010) produced the map of shadow banking in a 230-page colossal monograph

which was a Staff Report at the Federal Reserve Bank of New York and of which only the

first 80 pages were published in July 2010 with the remaining announced to be an

unpublished work in progress. But the table of contents for the complete monograph of 230

pages was provided. In the published 80 pages of this gigantic monograph, before the main

text starts and right after the abstract, a zoomed-out copy of the map of the shadow banking is

provided (see Figure 1)i. On the page after the map an “Authors’ Note” recommended

readers “... printing the ... map of the shadow banking system as 36’’ by 48’’ poster.” (Pozsar

et al. 2010) On an A4 page the map looks like a circuit board with multitude of illegible

boxes and lines. In a further improvement to the conceptualisation and mapping of the

shadow banking, after he moved to The Office of Financial Research, a post-crisis institution

based in the U.S. Treasury, from the Federal Reserve Bank of New York, Pozsar (2014)

opined further cartographic improvements to the mapping of the shadow banking and advised

that the existing official maps of money flows like financial accounts in the U.S. should be

improved by capturing flow of collateral, flow of risk and flow of Eurodollar satellite

accounts between financial institutions. The new home of Pozsar, The Office of Financial

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Research, describes its role in the regulatory structure in the U.S. as: “Our job is to shine a

light in the dark corners of the financial system to see where risks are going, assess how

much of a threat they might pose, and provide policymakers with financial analysis,

information, and evaluation of policy tools to mitigate them.”

(https://financialresearch.gov/about/).

This self-description by the Office of Financial Research brings to mind the fictional

“College of Cartographers” in Borges’s fable on map making referred to above. In his short

story called “Of Exactitude in Science” Borges writes “... the College of Cartographers

evolved a Map of the Empire that was the same Scale as the Empire and that coincided with it

point for point.” (Borges 1975, p.131) The French philosopher Jean Baudrillard announced

the death of such scientific knowledge by referencing to the Borges’s fable and by

announcing that in the post-modern world that we live in maps no longer pretend to represent

a reality and the hierarchy of truth between representation and reality has disappeared. For

Baudrilliard, maps, in our post-modern era, are as real as the reality itself-i.e. they are

hyperreal. “It is the generation by models of a real without origin or reality: a hyperreal. The

territory no longer precedes the map, nor does it survive it. It is nevertheless the map that

precedes the territory ...” (Baudrillard 1994, p.1) This Baudrilliardian understanding of

knowledge has also heavily influenced thinking on finance in some quarters of cultural and

social studies of finance (see for example Haiven 2014 and Muniesa 2014). Therefore the

return of the map as a mimetic model in modern cognitive studies of finance is of significant

interest to a cultural understanding of post-crisis regulatory economics.

The often cited first coiner of the name “shadow banking” is Paul McCulley, who was

working for one of the largest fixed income asset management company in the world,

PIMCO, when he described shadow banking, soon after the August 2007 turbulences in asset

backed securities market that later led to the great recession of 2008, as ‘the whole alphabet

soup of levered up non-bank investment conduits, vehicles and structures’ (McCulley 2007,

p.2). Pozsar’s successive maps after McCulley’s announcement of the existence of scary

shadow banking (Pozsar 2008 and Pozsar et al. 2010) were epic scale cognitive responses

bringing order to the chaos of “alphabet soup” of unregulated financial institutions.

Published in July 2008 before Lehman collapsed but after the first set of liquidity injections

by the Federal Reserve to both banks and non-banks to save the financial system Pozsar’s

2008 article heroically aimed to map a vast “…constellation of forces that drove the

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emergence of the network of highly levered off-balance sheet vehicles—the shadow banking

system—that is at the heart of the credit crisis” that the regulators and the majority of

academics have failed to see being formed in the territories of their cognitive interest (Pozsar

2008, p.13). This was literally a moment of Borgesian map making in a science that had

come under severe criticism from both within and outside the economics discipline. The

2008 article by Pozsar, which included the early crude version of the map of shadow banking,

offered in a footnote to provide “[a] guide to how to read the map” upon request (Pozsar

2008, p.17).

