PL14CH04-Helleiner ARI 14 April 2011 16:32

Understanding the 2007–2008Global Financial Crisis:Lessons for Scholars ofInternational PoliticalEconomyEric HelleinerDepartment of Political Science, University of Waterloo, Waterloo, Ontario N2L 3G1,Canada; email: ehellein@uwaterloo.ca

Annu. Rev. Polit. Sci. 2011. 14:67–87

First published online as a Review in Advance onJanuary 20, 2011

The Annual Review of Political Science is online atpolisci.annualreviews.org

This article’s doi:10.1146/annurev-polisci-050409-112539

Copyright c© 2011 by Annual Reviews.All rights reserved

1094-2939/11/0615-0067$20.00

Keywordssecuritization, financial regulation, global imbalances, capital mobility

AbstractEconomists have explained the 2007–2008 global financial crisis withreference to various market and regulatory failures as well as a macro-economic environment of cheap credit during the precrisis period.These developments had important political causes that scholars of in-ternational political economy (IPE) should have been well positioned tostudy before the crisis. How well did they anticipate the crisis? Althoughnone foresaw all the causes, a number of IPE scholars correctly identifiedmany of the dangers associated with new models of securitization as wellas accompanying regulatory failures and the politics underlying them.IPE scholars were less successful in identifying the macroeconomicroots of the crisis, particularly the role of international capital flows infueling the U.S. financial bubble, but some scholars did usefully explorethe politics that contributed to the latter phenomenon. The study ofIPE scholarship in this episode contains useful lessons for the field’sfuture.

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IPE: internationalpolitical economy

INTRODUCTION

The global financial crisis of 2007–2008 wasthe most severe since the Great Depressionof the 1930s. Some of the world’s best-knownfinancial institutions collapsed or were nation-alized, while many others survived only withmassive state support. More than any otherfinancial meltdown in the postwar period, thecrisis affected major financial centers acrossthe entire world (Reinhart & Rogoff 2009). Italso generated a collapse of international trademore severe than any since the 1930s, and abroader economic downturn that involved allregions of the globe.

After listening to economists discuss thecrisis during a tour of the London School ofEconomics in November 2008, QueenElizabeth II famously asked (Sunday Times2008): “If these things were so large, how comeeveryone missed them?” Her question crys-talized a widespread view that the economicsprofession largely failed to predict the massiveevent and had much to learn from its failure.The sentiment has provoked a wide-rangingdebate among economists about what specificlessons can be learned from the crisis—that is,how understanding the crisis ought to shapethe future direction of their discipline.

A similar debate has begun among po-litical scientists working within the fieldof international political economy (IPE).Echoing the Queen, Cohen (2009, pp. 437,436, 440–41, 438) argues that IPE scholarshad a “dismal” record in anticipating thecrisis, and he compares their “myopia” to thefailure of international relations scholars topredict the collapse of the Soviet Union twodecades earlier. He is particularly critical of the“American school” of IPE, whose “mid-leveltheory building” and “reductionist” styleof method precluded a focus on structuralinstability and systemic change. Although someworking within the “British school” were morefocused on the growing instability of globalfinance, Cohen argues they too have little tocelebrate: “Predictions were loosely framed

and often maddeningly imprecise. Few analystsforesaw the specific sequence of events thatunfolded; many were downright wrong aboutthe details; certainly none got the timing right.”This collective failure, in Cohen’s view, shouldprovoke a wide-ranging discussion about thelessons to be learned and the field’s futuredirection.

Mosley & Singer (2009, p. 420) questionwhether Cohen’s judgment of scholarly fail-ure is too harsh, since IPE scholars “are gen-erally not in the business of predicting finan-cial crises or recessions.” This may be true,but as Rajan (2010, p. 7) notes, “almost ev-ery financial crisis has political roots.” In ex-plaining this latest crisis, he and many otherprominent economists call attention to thepolitical dimensions of many of the causes,showing a renewed appreciation for the studyof political economy (Sheng 2009, Johnson& Kwak 2010, Roubini & Mihm 2010). Al-though political scientists working in the fieldof IPE may not be in the business of pre-dicting financial crises, they should have beenwell positioned to identify some of these causesin ways that anticipated what was to come.Cohen is right to ask whether they in fact wereso positioned and what can be learned from theexperience.

In this essay, I explore these questions.Although Cohen is correct that IPE scholarsfailed to anticipate the causes of the crisis in acomprehensive manner, I argue that the field’srecord was not quite as dismal as he initiallysuggested. Just as the economics disciplinecontained some individuals with unusual fore-sight, there were a number of IPE thinkers whoidentified many of the key sources of the crisis.After briefly outlining the chronology of thecrisis, I highlight two complementary sets of ex-planations put forward in postcrisis economicsliterature. The first focuses on various marketand regulatory failures, whereas the secondexplores the significance of a macroeconomicenvironment of cheap credit during the yearsleading up to the crisis. Both of these develop-ments had important causes that IPE scholars

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identified before the crisis.1 Their analyses, aswell as some of the oversights in precrisis IPEliterature, provide important lessons for thefield, which I summarize in the conclusion.

THE POLITICS OF MARKETAND REGULATORY FAILURESThe crisis of 2007–2008 unfolded in severalstages (Roubini & Mihm 2010). It began inthe United States with the bursting of a hous-ing bubble and the growth of mortgage de-faults, particularly those involving subprimemortgages that had been extended in grow-ing numbers at the height of the bubble toless creditworthy borrowers. These defaults in-creasingly affected the stability of financial in-stitutions with exposure to these mortgages aswell as financial products tied to these mort-gages (described below). Several hedge fundswere the first to collapse in May and June 2007,and by August, serious concerns broke out inmoney markets about the exposure of a widerange of financial institutions in the UnitedStates and Europe that had invested heavily inmortgage-related financial products. By mid-September, panic even broke out at the retaillevel, with Britain experiencing its first bank run(Northern Rock) since the nineteenth century.

Despite official efforts to calm the marketswith large doses of liquidity, the crisis onlydeepened in March 2008, when the majorU.S. investment bank Bear Sterns had to berescued by U.S. authorities. Three develop-ments in September 2008 then triggered atotal collapse of market confidence. Early inthe month, the U.S. government placed thetwo giant government-sponsored mortgagelending agencies, Fannie Mae and Freddie Mac(“Fannie and Freddie”), under a form of public“conservatorship” because of the enormouslosses they were experiencing. By the middle ofthe month, the U.S. investment bank Lehman

1Some of the cited references were published in 2008, butthese were generally written and accepted for publicationbefore the outbreak of the crisis.

AIG: AmericanInternational Group

Brothers was forced into bankruptcy. Shortlythereafter, the world’s largest insurance com-pany, American International Group (AIG),was rescued and nationalized by the U.S.government.

It was at this point that the severity of thecrisis began to be felt much more stronglybeyond the North Atlantic region. Becauseof their difficulties, U.S. and European bankspulled back their international loans, triggeringsevere financial problems and debt crises incountries that had been borrowing heavily fromabroad. International trade credits also driedup, bringing exports and imports to a standstillin many sectors and countries. Financial conta-gion was felt particularly strongly in countrieswhose financial systems were already vulnera-ble because of home-grown housing bubbles,financial excesses, and/or large current accountdeficits. Iceland was a particularly dramaticexample, but there were many others, such asBritain, Germany, Ireland, Spain, the Balticcountries, Dubai, Singapore, Australia, andNew Zealand. The impact of the financial crisisalso spread globally through various spilloversoperating through the “real economy,” suchas collapsing exports, commodity prices, andremittance payments.

Although economists largely failed to pre-dict this global economic seismic shock, theyhave since made up for their oversight by gen-erating a large and growing literature explain-ing the crisis. Many economists point to mar-ket failures that generated excessive risk takingand a financial bubble during the years leadingup to the crisis. Although some of the specificfailures were unique to this era, those with ahistorical perspective have usefully highlightedbroad parallels with past crises. Drawing onKindleberger’s (1978) classic work, they notethat financial manias are usually set off by achange in expectations or “displacement,” of-ten caused by some kind of innovation. Thatinnovation then generates overtrading and theemergence of a bubble driven by a kind of ex-cessive optimism and herd behavior. When thebubble eventually bursts, panic ensues.

