He starts with an interesting claim:

Economics normally provides rather dismal news, emphasizing tradeoffs among objectives and hard choices. In the case of redesigning the global financial architecture, however, such is not the case. It is not difficult to construct a set of mechanisms that resolve problems of illiquidity (by providing a responsive lender of last resort facility) while avoiding the governance and incentive problems attendant to counterproductive bailouts of risk takers.

Critique of the Global Financial Structure

The particularity of the financial crises in the late 1990s was the simultaneous collapse of banks and fixed exchange rates. Calomiris says that these were the reasons for these crises:

1. Counterproductive financial bailouts of insolvent banks, their creditors, and debtors by governments, often assisted by the IMF, at large social costs because of the transfer of resources from average citizens to wealthy risk-takers through taxation and thus encouraging excessive risk-takings by banks and corporations relying on the financial safety net by governments.
2. Asymmetric information about the incidence of observable shocks within the financial system, especially when combined with short-term debt finance can magnify the economic consequences of fundamental shocks by leading to a liquidity crisis or bank runs especially in emerging market economies, which can however be avoided if investors hold a diversified bundle of securities.
3. The expectations of speculators can exaggerate the effects of adverse shocks, and can even precipitate self-fulfilling financial collapses when weakened financial systems are also illiquid, which can be avoided if countries have enough reserves.
4. “Contagion” across countries in securities and loan markets increases the severity of the crisis.
5. Because of IMF protection, the costs of liquidity risk from government depending on short-term debt are not internalized

He concludes:

When a country suffers a banking system-cum-exchange rate collapse, its government protects politically influential domestic stakeholders by bailing out banks, their debtors, and their creditors, all at the expense of taxpayers. IMF loans to countries suffering financial collapse serve as bridge loans to permit the rescheduling of debt. The conditions imposed by the IMF along with its financial support help to ensure that tax increases to finance the bailout will be forthcoming, making the IMF an accomplice to the transfer of wealth from taxpayers to domestic oligarchs and global lenders.

Instruments for a stable global financial system

According to Calomiris, regulation ought to avoid the moral-hazard problems and protect against the four “liquidity” problems that can magnify fundamental shocks. There is a need to find a balance between liquidity assistance and market discipline.
In order to find that balanced global financial safety net, three “tranches of risk” must be defined: private exposure, government exposure and international (IMF-type)-exposure to risk.
Bank regulation consisting of capital requirements, “reserve” requirements, deposit insurance and “free banking” (capital market liberalization for financial institutions that comply with regulatory standards. These regulatory requirements should be mandatory for IMF membership, Calomiris argues, to provide a credible first tranche of private loss by ensuring that uninsured bank claimants (stockholders and subordinated debt holders) will lose wealth when banks suffer adverse shocks to the values of their risky assets. Minimum cash reserve ratio requirements ensure a margin of protection for insured debt), and also enhance bank liquidity. Minimum amount of “global securities” helps to diversify bank risk.
For the government exposure to risk, he wants the IFM to set standards for debt management and exchange rate policy, central bank reserve requirements, and require governments to allow banks to offer accounts denominated in both domestic and foreign currency)
The IMF role would be to provide liquidity to central banks in cases of speculative attacks against an exchange rate peg. He proposes that the IMF operates a discount window when lending to central banks which are normally solvent, but at a penalty rate. The IMF would finance the lending by borrowing cash from the central-banks.
Calomiris acknowledges that sharing reaching a system is not easy, especially since it will be strongly objected by governments, central bankers, banks and regulators.

The global financial architecture is very complex. Despite increasing liberalization of financial markets, increased system risk and integration of the economies through the financial markets in the last 30 years, there is no single World Financial Authority regulating the financial markets, as Alexander, Eatwell and Dhumale have suggested.

Instead what we have is a complicated system of co-ordination between regulators, intergovernmental co-operation and private standard-setting bodies creating “soft law” which then is adopted into legislation on the national and in case of the European Union on the transnational level.

Strangely enough, there is no single member-driven rule-based regime like in the fields of trade with the various trade rounds or environment with the Kyoto protocol, and no single dispute settlement emerged like the Dispute Settlement Body at the World Trade Organisation.

The Weak IMF, the strong BCBS

Even more puzzling is the fact that after the end of the Bretton-Woods-Regime of fixed exchange rates, the IMF did not develop into the center for political co-operation on financial matters as envisioned by the founders of the Bretton-Woods-Institution.