The article was published in a professional journal, The Regional Financial Review which is

aimed at investors including the ones who engage in commercial real estate and consumer

lending. The Regional Financial Review is a publication of Moody’s Analytics, a subsidiary

of Moody’s, providing non-rating services and where, at the time Pozsar was working as “US

macroeconomist”. The publication boasts that “[n]o other subscription product on the market

covers the U.S. macro and global national macro economies, along with their subnational

regional areas as extensively as the Regional Financial Review publication.”

(https://www.economy.com/products/research/regional-financial-review). Just like in his co-

authored 2010 paper at his next employer Federal Reserve Bank of New York, Pozsar, whose

career has attracted serious academic interest (see Engelen 2015) and whose work is

described as “ground breaking” by VoxEU.org, the policy portal of the European academic

network The Centre for Economic Policy Research, had an epic scale work in mind on

shadow banking in his 2008 paper too, announcing that it was the first of a total of four

papers on shadow banking which he then defined as “the network of highly levered off-

balance- sheet vehicles—the shadow banking system—that is at the heart of the credit crisis.”

(Pozsar 2008, p.13).

This epic work mapping shadow banking aims to restore order to the complexity of financial

system by introducing a classification system where the institutions and flows are

differentiated along a continuous flow of credit intermediation on the basis of their regulatory

status. As Foucault observed in his analysis of the knowledge characteristics of classificatory

systems “For taxonomy to be possible, on the other hand, nature must be truly continuous,

and in all its plenitude. ...[C]lassification requires the principle of the smallest possible

difference between things.” (Foucault 1970, p.174). The continuity in the case of shadow

banking is the flow of savings by households and businesses through financial intermediaries

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to the borrowers. On the shadow banking map money flows continuously in multiple

directions and temporalities without any break between numerous regulated and unregulated

institutions. And at the same time the map aims to show the smallest possible difference in

function and role between these financial institutions in the credit creation process. The

“alphabet soup” of the plenitude of financial institutions- special purpose vehicles, asset-

backed commercial paper conduits, money market funds, broker-dealers, monoline insurers,

hedge funds, banks, asset managers, etc. - is meticulously classified in the shadow banking

map that claims to truthfully mirror the reality. More stylised versions of the shadow banking

map and the various definitions and conceptualisations of the term “shadow” have naturally

followed in the publications by both regulatory and academic economists, the latter including

both mainstream and political economy academics (see for example Cooper 2015; Engelen

2015; Gabor 2015; Kessler and Wilhelm 2013; Lysandrou and Nesvetailova 2015). In his

political economy review of the policy discourse on shadow banking Engelen (2015) reports

that, as of 24 March 2015, Google.Scholar search showed 10,400 academic publications on

shadow banking with the original contributors (Poszar et al. 2010; Adrian and Shin 2009;

Gorton and Metrick 2010) are the most cited authors who share a similar background in

descriptive and applied economics rather than in theoretical economics that tend to attract the

critical attention of performativity literature in economics.

The impact of the shadow banking map was almost instantaneous on the politicians and the

policy makers. The Group of Twenty (G20) meeting in Seoul in 2010 and then the following

year’s meeting in Cannes started a process to extend the mapping exercise globally (G20

2010 and 2011).

“The shadow banking system can create opportunities for regulatory arbitrage and

cause the build-up of systemic risk outside the scope of the regulated banking sector.

To this end, we agree to strengthen the regulation and oversight of the shadow

banking system and endorse the FSB initial eleven recommendations with a work-

plan to further develop them in the course of 2012, building on a balanced approach

between indirect regulation of shadow banking through banks and direct regulation of

shadow banking activities, including money markets funds, securitization, securities

lending and repo activities, and other shadow banking entities. We ask Finance

Ministers and Central Bank Governors to review the progress made in this area at

their April meeting.” (G20 2011, p.6).

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After being mandated by the G20 in 2010 in Seoul Financial Stability Board (FSB)-which

was established in 2009 by the G20 as a successor of Financial Stability Forum to promote

the reform of international financial regulation- has started to develop standards to map,

measure and regulate shadow banking globally. The October 2011 FSB report on shadow

banking represents the first comprehensive international effort to deal with shadow banking.