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MBS: mortgage-backed security

CDO: collateralizeddebt obligation

CDS: credit defaultswap

OTC: over-the-counter

The Promise and Perilsof Securitization

In the case of this latest bubble, the keyinnovation is widely seen by economists tohave emerged in the financial sector itself in theform of new kinds of securitization (Roubini& Mihm 2010). One kind involved privatelyissued complex mortgage-backed securities(MBSs). MBSs had been pioneered in theUnited States in the 1970s by the government-sponsored Fannie and Freddie, which hadissued simple bonds backed by packages ofmortgages they held. But after the early 1990s,the volume of MBSs began to grow rapidly as awide range of private firms entered the market,offering securities that were structured in in-creasingly complex ways. After being bundledtogether, packages of mortgages—includingsubprime mortgages after 1997—were slicedup by these firms into MBSs with distinct riskprofiles that were sold and traded worldwide.The resulting MBSs themselves also began tobe divided and repackaged together into newcollateralized debt obligations (CDOs) whosecash flows derived from the other bonds.

The rapid growth in the trading of creditrisk through these increasingly complex secu-rities was not restricted to mortgages but alsoincluded other “asset-backed securities” linkedto car loans, student debt, credit cards, and soon. In addition to being divided up and tradedthrough these new instruments, credit riskswere also hedged via new kinds of derivatives,most notably the credit default swap (CDS).This product was invented in 1991, and it ef-fectively insured holders of bonds against therisk of default (by offering to pay the buyer ofthe CDS contract the full value of the bondon which the CDS contract was written in theevent of a default). Many buyers of CDSs didnot in fact own the underlying bond but simplywanted to speculate on the likelihood of defaulton specific bonds. A large market was even cre-ated before the crisis in CDS contracts based onindexes of bonds. By the end of 2007, the sizeof CDS contracts had grown dramatically to agross nominal value of more than $60 trillion,

a figure larger than the world’s overall grossdomestic product (although net exposure waslower because many contracts offset each other)(Financial Services Authority 2009, p. 81). Mostof the explosive growth of CDSs and otherderivatives during the past two decades in-volved “over-the-counter” (OTC) products ne-gotiated privately on a bilateral basis betweenthe buyer and the seller.

These new kinds of securitization gener-ated great enthusiasm among market playersnot only because of the profits to be made butalso because of the belief that these new prod-ucts were boosting the stability and resilienceof the financial system as a whole by dispers-ing risk and deepening markets for risk. Manytop regulators and public officials shared thisbelief. As then–Chairman of the U.S. FederalReserve Alan Greenspan put it in 2004, “notonly have individual financial institutions be-come less vulnerable to shocks from underly-ing risk factors but also the financial system asa whole has become more resilient” (quoted inKapstein 2006, p. 141-2). The crisis raised se-rious questions about this line of argument.

To begin with, as mortgage lenders increas-ingly passed on the mortgages they originated(rather than holding them), they began tooverlook prudential concerns in their quest togenerate fees that came from selling ever largervolumes of loans. As credit risk was transferredto parties far removed from the original sourceand bundled in increasingly complex ways,its quality also often became more obscureand underpriced. Investors frequently lackedfull understanding of complex securities theypurchased or the quality of the loans underly-ing the asset-backed securities in which theyinvested. They relied heavily on credit-ratingagencies, which often issued overly positiveratings because they too found it difficult toevaluate risks accurately and/or because ofvarious conflicts of interest (e.g., they were paidby, and relied on information from, the issuers).

Securitization also increased the numberand significance of financial actors who felloutside of traditional prudential regulationscovering commercial banks. As defaults on

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subprime mortgages began to rise in 2007, thefirst institutions to collapse were unregulated,highly leveraged hedge funds that had becomeinvolved in the trading of some of the riskiesttranches of CDOs. Next in line were variousstructured investment vehicles created offbalance sheet by commercial banks to investin various complex products and funded withshort-term commercial paper issues. As thevalue of the investments of these “shadowbanks” came into question, investors refusedto fund the vehicles further. Also suddenlyvulnerable were various nonbank mortgagelenders who had funded their loans frominvestors in MBS products. In addition, thecollapse of confidence in mortgage-relatedsecurities began to highlight the vulnerabilityof lightly regulated investment banks, whichhad become deeply involved in the buying andselling of complex securities and derivatives.

The growing troubles of the large invest-ment banks then highlighted a further prob-lem with securitization: the large-scale buyingand selling of complex securities and derivativeshad increasingly taken place among a very smallnumber of financial institutions, thereby con-centrating risks rather than dispersing them.When Bear Sterns’ troubles escalated in March2008, the significance of this concentration ofrisk became clear. U.S. authorities concludedthat because of the investment bank’s intercon-nections with other major institutions via com-plex securities and CDS contracts, it was toosystemically important to be allowed to fail.In September, the demise of Lehman Broth-ers, a firm that was deeply involved in deriva-tives and complex securities, confirmed that thecollapse of an interconnected investment bankcould generate a market meltdown.

The financial difficulties of AIG presentedanother dramatic example of the concentra-tion of risk in lightly regulated firms withinthe new securitized world. That institution hadsold vast quantities of CDSs without settingaside enough capital or liquidity reserves. In thewords of U.S. Federal Reserve Chairman BenBernanke, it had ended up acting “like a hedgefund sitting on top of an insurance company”

(quoted in Paulson 2009, p. 236). At the timeof its rescue, AIG had more than $2.7 trillionin notional derivatives exposure from 12,000contracts, of which $1 trillion was with onlytwelve financial firms (Sorkin 2009, p. 236–37).Authorities were forced to recognize that, asSorkin (2009, p. 394) puts it, “AIG had effec-tively become a linchpin of the global financialsystem.”

Securitization contributed to the severity ofthe crisis in two further ways. First, the hugemountain of securities and derivatives built onU.S. mortgages not only magnified the finan-cial impact of the bursting of the U.S. housingbubble but also spread it worldwide. Approxi-mately half of the MBSs and CDOs created byWall Street were sold to foreigners, especiallyEuropean banks and hedge funds (Roubini &Mihm 2010, p. 119). Second, once the cri-sis broke out, the far-flung diffusion of MBSsand CDOs also intensified the panic becauseof widespread uncertainties about which insti-tutions actually held these products and whattheir levels of exposure were. The lack of trans-parency was only compounded by the opacityof the enormous OTC derivatives markets. Atthe time of Lehman’s collapse, for example, noone knew the precise size of the CDSs on itsbonds or who held these contracts. As Tett(2009, p. 226) puts it, “the CDS market hadturned into a vast, opaque spider web of dealsin which banks, shadow banks, and brokers alikehad become dangerously ensnared, interlinkedby fear.”

A major cause of the global financial crisiswas thus the transformation in financial systemsunleashed by new models of securitization. Inthe words of Roubini & Mihm (2010, p. 272),“the crisis was less a function of subprime mort-gages than of a subprime financial system . . . theglobal financial system rotted from the insideout. The financial crisis merely ripped thesleek and shiny skin off what had become, overthe years, a gangrenous mess.” Although theU.S. financial system witnessed many of thegreatest excesses, it is worth emphasizing thatthe problems associated with securitizationtrends were not unique to that country’s firms

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FSF: FinancialStability Forum

and markets. Not only were many foreignfinancial institutions deeply involved in U.S.financial markets, but many other countries—particularly in Europe—had been experiencingsimilar trends in their own home markets.