FSB work focuses on (i) the definition of principles for the monitoring and regulation of the

shadow banking system; (ii) the initiation of a mapping process to identify and assess

systemic risks involved in shadow banking; and, (iii) the identification of the scope of

possible regulatory measures (FSB 2011).

Although in its initial reports FSB expressed grave concerns about the systemic risk that the

shadow banking can cause, especially drawing attention to the activities of unregulated non-

banks that included pension funds and insurance companies, FSB has later on started to tone

down the pejorative associations and regulatory implications of the word “shadow”. Since

the regulated banking still has not in most core capitalist countries recovered fully from the

effects of the 2007 crisis and now operates under stricter capital adequacy rules banks are

unwilling to restore credit flow to the private sector particularly to the small and medium size

companies. Therefore the sections of unregulated shadow banking system especially the ones

that are essential for loan securitisation are seen as alternative to bank lending to restore

credit flow to the economy (Carney 2014; European Commission 2015). In 2014 Carney

(2014), Chairman of FSB and Governor of the Bank of England, publicly acknowledged the

need for market-based finance, the sanitary technical term for shadow banking, to fill the

intermediation gap that the banks have left after the crisis. But nevertheless FSB continues to

monitor and oversee the shadow banking as the systemic risk in the shadow banking is still

considered a vital threat. And it continues to use the non-technical and morally charged term

“shadow banking” in its supervisory reporting rather than the sanitary equivalent “market-

based finance” despite its pejorative associations because “shadow” has been firmly

established in the official lingo (FSB November 2015, p.1).

FSB’s proto panopticon on the global shadow banking is an ongoing project as an

international consensus on the classification and regulation of shadow banking has not been

formed. For example IMF economists Claessens and Ratnovski (2014) challenged the FSB’s

definition of “shadow banking” for operational purposes in collecting and monitoring data,

and regulating the financial system. Also in some European countries where the

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bancassurance model and the universal banking model are part of their idiosyncratic capitalist

institutions separating insurance companies and pension funds as shadow banking institutions

runs against national and elite interests. Nevertheless the mapping of shadow banking now

firmly constitutes the analytical backbone of a post-crisis surveillance system that the

regulators have created under the name of macroprudential policy (see for example Borio,

2011 and Baker, 2013). Central banks have gained new supervisory powers after the 2007

crisis to monitor and control systemic risks in financial markets. Pre-crisis bank regulatory

paradigm was based on microprudential supervision of individual banks and financial

institutions. The interconnectedness and complexity associated with the 2007 financial crisis

and disclosed by the shadow banking map has changed the paradigm of regulation to

complement the microprudential with the macroprudential supervision which empowered

central bankers to intervene in the asset price formation processes that are related to bank

credit.

3. Shadow banking as the Doppelgänger (the Double) of the science of finance

Macroprudential policy is driven by the fear that the complex interconnectedness of financial

institutions -where unregulated shadow banks feed the growth of credit in the economy

through their links with the regulated banks in wholesale funding markets using instruments

like asset backed commercial paper and repurchase agreements- creates risky sources of

liquidity to the financial system. A run on regulated banks in this market, like it did in 2007

and 2008, can have catastrophic consequences both for the financial system and the economy

through collapse of mega banks and sudden seizure of credit to real economy. Central banks

are equipped with tools and mandate to deal with a run on banks that is caused by retail

depositors or loss of trust in interbank market. Under such extreme situations a backstop for

regulated banks exists because central banks can act as lender of last resort. In 2007,

however, the run on regulated banks happened in the wholesale markets where the

unregulated financial institutions like money market funds were indirect providers of

wholesale funds to the banks. In order to save the regulated banks the U.S. Federal Reserve

had to provide liquidity to the unregulated financial institutions initially through new

facilities like Term Securities Lending Facility, the Primary Dealer Credit Facility and

Money Market Investor Funding Facility (see Gorton 2010; Mehrling 2011;

www.federalreserve.gov/monetarypolicy/bst_lendingother.htm). This kind of lender of last

resort role in the shadow banking system was unprecedented for a central bank like Federal

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Reserve. Post-crisis regulatory powers under the macroprudential policy after the crisis aim

to equip central banks with new ex-ante tools to prevent possible break-downs triggering

lender of last resort role involving shadow banks. Such tools allow central banks intervene in

excess credit creation to stop asset bubbles, especially in real estate, from getting out of hand.

The mapping of and research on shadow banking then arm central banks with the panopticon

visions of the field to empower them in performing their new post-crisis macroprudential

policies. Post-crisis macroprudential regulation is the manifestation of the fear of systemic

risk due to internal excesses (leverage, collateral use, shadow banking) of the financial

system that can cause crisis or serious disruptions to the functioning of the financial system.

As such macroprudential regulation differs from microprudential regulation where systemic

implications of an individual bank’s excesses in leverage, risk taking, etc. are the aim.

For the reasons explained above a run on shadow banking is seen as the most serious novel

threat to the financial stability in financialised capitalism. The regulatory research on shadow

banking acknowledges the continuing presence of a sizeable quantity of darkness in the

financial system that requires a globally coordinated surveillance (IMF 2016a). As such fear

is mediated through regular and in most parts inconclusive economic information and

analysis on shadow banking. The trope of “shadow” that strongly and effectively conveys

the emotion of fear and foreboding mentioned above in Haldane quotation is still preferred in

official regulatory language to the term “market-based finance” that has more rational and

technical associations. As academics from literary studies, Crosthwaite, Knight and Marsh

(2014) comment in their book on the visual representations of finance in arts and culture from

the 18th century to the 2007 crisis mainstream economists prefer to deny or ignore the cultural

and emotional factors in finance (p.1). The sociology of finance literature too challenges the

mainstream economics’ purely rationality-based representation of economic reality. For

example McFall (2009 and 2014) argues in her work on consumer market transactions the

importance of the emotional aspects of markets by introducing the concepts of attachment

and charisma in explaining the way the consumers actually behave in making purchasing

decisions. For culturally minded studies of economics and finance the discursive element in

the post-crisis regulatory economics on shadow banking cannot be merely seen as a linguistic

detail without a semantic depth. For example de Goede (2009) stresses that:

“[i]t needs to be understood that the material practices of financial markets and

financial regulation intimately depend upon the ways in which discursive

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understandings of financial crisis unfold... It is these discourses that bring economic

and financial reality into being, and that render certain (policy) interventions more

possible than others. While not new to economic and financial history, moreover, it is

probably the case that processes of mediation have become more important in the

current globally mediated age.” (p.295 and 297)

Another cultural economist, Finel-Honigman (2010, p. 43), includes fear in her list of

attitudes towards money in defining financial and economic culture: “Fear, myth, fantasy and

revulsion toward money, its actors, transactions, and institutions are an integral part of

financial and economic culture...” Historically, finance has always been associated with

morally charged activities like speculation and gambling that corrode social cohesion, ruin

individuals and families (de Goede, 2005). Moretti (1982), a cultural studies scholar, in his

study of cultural representations of capitalism through fictional monsters like Frankenstein,

reinforces Finel-Honigman’s pairing of fear and economics by adding economy to a list that

includes ideology, psychology, sex and religion as a cause for fear. Moretti (1982) also lists

science as a subject that horror stories are about:

“Frankenstein (like Jekyll and Hyde) does not want to scare readers, but to convince

them. It appeals to their reason. It wants to make them reflect on a number of

important problems (the development of science, the ethic of the family, respect for

tradition) and agree -- rationally -- that these are threatened by powerful and hidden

forces.” (p.84).

Moretti’s views can be applied to the shadow banking literature because this literature, too, at

one level, is fundamentally an affective reflection on the science of finance, financial

innovation, financial engineering. Shadow banking is also a discourse about how powerful

and hidden forces in the configurations of CDOs, credit securitisation, credit default swaps,

etc. threatened and continue to threaten the economic order and the traditional financial

intermediation where regulated banks originated loans and kept them on their balance sheets.