What Were the Regulators Doing?Blame for these developments rests not onlywith market participants but with regulatoryauthorities who failed to address the dangersthat had been building in the global finan-cial system. The failure was particularly strik-ing because this was an era in which regulatorsworked intensively to build and strengthen in-ternationally coordinated prudential standardsthat were designed to create more shock-proofglobal financial markets. These efforts had be-gun with the creation of the 1988 Basel Accord,which set out common capital standards for in-ternational banks (updated between 1998 and2004 into “Basel II”). They then acceleratedin the wake of the 1994 Mexican and 1997–1998 East Asian financial crises, when policymakers from the G7 countries began to pro-mote the global adoption of international best-practice standards. These standards applied toa wide range of prudential issues relating tobank supervision, securities regulation, insur-ance, accounting, auditing, payments systems,and corporate governance. In addition, the in-stitutional environment in which internationalregulatory and financial stability issues werediscussed was strengthened with the creationof the Financial Stability Forum (FSF) in 1999.This body brought together in one place for thefirst time the key international standard settingentities and other national and international of-ficials concerned with financial stability, and itwas tasked with anticipating and preventing theaccumulation of system-wide risk.

Despite these initiatives, the content ofthe emerging “international financial standardsregime” (Walter 2008) had important limita-tions. Although common international capi-tal standards were developed for banks, thosestandards did not apply to the institutions thatwere becoming more and more systemically

important because of securitization trends, suchas investment banks, insurance companies, andhedge funds. Regulators in the United Statesand Europe also did not rein in banks’ cre-ation of structured investment vehicles, eventhough these entities enabled evasion of theBasel capital requirements. Both U.S. andEuropean regulators also allowed banks tolower their reserves through the purchase ofCDS contracts, despite the fact that many is-suers of those contracts—such as AIG—werenot subject to the same capital requirements asbanks (Tett 2009, pp. 45–49, 60–64).

These weaknesses were part of a broadertrend in which regulators increasingly sup-ported more “market-friendly” approaches toregulation that trusted private actors to self-regulate (Porter 2005). In some sectors, such asOTC derivatives, accounting, and hedge fundmanagement, standards developed by privatebodies were endorsed by policy makers. In otherkey areas, such as credit rating, internationalstandard setters developed only voluntary rulesfor the industry. Even the international stan-dards that encouraged mandatory regulation bynational public authorities, such as bank capitalrules, increasingly moved in the same direction.In 1996, Basel I was amended to allow largebanks to use their internal value-at-risk mod-els to calculate capital charges for market risk.The 2004 Basel II agreement then reinforcedthis approach, allowing large banks to use in-ternal risk models to determine the amount ofcapital to put aside for overall credit risk. It alsoassigned credit-rating agencies a formal role incredit risk assessment for banks and elevated“market discipline” to become one of its threepillars of regulation (alongside formal capitalrequirements and supervision).

Given the problems accumulating in themarkets, these regulatory trends could not havecome at a worse moment. The growing re-liance of regulators on market-based mecha-nisms for valuing risk and assets also had dan-gerously procyclical effects. During the boom,risk valuation models drawing on market pricessignaled a relatively low-risk environment andthus encouraged further buying. Once the crisis

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began, however, the same models unleashed avicious downward cycle by prompting mass sell-ing. The new requirements under internationalaccounting rules to use “fair value” account-ing have also been criticized for having had thesame effect because they forced institutions tovalue assets at their market value at any givenmoment.

These international trends were reinforcedby various deregulatory initiatives at thenational level, of which moves in the UnitedStates proved particularly important for theglobal system ( Johnson & Kwak 2010, Roubini& Mihm 2010). In 1999, the U.S. Congresslargely repealed the separation of investmentand commercial banking that had been estab-lished after the Great Depression. This changefacilitated the greater participation of com-mercial banks in the securitization trends andintensified competitive pressures among firms.The next year, Congress locked in a laissez faireregulatory environment for OTC derivatives.In 2004, the U.S. Securities and ExchangeCommission lifted a 12:1 leverage ratio forinvestment banks, a move that enabled themto engage in greater risk taking. Finally, in theyears leading up to the crisis, U.S. authoritiesdid not do enough to stop the growth of poormortgage lending practices in the private sec-tor, especially vis-a-vis subprime loans.2 Thederegulatory trends in the United States wereechoed in many other countries, most notablythe United Kingdom, which trumpeted its“light-touch” regulatory environment.

IPE Scholarship Before the CrisisHow well did IPE scholars identify the prob-lems being generated by securitization andregulatory trends during the lead-up to thecrisis? Particularly prescient was Kapstein(2006), who questioned the conventional

2Some also blame the U.S. policy makers for pressuringFannie and Freddie to buy more subprime loans, but oth-ers argue that the growth of subprime lending was mainlyunderwritten by private lenders rather than these agencies( Johnson & Kwak 2010, pp. 144–46; Roubini & Mihm 2010).

wisdom that securitization was making theglobal financial system safer in a 2006 articlesurveying what he called the contemporary“financial risk environment.” Kapstein notedthat the opacity of derivatives created riskexposures for financial institutions that weredifficult to monitor, and that banks were usingCDS contracts to reduce capital requirementsin ways that shifted risks to the sellers ofthe insurance. He also highlighted the newoff-balance-sheet risks as well as the potentialprocyclicality of Basel II in a downturn. Inaddition, Kapstein argued that increasinglylarge banks might be generating new risksbecause of their growing interconnectedness,their managers’ difficulties in monitoring firmactivities, too-big-to-fail mentalities, and po-tential exposure to a housing market collapse.He warned of a possible future crisis involving“the collapse of a trillion dollar institution,with myriad tentacles of complex financial en-gagements reaching deeply into firms, markets,and households” (Kapstein 2006, p. 148). Sucha crisis, he argued, would require a massivebailout involving legislative support. This, inturn, would encourage domestic politicians tobecome much more interested in regulatoryissues than they had been before the crisis.

A number of other specialists in the IPEof finance also anticipated important partsof the story. Strange (1998) warned of amajor crisis because global markets wereincreasingly out of the control of regulatorsand supervisors. Among other developments,she called particular attention to the dangersposed by the delegation of regulatory functionsto private actors in international standards andby the growing opacity of, and leverage within,OTC derivative markets. Before the crisis,Underhill (1995) had also been a longstandingcritic of the endorsement of self-regulation ininternational standards, and, along with somecolleagues, he developed a strong critique ofBasel II’s procyclicality and its endorsement ofinternal risk models (Claessens et al. 2008).

Blyth (2003) also criticized the procycli-cality of banks’ internal risk models as well asthe decision of Basel regulators to give them

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more prominence. He worried too that thecomplexity of derivatives made risk monitoringparticularly difficult, and he predicted that theirgrowth would mean that future crises would be“amplified through the system in unpredictableways” (Blyth 2003, p. 248). Three years later,a book by Bryan & Rafferty (2006, p. 209) alsosurveyed the political economy of derivativesand argued that “derivatives have made it likelythat any financial crisis will have a more perva-sive and speedy impact than was previously thecase.” Best (2005) similarly warned about theopacity of derivatives and the links they createdacross markets. More generally, she expressedskepticism about the trend of “privatizing risk”and supporting market-friendly regulation,highlighting the difficulties for market actorsof accurately determining any institution’srisks at any given time.

Other IPE scholars also focused on some ofthe lightly regulated private actors that were be-coming increasingly significant in global mar-kets. Sinclair highlighted how securitizationtrends were boosting the influence in global fi-nancial markets of credit-rating agencies, andhe warned about giving them too large a reg-ulatory role given that their ratings were pro-cyclical and often flawed because of conflictsof interest and various biases (King & Sinclair2003, Sinclair 2005). Harmes (2001a, 2002) alsocalled attention to the growing power of hedgefunds and argued that their herd behavior andoverleverage could be a source of financial in-stability and systemic risk. He urged strictermandatory regulation, arguing that voluntarystandards and market discipline were unlikelyto constrain their risky activities.

Finally, some IPE scholars also identifiedthe importance of securitization trends in thehousing sector before the crisis. Particularlynoteworthy was the work of Langley (2006),who called on scholars to pay more attentionto growth of the MBS market in the UnitedStates and United Kingdom. In an analysishe subsequently expanded in a 2008 book,Langley urged his IPE colleagues to rec-ognize that international capital flows wereincreasingly linked to the housing-related

borrowing and saving in these two countries.He highlighted how MBSs (and other asset-backed securities) had become major parts ofAnglo-American capital markets and describedthe process by which mortgages were trans-formed into MBSs and CDOs and spread acrossthe world. He also identified the key role ofcredit-rating agencies in the process and ways inwhich banks, such as Northern Rock, were us-ing off-balance-sheet accounting to evade Baselcapital rules. Although he did not predict thecrisis, he was skeptical of market actors’ claimsthat they could capture, measure, and managethe risks involved in mortgage lending.