Regulatory economists see the model of financial intermediation where banks originate loans

and then securitise and sell them to other unregulated financial institutions, i.e. distribute

them, rather than hold them on their balance sheets, as the defining characteristic of shadow

banking (Claessens et al. 2012; Gennaioli et al. 2013; Luttrell et al. 2012). Financing of and

investment in credit risk moves from regulated banks’ balance sheet to an intermediation

15

abyss called shadow banking that does not have a backstop from bank regulators. Lutrell et

al. (2013) calls the set of events in shadow banking that require a backstop “negative vortex”.

What the regulatory economists separate after the crisis into two, regulated and unregulated

(shadow) space in finance, the chief regulator in the U.S., the chairman the U.S. Federal

Reserve, Bernanke, saw as one continuous natural space of efficient finance before the crisis:

“We should also always keep in view the enormous economic benefits that flow from

a healthy and innovative financial sector. The increasing sophistication and depth of

financial markets promote economic growth by allocating capital where it is most

productive. And the dispersion of risk more broadly across the financial system has,

thus far, increased the resilience of the system and the economy to shocks.”

(Bernanke 2007)

Bernanke speaks truth in a discursive space where the science of finance promises progress

and welfare. One of the leading authorities of the science of finance, the Nobel Prize winner

Merton (2000, p.7), confidently declared that:

“Just as the science of finance has helped shape the practice of finance, so practice in

turn has helped shape the evolving theory. Financial innovation has generated a great

variety of new institutions to serve financial functions, presumably more efficiently.

Since theory is not institution based, those real-world innovations provide financial

scientists a rich opportunity to understand the selective processes mapping institutions

to functions.”

For Merton, unlike the post-crisis regulatory economists, financial functions –without

discriminating against shadow functions- are more important than the institutional vehicles –

regulated or unregulated- that perform these functions because such institutions –shadow or

not- create efficiency. However Merton’s science of finance scared ex-post not only the

regulators who are the statutory watchmen of the financial system but also some of the

leading practitioners in finance like Bill Gross, co-founder of the one the largest asset

management firms, PIMCO:

“What we are witnessing is essentially the breakdown of our modern-day banking

system, a complex of leveraged lending [that is] so hard to understand,” Bill Gross,

16

head of Pimco asset management group recently wrote. “Colleagues call it the

‘shadow banking system’ because it has lain hidden for years, untouched by

regulation yet free to magically and mystically create and then package subprime

loans in [ways] that only Wall Street wizards could explain.”

(Tett and Davies 2007).

What the Nobel Prize winner in economics sees as scientists of finance the practitioner Gross

who, in his daily practice, experience, come face to face with the creations of finance

scientists, describes them as “wizards” working with magic and mystical powers. Cultural

history is full of powerful symbolic representations of scientific creations turning into

monsters and destroying their creators and threatening the whole society and even the whole

civilisation. Yanis Varoufakis, the Keynesian economist and the ex-finance minister of

Greece, makes references to these fictional stories of fear and horror when reflecting on the

Greek sovereign debt crisis. Varoufakis (2015) writes about the “fear of losing out to our

creations” in past and contemporary works of popular culture and lists Shelley’s novel

Frankenstein and films like Blade Runner, The Matrix, Terminator in his analysis of crisis in

capitalism.

One of the moments in cultural history of capitalism when monsters of scientific creation

were visualised through their shadows was in German expressionist cinema between the two

world wars in the 1920s and the 1930s. According to the literary devices dictionary the

German term “Doppelgänger” means “‘look-alike’ or ‘double walker, originally meant a

ghost or shadow of a person but nowadays it simply refers to a person that is a look-alike of

another person. In literature, Doppelgänger is usually shaped as a twin, shadow or a mirror

image of a protagonist. It refers to a character who physically resembles the protagonist and

may have the same name as well.” (http://literarydevices.net/doppelganger/).

“A survey of Doppelgänger examples leads one to conclude that this literary device

serves a variety of purposes in literature. It may be used to show the “other self” of a

character that he or she has not discovered yet. This “other self” could be the darker

side of the character that troubles or the brighter side that motivates. Hence, it helps

writers to portray complex characters. Moreover, Doppelgänger gives rise to a

conflict in a story. The doppelganger acts in a way that promises dire consequences

for the main character that puts in efforts to undo the actions of his double.

17

Sometimes, the conflict is an inner one where a character tries to understand himself

by understanding his Doppelgänger.” (http://literarydevices.net/doppelganger/)

One of the best known examples of the Doppelgänger theme in literature is Robert Louis

Stevenson’s “Dr. Jekyll and Mr. Hyde”. Hyde is an evil double of the honourable Dr. Jekyll.

Hyde is the manifestation of the evil that existed in Dr. Jekyll. The reasoning of mainstream

economists writing on shadow banking reveals a Doppelgänger aspect in modern finance.

Writing in the prestigious Journal of Finance academics Gennaioli et al. (2013) explain the

shadow banking’s threat to the financial system by investors’ collective indifference to the

fundamentals of portfolio risk: “The shadow banking system is stable and welfare improving

under rational expectations, but vulnerable to crises and liquidity dry-ups when investors

neglect tail risks. ... While harmless when market participants recognize all risks, the

diversification myth becomes deadly when they do not.” (p. 1331 and 1333).

The shadow banking system as the Doppelgänger or the Double of financial innovation or

regulated financial intermediation is explained and described in mainstream economics, both

regulatory and academic mainstream economics, in variations of detail in events, institutions,

activities and statistics. But there is one thing that is constant in all narrations of shadow

banking and especially in those narrations by the regulatory economists. There is public

backstop for the regulated financial intermediation or credit creation process. There is an

implicit or explicit central bank put for the regulated financial system. However its double,

shadow banking system, does not have an institutionalised private or public backstop and that

is the source of fear. In the absence of a pre-arranged and socio-politically justified backstop

for the double of regulated financial intermediation the whole financial system is fragile and

potentially a catastrophic risk to both financial and real economy. What is not being admitted

by the mainstream accounts of shadow banking however is the Double as disavowal. In his

analysis of the German expressionist cinema of the early 1920s Elsaesser (2003) sees, in

films of the time like The Golem, Frankenstein, Dr. Caligari, Dr. Mabuse, etc., stories of

creators who bring to life “... creatures whose power outstrip their creator and over whom

[they not only lose] control, but who might actively turn against [them].” (p.58). In such

discourses the uncanny moment results when the creator tries to defend itself, to protect itself

from its own creation which is an act of disavowal. Mainstream economics and finance, too,

create an uncanny moment when they try to protect economically useful financial

intermediation from their creation of credit derivatives and complex forms of securitisation,

which they call after the crisis “shadow banking”. And consequently the “shadow banking”

18

discourse becomes an act of disavowal for the mainstream economics, especially in the

regulatory circles, because the responsibilities -or hubris as is most popularly expressed in the

post-crisis debates on regulators and mainstream economics- arising from the pre-crisis

promotion of financial innovation are not admitted. Moretti (1982) is interested in the effects

of such disavowal: “And thus, while professing to save a reason threatened by hidden forces,

the literature of terror merely enslaves it more securely. The restoration of a logical order

coincides with unconscious and irrational adherence to a system of values beyond dispute.”

(p.84). Similarly the literature on shadow banking and the Financial Stability Board’s work

on it perpetrate the fear rather than exterminate it in rational terms.