An important characteristic of the work ofall these scholars was their willingness to openthe “black box” of global finance (Mackenzie2005) and link the detail found therein backto the big picture of global financial stability.Instead of seeing “global finance” or “capitalmobility” in an abstract way or focusing exclu-sively on macroeconomic outcomes, they calledattention to the specific practices and prod-ucts, institutions and rules, and ideas and cul-tures that made up global financial markets.This perspective led them to recognize im-portant trends in markets and regulation thatmore exclusively macro perspectives missed. Italso encouraged them to question the claims ofneoclassical economics that the markets wereperfectly functioning, self-regulating machines.This skepticism was also present among othercritics who highlighted the broader dangers offinancial deregulation and liberalization, ofteninspired—as were many of the IPE scholarsnoted above—by famous past critics of unfet-tered finance, such as John Maynard Keynesor Hyman Minsky (Kirshner 2003, 2006;Nesvetailova 2007; Palan 2009).

Explaining the Regulatory TrendsIPE scholars not only identified key problemsemerging but also offered important politicalexplanations of the trends they saw, particularlythe trend toward more market-friendly regu-lation. Perhaps the most common explanationin precrisis IPE scholarship of the latter was

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that it reflected the power of private financialinterests at both the national and internationallevels. Plenty of evidence of private influencepushing in this regulatory direction has beenunearthed at the national level, particularlysince the outbreak of the crisis ( Johnson &Kwak 2010). Before the crisis, a number ofIPE scholars also noted the growing capture ofinternational policy-making processes by pow-erful market players organized in transnationallobby groups (Porter 2005, Tsingou 2006,Claessens et al. 2008, King & Sinclair 2003).

Anticipating many postcrisis popular anal-yses, IPE scholars also highlighted reasonswhy financial regulatory policy was particularlyprone to “capture” by private interests, suchas its complexity, its less obvious distributionalconsequences (for all but the financial sector),the prevalence of revolving doors between thefinancial industry and regulators, and an insti-tutional setting in which regulators often hadconsiderable autonomy from domestic politics.A number of analysts also pointed to somelarger structural developments that they arguedhelped to explain the growing political clout offinancial interests. One was the heightened mo-bility of financial capital, which strengthenedthe structural power of the financial industryin regulatory affairs (Underhill & Zhang 2008).Another was the fact that the financial sectorhad become an increasingly important source ofprofit accumulation and growth in capitalist so-cieties since the 1980s, a development that somescholars linked to the exhaustion of the post-war production-centered regime (Bello 2006).Others attributed the growing significanceof private standards and self-regulation to abroader weakening of the territorial nation-state and the emergence of a broader post-Westphalian world order (LiPuma & Lee2004).

To some analysts, these structural expla-nations of private financial power appear lessconvincing in the postcrisis era because stateshave suddenly been tightening regulation overthe financial sector at both the national andinternational levels, including in areas that hadlargely self-regulated before the crisis, such

as credit rating, OTC derivatives, and hedgefunds. Because many aspects of this trend havetaken place in the face of the opposition ofprivate financial interests, the influence ofthe latter now appears to some scholars morecontingent on domestic politics and less aproduct of deeply rooted long-term structuraldevelopments (Helleiner & Pagliari 2010,Clapp & Helleiner 2011). As Kapstein (2006)predicted, the massive bailouts in the UnitedStates and Europe mobilized domestic societalgroups and national politicians to pressureregulators for tighter rules. Although privatesector voices had strong influence during theprecrisis years of relative financial stability,regulators were now prompted to appeasedomestic legislative bodies and respond tobroader domestic demands for stability inorder to preserve their long-term autonomy,prestige, and future job prospects. Instead ofseeing regulators as structurally subject to cap-ture, this perspective sees them as “bureaucratswho attempt to resolve conflicting public andprivate sector interests in such a way as tomaintain and enhance their positional powerwithin their domestic political structures”(Kapstein 2006, p. 123; see also Singer 2007).

Alongside the influence of financial inter-ests, precrisis IPE scholarship also attributedthe trend toward market-friendly forms ofregulation to ideational factors. Analystshighlighted how many top officials genuinelybelieved, as noted above, that securitizationwas creating a more resilient and risk-freefinancial environment. This belief dovetailedwith broader triumph of free market ideologyafter the end of the Cold War and was but-tressed by technical economic ideas such as theefficient-markets hypothesis and other aspectsof modern finance theory (Blyth 2003, Best2005, Mackenzie 2006). This cluster of ide-ological and technical beliefs was particularlystrong among U.S. officials, but it was alsoquite widespread among what Tsingou (2006)calls the “transnational policy community” ofexperts, technical officials, and private sectoractors who dominated international regulatorydebates before the crisis. This ideational

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IMF: InternationalMonetary Fund

context not only generated support formarket-friendly regulation at the official levelbut also helped encourage excessive optimismwithin financial markets at the time (Reinhart& Rogoff 2009). Some IPE scholars have alsoexplained the latter with reference to deeperideational influences within Anglo-Americanculture, such as the discursive power of “riskmanagement” and its link to identities of lib-eral subjectivity (Langley 2008), as well as thegrowth of a “mass investment culture” in whichmembers of the general public increasinglyassociated their own prosperity with that offinancial markets (Harmes 2001b, Johnson &Kwak 2010, pp. 104–18).

Finally, some analysts explained support formarket-friendly regulation in more statist termsas a U.S.-driven or Anglo-American project.Because of the international importance of theirfinancial markets, the United States and Britainhad unique power to determine internationalregulatory outcomes by controlling access tothose markets, implementing unilateral dereg-ulatory moves, and vetoing international initia-tives they did not like. They also had strongrepresentation and influence in many of thekey international forums in which regulatoryissues were discussed. U.S. and British supportfor precrisis regulatory developments was at-tributed partly to the strong influence in thesecountries of private financial interests and theideational trends noted above. But scholars alsoargued that policy makers in these states be-lieved that these trends would benefit theirstates disproportionately. Not only would theirpowerful firms and attractive markets flourishin a more market-oriented global financial or-der, but free-flowing capital would be attractedto their territories to help fund current accountand fiscal deficits (Blyth 2003, Kirshner 2006,Wade 2007; see also Strange 1986).

Taken together, these three broad politicalfactors—private interests, ideational influences,and Anglo-American power and interests—offered important explanations for pre-2007global regulatory trends (Blyth 2003, Kirshner2003). But there was also an important lacuna

in precrisis literature that was revealed oncethe crisis broke out. Although the crisis wasglobal in scope, there was considerable variationin countries’ experience. As Roubini & Mihm(2010, p. 9) put it, the crisis “was not indiscrim-inate in its effects; only countries whose finan-cial systems suffered from similar frailties [as theUnited States] fell victim to it.” The financialsystems of a number of countries—includingCanada, right next door to the epicenter of thecrisis—remained relatively stable through thecrisis, and this outcome was widely attributedto regulatory choices made before the crisis.These differentiated experiences highlight theneed for more comparative analysis of finan-cial regulatory politics (Mosley & Singer 2009).National financial systems remain regulated inquite distinct ways, despite globalization pres-sures and the emergence of the internationalstandards regime after the late 1990s (Walter2008). This kind of comparative work will alsohelp encourage IPE scholars to move beyondthe Anglo-American focus of much of the pre-crisis literature.