Importing concepts and analysis from cultural studies that contemplate on the stories of the

Doppelgänger and science losing control over its creations in German expressionist cinema

has insightful relevance for the analysis of our epoch of financialisation. The Weimar

Germany of the early 1920s was suffering a similar monetary instability to ours due to

extremely high levels of inflation at the time. The expressionist cinema in Germany reflected

the “massive social and political upheaval” during the hyperinflationary period in German

history when Germany was suffering from an extreme form of monetary chaos where the

value of money becoming meaningless with inflation rates in thousands (see for example

Cooke 2002, p.12; Kracauer 2004[1947], p. 11 and 59; Scheunemann 2003, p.2). The

financial crisis of 2007 has left behind a ruined economic, social and political landscape in

core capitalist countries that can not escape the suffocating tentacles of monetary reality and

logic. International Monetary Fund’s (IMF) most recent assessment of the world economy

(IMF 2016b) warns against a high probability of a return of financial turmoil with added

complications of political and geopolitical risks that are related to the still dysfunctional

financial system. The map of shadow banking that the regulatory economists has drawn soon

after the 2007 crisis to bring finance and monetary reality under control has not produced the

desired macroprudential outcome. In his philosophical reflection on the 2007 crisis Serres

(2014, p. xii), based on the etymology of the word crisis, explained the choices of an

organism that experiences a life-threatening crisis: “A crisis propels the body either towards

death or to something new it is forced to invent. ... [C]reating automatically, from scratch, an

entirely different organization of the organism!” The regulatory economics instead produced

a cognitive response that is driven by the fear of the Doppelgänger (the Double) to bring

finance under control, to gain mastery over the totality of financial reality of which a major

part was in shadows.

19

As such the science of neo-classical economics in its regulatory version exhibits yet again its

physics envy to gain a respectable epistemological status as it has been doing since its birth

(see for example Mirowski 1989 and 2002). Regulatory economics aim to discover the laws

of shadow banking as if they were like laws of physical world because only then the mastery

of the economic reality and defeating the fear of a systemic collapse of financial economy

becomes possible. The body of work on shadow banking share a common objective which is

to map a complex financial system with the Doppelgänger problem and with universal laws

governing the way money moves around and create credit- i.e. laws that determine financial

intermediation in an economy involving both regulated and unregulated financial institutions.

These laws of finance determine how maturity, liquidity and credit risk are transformed in the

financial system with systemic risk consequences. Mapping reveals how these laws operate.

According to Serres (2000) such knowledges share a common theology that reality is

subordinate to its creator, and by extension to anyone who can divine its eternal laws. The

regulatory economists of shadow banking share a desire to have a natural order in economics

with stability and resilience, and tend to see bubbles and crises as occasional ‘chance’ events

(tail risk) that do not obey the law. According to Serres (2000, p. 134) such epistemological

approach in sciences, where the scientist aims to make the reality subservient to himself or

herself because he/she is the master through knowing the reality’s universal laws, fails to

project politics and sociology onto its object of study. Consequently the knowledge is not

about a political and social pact with the object studied but it is about a relationship of

control. Controlling and regulating finance for stability do not necessarily mean creating a

system that is democratically accountable to its stakeholders or socially responsible and

useful in its allocation of capital. In the following concluding section I will introduce some

of Serres’s concepts on knowledge and science to argue that a social contract needs to be

embedded in our activities of producing knowledge on finance which is missing from the

aims of the regulatory economics on shadow banking.

3. Conclusion: from a science with a fear of the Doppelgänger to a science of pact:

lessons from Serres’s history of knowledge

Michelle Serres’ work on the history of physics and the western thought’s history of

modelling nature, The Birth of Physics, a book of philosophy covering epistemology, history

of thought, morality, the relationship between science and philosophy, provides a critical

20

source of theoretical insight in discussing knowledges of finance in the shadow banking

literature. The production of knowledge on shadow banking is guided by the kind of thinking

that characterises Newtonian physics-inspired neo-classical economics. Such thinking sees

equilibrium and order as a natural state. The shadow banking as the Doppelgänger of

financial innovation is a threat to the financial stability because it destabilises the equilibrium.