To explain precrisis regulatory trends, onefinal aspect of international regulatory poli-tics deserves more attention: the politics withinthe FSF. In the wake of the East Asian crisis,many policy makers hoped that this new in-stitution would play a major role in promot-ing global financial stability. These hopes wereclearly dashed, but there is almost no academicliterature in IPE (or beyond) explaining why. Athorough analysis of the politics of the FSF isalso needed because the G20 leaders have nowupgraded the FSF into a more substantial body,the Financial Stability Board (FSB), with a for-mal charter, more staff, and a strengthened or-ganizational structure. The FSB is being toutedby top policy makers as a “fourth pillar” ofthe international economic architecture along-side the World Bank, International MonetaryFund (IMF), and World Trade Organization(Helleiner 2010). Understanding the history ofthe FSF, on which the FSB is built directly, willhelp IPE scholars better interpret the prospectsfor this institution.

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THE POLITICS OF CHEAPCREDIT AND GLOBALIMBALANCESMarket and regulatory failures were not theonly inducements to excessive risk taking dur-ing the lead-up to the crisis. Also important inmany countries was a macroeconomic environ-ment of cheap credit during the half decade be-fore 2007. In the past, low interest rates haveoften acted as a catalyst for financial bubbles,encouraging excessive debt accumulation andleverage, as well as the pursuit of riskier in-vestments. They played the same role in thiscrisis, acting as a kind of fuel that set in mo-tion many of the market processes described inthe previous section. Some analysts blame thecheap credit environment solely on domesticpolicy mistakes made by central banks, such asthe U.S. Federal Reserve, which is said to havekept interest rates too low in this period (Taylor2009). Others, however, take a more interna-tional view, focusing on the role of internationalcapital flows and global imbalances. Given theirinternational focus, IPE scholars should havebeen particularly well placed to study this lattercause. How well did they do?

International Sources of the U.S.Financial BubbleLet us first examine how international capi-tal flows contributed to the crisis. During thelast two decades, financial crises in developingcountries were often caused by large inflowsof foreign capital, which created cheap creditconditions and contributed to financial bubbleswithin the country. Many of the countries af-fected worst by the 2007–2008 crisis had a sim-ilar experience during the years leading up tothe crisis. Particularly important for the globalsystem was the experience of the United States,which absorbed large amounts of foreign cap-ital before the crisis from various countries inAsia, Europe, and the Middle East with largecurrent account surpluses and high savings.

These capital inflows drove down the cost ofcredit in the United States, helping to explain

why long-term interest rates and fixed mort-gage rates remained low even after the FederalReserve began to raise the federal funds ratein 2004–2006 (Roubini & Mihm 2010). Capitalinflows contributed to the U.S. financial bub-ble not just at this aggregate macroeconomiclevel but even in a more direct fashion in thehousing sector. Alongside U.S. Treasury bills,the most popular U.S. financial assets for for-eign investors to purchase were MBSs, espe-cially the “agency” bonds issued by Fannie andFreddie, which many foreigners assumed to bebacked by the U.S. government (Setser 2008,p. 28; Thompson 2009).

Before the crisis, a number of IPE schol-ars explored the macroeconomic significanceof growing foreign investment in the UnitedStates. Some even predicted that this situationmight generate major global financial instabil-ity, perhaps triggered by a U.S. financial cri-sis (Kirshner 2008) or the bursting of a spec-ulative bubble that was emerging in the U.S.financial system (Dieter 2007). Like most oftheir economist colleagues (e.g., Eichengreen2006), however, IPE scholars working in thisarea anticipated quite a different crisis than theone that ultimately happened. These scholarswere more focused on how foreign capital washelping to fund the growing current accountand fiscal deficits of the United States, andthey considered whether a sudden withdrawalof foreign support could generate a “hard land-ing” involving a dollar collapse and skyrocket-ing interest rates (see also Andrews 2008, Cox2004, Helleiner 2008). From this perspective,the key macroeconomic danger posed by for-eign investment was not that it was excessivebut rather that it could be insufficient. The do-mestic U.S. financial bubble was relevant to theanalysis only insofar as it might act as a triggerfor a collapse of foreign confidence. Althoughthese analyses were right to draw a link betweenglobal imbalances and an impending global fi-nancial crisis, the crisis that unfolded was causedby too much foreign investment in the UnitedStates rather than too little. (The bursting of theU.S. bubble also did not trigger a withdrawalof foreign capital, and it was accompanied by a

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dramatic lowering of U.S. interest rates as wellas an appreciating dollar, as discussed below.)

The IPE scholars who came closest to iden-tifying the correct causal link between for-eign investment and the U.S. bubble were an-alysts who examined foreign involvement inthe U.S. mortgage market. One of these wasLangley (2006, 2008), who highlighted howMBSs proved particularly attractive to foreigninvestors. More important, however, was thework of Schwartz (2007). He identified foreigncapital inflows as drivers of the U.S. housingboom in work written before the crisis brokeout, which he developed further in his 2009book Subprime Nation. He argued that cheapercredit, induced partly by foreign capital inflows,generated a particularly strong stimulative ef-fect on the U.S. economy because of high levelsof home ownership and mortgage debt, as wellas the structure of U.S. housing finance, whichenabled easy mortgage refinancing.

Neither Langley nor Schwartz predictedthe crisis, and neither identified how capitalflows drove a broader financial boom involvingderivatives and the shadow banking system. Buttheir work was important in identifying one as-pect of the link between foreign capital inflowsand the U.S. bubble. Their insight stemmedfrom a common desire to move beyond conven-tional IPE approaches, which often conceptual-ized global finance as some anonymous, distant,and abstract force “out there.” That approachhad already begun to be critiqued effectively bymany of the scholars discussed in the previoussection, who studied various actors, institutions,and social practices in the leading global finan-cial markets. Langley and Schwartz went fur-ther to show how those global markets werelinked to more micro dynamics of domestic fi-nancial systems and what Langley (2008, p. 284)calls “our everyday ‘real’ economic practices”of saving and borrowing. This analytical focusled them to see key causal dynamics that oth-ers in the field missed. Indeed, before the crisis,most IPE scholars would have considered thedetails of local housing finance to be primar-ily a domestic subject beyond the focus of theirfield.

IPE scholars may have overlooked the waysin which foreign capital inflows were helpingto generate an unsustainable financial bubblefor two other reasons as well. One was theirtendency to discuss the political economy of fi-nancial crises in developing countries separatelyfrom that in developed countries. Although IPEscholars were very familiar with the role of for-eign capital in generating bubbles in developingcountries, they failed to extend this understand-ing to the U.S. situation. Second, the literatureon the role of capital flows in developing-country crises had been focused primarily onspeculative private capital movements. As I dis-cuss in the next section, however, many of thekey investors pumping foreign capital into theUnited States before 2007 were foreign govern-ments. For those IPE scholars who had becomeaccustomed to blaming private speculators, out-of-control private markets, and “neoliberalism”more generally, this phenomenon was lessfamiliar territory (Helleiner & Lundblad 2008).

Why Did Foreigners Supportthe United States?Although they failed to see how global financialflows were generating a U.S. financial bubble,IPE scholars did a better job at exploring thepolitics that encouraged foreigners to invest soheavily in the United States in this period. Someof the foreign support came from private in-vestors from high-income countries with largecurrent account surpluses, such as Germanyand Japan. These countries’ focus on export-led growth has been explained by the structuralfeatures of their domestic political economies,such as the power of their export lobbies, po-litical resistance to boosting domestic demand,and the inefficiency of domestically orientedsmall firms (Rajan 2010, Schwartz 2009). IPEscholars highlighted how private investors fromthese countries were attracted to put money inthe United States in this period because of thedollar’s international role and the unique depth,liquidity, and security of U.S. financial mar-kets, factors that contributed to what Strange(1988) called America’s “structural power” in

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global finance (Helleiner 2008, Schwartz 2009).Schwartz (2009) also noted that elite groups inthese countries had long resisted the develop-ment of financial markets that might competewith those of the United States because theysaw bank-based financial systems as crucial totheir export success.

What attracted more attention from IPEscholars was the fact that foreign capital flowsto the United States also came increasinglyfrom foreign governments in the immediateyears before the crisis, most notably thoseof China, Japan, oil-exporting countries (in-cluding Russia), and some other developingeconomies (particularly in Asia). In the case ofoil exporters, the boom in oil prices after 2002generated surplus funds, which these countriessought to invest securely and profitably in U.S.markets. Some IPE scholars also suggestedthat the U.S. investments of the oil-exportingGulf states were tied to their broader securityalliance with the United States (Momani 2008).Past IPE scholarship has shown how the dollarreserve holdings of West Germany in the1960s and those of Saudi Arabia in the 1970swere linked explicitly to broader bilateralsecurity relations with the United States (Spiro1999, Zimmermann 2002), and some haveexplained Japan’s large dollar reserve holdingsin this way as well (Murphy 2006).

Other explanations were put forward to ac-count for the willingness of China and manyother developing countries to invest so heav-ily in the United States during this period.Their investments stemmed from these coun-tries’ rapidly growing foreign exchange reservesafter 1999, which they recycled into U.S. assetssuch as Treasury bills or agency bonds. TheChinese case was particularly important be-cause of the speed and scale of the accumulationof its reserves, which increased almost tenfold ina decade to become the world’s largest.Beforethe crisis, China’s reserves stood at over$1.5 trillion (of which approximately 70%–80%was in dollar-denominated assets).

One of the most prominent political expla-nations of the accumulation of dollar reservesby China and other developing countries

before the crisis was in fact developed by threeeconomists: Dooley, Folkerts-Landau, andGarber. They argued that these countries’policies were driven by their goal to promoterapid export-oriented industrialization. Inorder to boost the competitiveness of theircountries’ firms, governments maintainedundervalued exchange rates by accumulatingforeign exchange reserves. Those reserves werethen strategically recycled into U.S. assets inorder to help keep their major foreign marketeconomically healthy enough to continuepurchasing their exports. These economistsdrew a parallel to the reserve accumulation ofmany Western European countries and Japanduring the 1960s under the Bretton Woodsexchange rate system (Dooley et al. 2003).

A number of IPE scholars endorsed this“Bretton Woods II” explanation for reserve ac-cumulation, and some refined it to highlight thedomestic Chinese interests that were served bythe arrangement. Instead of assuming Chinesepolicy makers were pursuing their country’s“national interests,” Schwartz (2009) arguedthat it was necessary to look at the interests ofthe Communist Party elite who derived privateprofits from their control—or their children’scontrol—of export industries, while deflectingto the mass public the costs of U.S. support(e.g., losses on dollar holdings, inflationarypressures). Hung (2008) also pointed out therole of the powerful coastal export sector inbacking the country’s exchange rate policy.

Others interpreted the rapid growth ofreserves as a tool to preserve national politicalautonomy in the wake of the traumatic 1997–1998 East Asian financial crisis. From thisperspective, policy makers sought to build a warchest of reserves to defend themselves againstvolatile capital flows as well as dependence onthe IMF, whose role in the crisis was widelyseen in the East Asian region as unhelpful,too intrusive, and overly influenced by U.S.policy makers’ goals (Bowles & Wang 2006,p. 247; Cohen 2008a, p. 461; Setser 2008, p. 19;Wolf 2008). This desire for “self-insurance”generated what Rajan (2010, p. 82) called a “su-percharged export-led growth strategy” to earn

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foreign exchange. U.S. assets were particularlyuseful for the reserve function given the dollar’srole as the world’s most widely used currency.From this more nationalist perspective, theholding of U.S. assets might also have beendriven by the objective of cultivating someleverage over the United States. Althoughthe Bretton Woods II theorists spoke of the“mutually beneficial gains” involved in theUnited States’ relations with its major creditors(Dooley & Garber 2005, p. 148), more nation-alist views agreed more with Larry Summers’description of it as a “balance of financial ter-ror” (Thompson 2009; Cohen 2008a, p. 462).

From the self-insurance perspective, then,reserve accumulation reflected countries’ grow-ing distrust of the international system, a dis-trust only compounded by the absence of se-rious governance reform at the IMF and theexclusion of these countries from key inter-national financial standard-setting bodies andthe new FSF. IPE scholars have not attemptedto systematically evaluate the accuracy of theself-insurance perspective against the BrettonWoods II hypothesis, and this would be a diffi-cult task because the two goals reinforced eachother in ways that may be difficult to disentan-gle. Was reserve accumulation a byproduct ofthe goal of boosting exports, or was the pushfor export growth serving the goal of boostingreserves? The relative importance of these mo-tivations undoubtedly differed across countriesand may have changed over time. The advan-tage of the self-insurance story, however, is thatit explains why reserve growth suddenly grewsharply after 1999. Recent statistical work byeconomists also suggests strong support for thisexplanation (Obstfeld et al. 2010).

IPE scholars also suggested one final moti-vation for reserve accumulation that may havebecome more important as time went on, par-ticularly in the case of China. As its reservesgrew ever larger, Chinese policy makers wereforced to recognize that any initiative to diver-sify reserves risked triggering market reactionsthat undercut the value of their country’s re-maining massive investments (Andrews 2008,Cohen 2008a, p. 462). With its claims on the

United States equal to approximately one thirdof the Chinese gross domestic product by thetime the crisis broke out, China may have beenincreasingly subject to what Kirshner (1995)called a kind of “entrapment,” with its fate in-creasingly tied up with that of the dollar.

What About the Costs?Although there were various benefits to officialreserve accumulation (as explained by geopolit-ical, Bretton Woods II, self-insurance, and en-trapment interpretations), there were also im-portant costs that IPE scholars highlighted inthe lead-up to the crisis (Dieter 2007, Helleiner2008, Kirshner 2008; see also Eichengreen2006). As foreign reserves grew in size, theyrisked generating inflationary pressures becauseof the difficulties of sterilizing them. The valueof reserves was also eroded by the dollar’s de-preciation after 2002, a depreciation that lookedlikely to continue given the external debt andcurrent account deficits of the United States. Asthe costs of reserve holdings grew, analysts alsohighlighted the risk that some reserve holdersmight be tempted to be the first to sell in or-der to minimize their losses before others madethe same move, a dynamic that could generatea herd-like selling of the dollar. Such a disor-derly dumping of dollars seemed all the morelikely because of the existence of a new attrac-tive alternative reserve currency, the euro, andthe absence of the kinds of alliance ties and in-tergovernmental networks of officials that hadworked to contain this kind of behavior duringthe Bretton Woods period. Indeed, some ana-lysts highlighted the possibility that countriesdissatisfied with U.S. foreign policy might betempted to sell reserves for strategic reasons, apossibility that Johnson (2008) suggested wasalready under way in Russia before the crisis.

It was these risks that led to the predictionsof a possible dollar collapse noted above. Thosepredictions anticipated that major creditorcountries might soon judge these costs to behigher than the benefits of holding large dollarreserves. In the end, however, creditors held theopposite view—by a large margin. The danger

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to the United States before 2007 was not aforeign pullout but rather foreigners’ excessiveenthusiasm for U.S. assets. The crisis that brokeout was a product of the fact that creditorswere too generous rather than too frugal.

Even once the U.S. financial crisis brokeout, there was no foreign withdrawal, despiteworries among analysts and policy makers atthe time. In most emerging-market countriesover the previous two decades, the burstingof domestic financial bubbles was accompa-nied by capital flight, which only exacerbatedthese countries’ financial crises by generatingexchange rate depreciation and higher inter-est rates. But foreign funding of the UnitedStates—both public and private—continuedduring the crisis, even as the United States low-ered interest rates dramatically. Indeed, the dol-lar even strengthened as the crisis became moresevere after mid-2008. This outcome preventedthe crisis of 2007–2008 from being even moresevere than it was both for the United Statesand for the world economy as a whole.