The post-crisis regulatory economics opposes shadow banking not because shadow banking

is part of a financial system that enriches the financial elite, generates economically and

socially useless real estate bubbles or creates credit for speculation on asset prices but

because it fatally disturbs the equilibrium in financial markets and makes the financial system

unstable for regulators to be in control. Serres’s philosophy, on the other hand, challenges

these equilibrium oriented epistemologies by digging out concepts of turba and turbo from

the history of sciences going back to the atomists in Ancient Greece. Michelle Serres,

following ancient atomists, proposes a fluid dynamics concept of disorder and order in

nature:

“There is a distance between turba and turbo. The first designates a multitude, a large

population, confusion and tumult. It is disorder: the Greek […], turbé, is also used of

the mad dancing in Bacchic festivals. But the second is a round form in movement

like a spinning top, a turning cone or vertical spiral. This is no longer disorder, even

if the whirl is of wind, of water or of storms. In fact the turning shifting movement is

that of the stars, of the heavens, now and originally. The world in its globality may be

modelled by vortices. The origin of things and the beginning of order consist simply

in the narrow space between turba and turbo, an incalculable population tossed by

storms, by unrest, in vertical movement. Perhaps there is an analogous distance, in

French, between turbulence and vortex, if we take these words in their everyday

sense, apart from fluid dynamics. The first is simply disorder and the second is a

particular form in movement.” (Serres 2000, p.38)

In this tradition of science that Serres traces back to the ancient atomists order and

disorder naturally co-exist rather than order and stability being the normal state of things.

Serres gives the example of the toy spinning top which, in motion, exhibits the qualities of

seemingly erratic movement and stability at the same time. As long as the conditions last the

spinning top will be in motion in proportion to its circumference and axis. Therefore a

spinning top is a “circum-stance” of vortex. Serres’s work emphasizes the irregular,

21

immeasurable qualitative aspects of form and inclinations not linearity in nature. The

concept of vortex and other accompanying concepts are the tools of a science that is

interested in impurity, the singular, the complexity, the concreteness of things. Studying the

concreteness of the varying conjunctures in a financialised economy is more insightful

intellectual activity than searching for universal laws that aim to explain finance as a

mappable complex activity. Therefore scientists who do not acknowledge vortex as natural

tend to develop conceptual models that equate rigour with exactitude and do not attend to the

qualities of reality that can not be easily measured and quantified. Serres’s investigations in

history of science and introduction of the concept of turbo (vortex) to the modern debates on

knowledge and society invite novel ways of investigating the present day financialised

capitalism. Financialised capitalism tends to feed on asset bubbles that are like spinning

tops defined by circum-stances and are conjunctural vortices – unstable and stable,

fluctuating and in equilibrium- lasting as long as circum-stances allow. Vortices of financial

innovations like complex securitisations known as CDOs that constitute the shadow banking

analysis are not systems of turbulence, disorders, chance events but are conjunctural financial

bricolage (see Erturk et al 2013) that derive their stability and instability from a singular but

complex localities in our financialised capitalism. There are strong reasons to recognise that

the study of finance invites less metrical and more phenomenal cognitive frameworks

because financial reality tends to occur as concrete complexities in flow rather than static

solid states than can be mapped.

Knowledges of finance, like the mapping of shadow banking by the regulatory economists

after the 2007 crisis, that are based on the scientific notion that the reality can be accurately

represented and mirrored in models so that its laws are revealed and understood before a

technology of control unleashed upon it, belong to a history of science that does away with

social contracts with its object. The financial system that has evolved and included what the

regulatory economists ex-post called shadow banking has been an elite project in

financialised capitalism that resulted in enriching a financial elite rather than delivering

economic and social welfare (see Engelen et al. 2010; Ertürk et al. 2013). Such approaches

tend to model their political conventions on nature. We can instead have a pact, an alliance

with finance (foedera natura) by reforming it for social value rather than being driven by an

unrealistic search for foedera fati (laws of destiny) in finance that aims mastery and control

for a permanently stable state (see for example Black 2013). An epistemology that

recognises the complexity of open turbulent systems can help us achieve this. Otherwise, as

22

we have been experiencing since the 2007 crisis, the fear of the Doppelgänger in our

financial system is very likely to outlast the Borgesian maps of exactitude by the regulatory

economists working on shadow banking.

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i The map can also be accessed online at https://www.newyorkfed.org/medialibrary/media/research/economists/adrian/1306adri_map.pdf

Figure 1: The map of shadow banking

Source: Pozsar et al. 2010