IPE scholars have not yet produced detailedexplanations for the foreign support providedduring the crisis. Future scholarship may dis-cover that it reflected the geopolitical, BrettonWoods II, self-insurance, and entrapment con-siderations discussed before the crisis. But itseems very likely that one of the most importantexplanations was the structural position of theUnited States in global financial markets. De-spite the enormity of the U.S. financial troublesat the time, the U.S. Treasury bill remainedthe investment of choice for financial institu-tions and investors scrambling for liquidity andsecurity in the midst of the panic (Reinhart &Rogoff 2009, p. 222). This development high-lighted not only America’s structural power butalso the failure of the euro to inspire more con-fidence. The euro’s problems were caused byits weak political foundations, a fact that severalIPE scholars had highlighted before the crisis(Cohen 2003, Pauly 2008). Because the Maas-tricht Treaty had failed to specify mechanismsfor the prevention and resolution of euro-zonefinancial crises, national governments acrossEurope scrambled to support distressed firms

in an ad hoc and uncoordinated manner, lead-ing markets to wonder whether the integratedfinancial space and monetary zone might un-ravel. The lack of a single fiscal authority alsoprevented Europe from developing a financialmarket that could challenge the U.S. Treasurybill market as the key fulcrum of global financialmarkets.

The U.S. Side of the StoryIf there were a number of possible reasonswhy foreigners exported such large volumes ofmoney to the United States in the years leadingup to the crisis, why did the United States acceptthe money given the dangers that it posed to itsfinancial system? Some analysts have suggestedthat the United States in fact had little choice,that it was essentially a victim of the choices offoreigners to send their money to the UnitedStates. This view often draws on a famous 2005speech by Ben Bernanke in which he attributedthe growth of U.S. current account deficits andcapital inflows to excessive savings in the send-ing countries (Wolf 2008). But efforts to castthe United States as a passive victim in theface of a “global savings glut” overlook the roleof U.S. macroeconomic and regulatory policymistakes in contributing to its own financial cri-sis (Roubini & Mihm 2010, pp. 249–50; Stiglitz2010, p. 9; Taylor 2009). They also neglectthe involvement of the United States in medi-ating and encouraging foreign capital inflows,through its Treasury bill sales and the role ofFreddie and Fannie in creating a global mar-ket for securitized mortgages (Gotham 2006),as well as through its broader support forglobal financial liberalization. More generally,Reinhart & Rogoff (2009, p. 209) note that an-alysts need to explore why U.S. authorities dur-ing the bubble years did not ask themselves:“Can there be too much of a good thing?”

Reinhart & Rogoff (2009, p. 213) them-selves see the U.S. policy stance as reflecting anideational complacency—or even “conceit”—among top U.S. policy makers who believedthat their “financial and regulatory systemcould withstand massive capital inflows on a

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sustained basis without any problems.” Beforethe crisis, IPE scholars such as Walter (2008)also noted this overconfidence in the superi-ority of the U.S. financial system during thisperiod. Walter argued that it was boosted par-ticularly by the East Asian financial crisis, whichencouraged U.S. policy makers to see their fi-nancial system as a model for the world (seealso Johnson & Kwak 2010, pp. 40, 55). Theprominence of a laissez-faire approach to finan-cial regulation noted in the previous section alsocontributed to the U.S. complacency.

Like other past experiences of emerging-market countries, capital inflows also servedmany U.S. interests. Financial firms benefitedfrom being at the center of what Schwartz(2009) calls the “global arbitrage,” sellingsecurities to foreign investors (Setser 2008,p. 26). The housing-led boom was popular at amass level among Americans, for whom homeownership served as a key means for buildingpersonal wealth, particularly in an era of grow-ing inequality and economic insecurity (Rajan2010, Seabrooke 2006). In the political arena,foreign capital helped to fund ballooning fiscaldeficits generated by tax cuts and increaseddefense spending during the Bush adminis-tration. The Bush administration’s strategy ofrelying on foreign capital to live beyond itsmeans was not unique to this era; IPE scholarshave long noted a shift in U.S. policy since the1960s toward what Gilpin (1987) called a more“predatory” form of hegemony to fund fiscaland current account deficits. The difference inthis period was that some of the sources of for-eign support shifted (Calleo 2009, Cox 2004).

There was thus a strange complementaritybetween political developments within theUnited States and those within the majorcreditor countries that encouraged large sumsof capital to flow from the latter to the formerduring the years leading up to the crisis.Supercharged export-led growth strategiesof governments in the creditor states werecomplemented by American fiscal overstretchand official complacency in the wake of theEast Asian crisis. At the societal level, export-oriented interests in the former found common

cause with Wall Street and home-buyingAmericans. At a more structural level, financialrepression within most creditor states foundits perfectly matched opposite in the uniquelydeep and liquid U.S. financial markets. Andhovering over the entire politics of global im-balances in this period were some geostrategicrelationships between the United States and itscreditors, which may have come into play.

In summary, IPE scholars may have notforeseen the mechanism by which global im-balances would generate a crisis, but some ofthem did develop insights about the politicsthat generated and sustained the imbalances be-fore the crisis. There remains, however, muchmore to be explored on this topic. More detailedresearch is needed into the politics of reserveaccumulation before the crisis in order to ad-judicate between geopolitical, Bretton WoodsII, self-insurance, and entrapment explanations.We also need a better understanding of thedistributional politics within the United Statesduring this period, particularly of the domesticlosers from capital inflows (e.g., some manu-facturing sectors) and why their voices were solittle heard. Work that compares the U.S. expe-rience with those of many developing countriesthat experienced bubbles in previous decadesmight be particularly insightful for this pur-pose (Sheng 2009). More analysis is also neededof the politics within other countries receivinglarge inflows of foreign capital in this period,which generated similar, though less systemi-cally significant, bubbles as that in the UnitedStates (Seabrooke & Schwartz 2008).

One final issue that needs to be addressed iswhy more leadership was not forthcoming fromthe one multilateral institution that has a man-date to tackle the issue of global imbalances:the IMF. Under the original Bretton Woodssystem, the IMF had been given a mandate toencourage countries to “shorten the durationand lessen the degree of disequilibrium inthe international balances of payments ofmembers.” After the Bretton Woods exchangerate regime broke down in the early 1970s,the IMF’s role in this area faded. But one yearbefore the outbreak of the 2007–2008 crisis,

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the IMF attempted briefly to play a leadershiprole in this area, hosting a “multilateral consul-tation” process that involved China, the euroarea, Japan, the United States, and Saudi Arabiaand was designed to address global imbalances.In the end, this initiative had little impact and ithas received little attention from IPE scholars.But this outcome needs to be explained becauseit was an important “nondecision” (Strange1986, 1998) in the history of the causes of thecrisis.

CONCLUSIONHow well did IPE scholars anticipate the globalfinancial crisis of 2007–2008? It is certainly truethat no IPE scholar predicted its timing, its de-tails, and its causes in a comprehensive man-ner. But the record of the field was not entirelydismal during the years leading up to the cri-sis. A number of IPE scholars correctly iden-tified many of the key market and regulatoryfailures that ended up contributing to the cri-sis. They warned about many of the dangers as-sociated with securitization, such as risk prac-tices in mortgage securitization, the perils ofrelying on credit rating agencies, the growingsystemic significance of unregulated or lightlyregulated firms and sectors, the amplification ofcrises across markets and countries, the opacityof OTC derivatives, and the concentration ofrisk in large and interconnected firms. In theregulatory realm, they critiqued authorities forfailing to update regulations to take account ofmany of these dangers and for relying moregenerally on market-friendly forms of regula-tion. They also developed analyses of politicalcauses of regulatory trends, arguing that theyreflected the power of private financial inter-ests and ideational trends as well as U.S. andBritish power and interests.

IPE scholars were less successful in iden-tifying the more macroeconomic causes ofthe crisis, particularly the role of interna-tional capital flows in helping to generatethe U.S. financial bubble. But a number ofscholars did usefully explore the politics thatcontributed to this phenomenon, notably the

complementarity that existed (a) betweenfinancial repression in creditor countriesand U.S. structural power in global financialmarkets, (b) between turbo-charged export-ledgrowth strategies and U.S. fiscal overstretchand regulatory conceit, and (c) between exportinterests in surplus nations and America’sWall Street and home-buying citizens. Somepredicted that the growing global imbalancesmight generate a global financial instability,but they incorrectly anticipated a dollar crisisbecause of their judgment that the politics sup-porting reserve accumulation in creditor stateswere quite fragile. Political support for reserveaccumulation proved instead to be too robust.This was a misjudgment—one echoed by manyeconomists—but hardly a case of “myopia.”

What lessons can be learned for the futureof the field of IPE from the record of IPE schol-arship in anticipating the crisis? Cohen (2009)suggests that IPE’s poor record in anticipatingthe crisis highlights the need for a major shiftin direction at an epistemological level. He isparticularly critical of the epistemology of the“American school,” which emulated neoclassi-cal economics with its reductionist assumptionsand rationalist modeling, thereby discountingthe possibility of major systemic change. Hecalls on members of this school to considermore historical, institutional, or interpretivekinds of analysis, and he urges them to readmore widely in the “British school” tradition,which has embraced that approach. Reinforc-ing this point is Palan (2009), who argues thatthe British school was much more successfulin seeing the crisis coming, and he attributesthis to its greater focus on history and struc-tural change, its greater skepticism of neoclas-sical economics, and its more empirical and in-ductive orientation.

In some respects, my analysis suggests asimilar conclusion. Far more of the articles Ihave cited were published in what these authorsconsider British school journals than in theirAmerican school counterparts. A number ofthe authors I have mentioned are also ones thatCohen and Palan associate with the Britishschool. Indeed, it is striking that the two senior

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scholars whom Cohen sees as pioneering theBritish school—Susan Strange and RobertCox—each frequently called attention tofinancial fragility as a major structural featureof the global political economy during theyears preceding the crisis. Interestingly, theBritish International Studies Association’s IPEGroup also awarded its annual book prize in2007 to a detailed analysis of the new central-ity of derivatives markets in global finance:Mackenzie’s (2006) An Engine Not a Camera.

At the same time, however, a number ofthe scholars whom I have cited were alsotrained and/or inspired by many of the thinkersCohen (2008b) describes as founders of theAmerican school, not least of whom is CharlesKindleberger. These are scholars who havenot embraced the more recent trends in theAmerican school toward rationalist modelingand remain committed to the broader ap-proaches to the field that the founders of theAmerican school themselves embraced at thetime of its creation. Many of these schol-ars now seem to be positioned in a kind of“missing middle” category (Ravenhill 2008) be-tween the newer American school approach andthat of the British school—what Katzenstein(2009) describes as a “mid-Atlantic” position.Although the “American versus British school”typology thus raises some questions, the litera-ture described in this essay does suggest supportfor Cohen’s endorsement of more historical, in-stitutional, and/or interpretive methods.

Does the experience of scholarship beforethe crisis suggest support for some of the othermore traditional intellectual divides in IPE?Looking at the list of scholars I have cited,it is striking that representatives of many ofthe big paradigms, such as liberalism, realism,Marxism, constructivism, and poststructural-ism, all had important insights. So too did schol-ars on both sides of other divides, such as thosebetween systemic and domestic perspectives orbetween structuralist and agency-centered ap-proaches. The record of precrisis scholarshipthus makes a strong case for analytical eclecti-cism (see also Cohen 2009, Katzenstein 2009).And included in this eclecticism should be an

openness from political science IPE scholarsto insights from economists (who developedimportant political economy explanations be-fore the crisis, and have done so even more af-ter the crisis) as well as from scholars in otherdisciplines.

In addition to these general methodologicalpoints, the crisis has also obviously strength-ened the case for IPE scholars to pay moreattention to the study of global finance. Forthose who are already specialists in this area,I have highlighted some more specific lessonsthat emerge from the precrisis literature. Oneis the importance of opening the black box ofglobal finance to explore the specific practicesand products, institutions and rules, as well asideas and culture that make up global markets.Second, more attention needs to be paid tothe links between global markets and financialpractices at more local and everyday-life levels.Third, IPE scholars need to be careful not toassume that “capital mobility” is always drivenby private actors, since many public authoritiesare playing increasingly important roles as in-vestors in global markets.

I have also highlighted some issues that re-quire more research if we are to gain a fullerunderstanding of the causes of the financialcrisis itself. Much more comparative work—particularly outside of the Anglo-Americancontext—is needed to understand how coun-tries experienced the crisis in quite differentways because of distinct regulatory regimes,different political responses to capital inflows,and unique patterns of integration in the globaleconomy. Some precrisis understandings of pri-vate “capture” of regulators also may need tobe re-evaluated in light of postcrisis trends. Tobetter understand the growing global imbal-ances in the pre-2007 period, more research isrequired into the politics of reserve accumula-tion in major creditor states. The distributionalpolitics within the United States during this pe-riod also needs further study, particularly in acomparative context that includes the experi-ence of developing countries over the past twodecades. In addition, at the multilateral level,IPE scholars should explore the politics of the

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FSF’s functioning during its first decade as wellas the failure of the IMF’s 2006 multilateralconsultation exercise.

Finally and more generally, scholars mightconsider developing more comprehensiveanalytical tools to explain global financial crisesfrom an IPE perspective. Because crises onthe scale of the 2007–2008 crisis happen sorarely, IPE thinkers have not spent much timetrying to develop these tools. If they had, thefield might have avoided the situation where anumber of IPE scholars identified partial causesof the crisis of 2007–2008 without anyone rec-ognizing the whole picture. In particular, fewscholars succeeded in drawing together the pol-itics of the macro story of the global imbalanceswith the politics of the micro-level market and

regulatory failures. The best-known analyticaltool that IPE scholars have to explain majorsystem-wide financial crises is the one devel-oped by Kindleberger (1973) to explain the lastglobal financial crisis of this scale: the GreatDepression of the 1930s. But his “hegemonicstability theory” was really more a theoryto explain how existing crises could be pre-vented from spiraling out of control throughleadership activities such as maintainingopen markets, encouraging counter-cyclicallong-term capital flows, and acting as an inter-national lender of last resort. The developmentof a more comprehensive understanding ofthe political economy of the underlying causesof global-scale financial crises remains animportant task for future IPE researchers.

DISCLOSURE STATEMENTThe author is not aware of any affiliations, memberships, funding, or financial holdings that mightbe perceived as affecting the objectivity of this review.

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Annual Review ofPolitical Science

Volume 14, 2011Contents

A Life in Political ScienceSidney Verba ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! i

Leadership: What It Means, What It Does, and What We Want toKnow About ItJohn S. Ahlquist and Margaret Levi ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! 1

Examining the Electoral Connection Across TimeJamie L. Carson and Jeffery A. Jenkins ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! !25

Presidential Appointments and PersonnelDavid E. Lewis ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! !47

Understanding the 2007–2008 Global Financial Crisis: Lessons forScholars of International Political EconomyEric Helleiner ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! !67

Presidential Power in WarWilliam G. Howell ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! !89

The Politics of Regulation: From New Institutionalism to NewGovernanceChristopher Carrigan and Cary Coglianese ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! 107

The New Judicial Politics of Legal DoctrineJeffrey R. Lax ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! 131

The Rhetoric Revival in Political TheoryBryan Garsten ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! 159

The Rhetoric of the Economy and the PolityDeirdre Nansen McCloskey ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! 181

The Contribution of Behavioral Economics to Political ScienceRick K. Wilson ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! 201

The Causes of Nuclear Weapons ProliferationScott D. Sagan ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! 225

Network Analysis and Political ScienceMichael D. Ward, Katherine Stovel, and Audrey Sacks ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! 245

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PL14-frontmatter ARI 11 April 2011 17:22

The Big Five Personality Traits in the Political ArenaAlan S. Gerber, Gregory A. Huber, David Doherty, and Conor M. Dowling ! ! ! ! ! ! ! ! ! ! 265

ClientelismAllen Hicken ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! 289

Political Economy Models of ElectionsTorun Dewan and Kenneth A. Shepsle ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! 311

Modeling Dynamics in Time-Series–Cross-Section PoliticalEconomy DataNathaniel Beck and Jonathan N. Katz ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! 331

Voting TechnologiesCharles Stewart III ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! 353

Indexes

Cumulative Index of Contributing Authors, Volumes 10–14 ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! 379

Cumulative Index of Chapter Titles, Volumes 10–14 ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! ! 381

Errata

An online log of corrections to Annual Review of Political Science articles may be foundat http://polisci.annualreviews.org/

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