The joint expertise of the World Bank (which is really a development fund) and the IMF (which is really a bank for sovereign debt) would have made it an ideal combination to govern the worlds financial markets.

It is important to remember that Harry Dexter White, who negotiated on behalf of the US at Bretton Woods, wanted to abolish the Bank of Central Banks (the BIS in Basel) and give more power to the IMF to conduct monetary matters, but he never succeeded.

Not only did the IMF never fulfill its role as envisioned by Keynes and White, but after the end of the Bretton-Woods other key players re-surfaced in the turmoiled waters of financial regulation.

The Basel-System centered around the Bank for International Settlements gave birth to a transformed committee working on what turned out the most relevant dimension of global financial governance: banking supervision. The standards set by the BCBS have shaped the financial architecture more than any other standards set by the IMF or the OECD.

Evolution in Waves

Together with the BCBS, a plethora of private and public bodies emerged since the 1970ies. The evolution of this system was crisis driven, with the G7 Finance Ministers and the G10 Central Bank Governors setting the agenda.

From the middle of the 1970s onwards, several international organizations were founded and specialised in their respective part of the financial markets. The second half of the 1980s sees a further specialisation and the founding of specific task groups, like the Financial Action Task Force on Money Laundering.

The second half of the 1990s sees attempts to coordinate the various bodies more efficiently and approach problems such as threats to global financial stability. Since the turn of the millenium, the founding of several European bodies reflects the increased integration of the European Financial Markets.

There is no clear trend that financial regulation moves strictly in one way from the national to the international level. There is also no clear trend that national regulation moves from the strict functional approach of having supervisory agencies for the different type of actors in financial markets (banks, securities firms, insurers) to unified supervisory structure, although at least in some countries of the large G8 countries (UK, Germany, Japan) unified supervisory agencies have emerged (in countries like France, Italy and the US discussions about unifying the supervisory structures have started).

Explanations for the absence of institutionalism in financial governance

Financial governance consists of various dimensions:

1. Establishing a framework for the functioning of financial markets (for instance by establishing clearing and payment settlement systems).
2. Regulate, supervise and enforce regulation on market participants.
3. Improve competiveness of the financial markets by allowing new types of financial products.
4. Encourage market transparency and availability of information about markets.
5. React to financial crises, for instance with a Central Banks as a lender-of-last-ressort-function.
6. Restructure financial regulation to achieve financial stability, avoid contagion and reduce systemic risk.
7. Manage international macro-economic conditions through the intervention in exchange rate markets, managing national macro-economic through monetary and fiscal policy.
8. Discourage criminal activity in the financial markets, such as fraud, money laundering, financing of illegal activies (drugs and terrorism).

There are some explanations for this complex financial architecture with multiple power centers and various levels:

• The different aims of financial governance compete and sometimes contradict with each other. For instance macro-economic exchange rate management competes with the aim of financial stability if exchange-rate management needs to a currency crisis. Thus it is more rational to spread the various dimensions of financial governance to various bodies.
• The required level for market- or government-knowledge is very different for each of the dimension. For instance standard-setting and supervision needs a lot of technical information about the markets, therefore the BIS and Central Banks have a clear advantage because they operate in the markets. For other functions, for instance managing sovereign debt it is more important to have access to administrations and governments, therefore the IMF is better suited for that task.
• The different centers of financial governance reflect that financial architecture is not neutral, but it protects or damages interests of certain parts of the financial industry. For instance, the Basel-System can be seen in opposition to the Washington-based institutions reflecting different preferences of Europeans vs. Americans.
• Communication and coordination methods have changed how intergovernmental co-operation is conducted. An institution like the IMF would maybe look very different if founded today, but path-dependence restricts reform of institutions drastically.

A Research Outline

These explanations however offer only superficial insight into the dynamics of the financial architecture. Research on this topic will most likely have the following structure:

1. Defining Financial Governance
   • comparing several theoretical approaches from Political Economy and Political Science
   • outlining the difference between governance and government
   • outlining the difference between institutionalism and intergovernmentalism
2. Describing the Financial Architecture
   • Mapping the Financial Architecture
   • Describing the different power centers of financial governance
   • Describing the role of different organisations
   • Outlining co-operation mechanisms
   • Explaining the evolution of the current financial architecture
   • Discussing the various types of intergovermentalism in the current financial architecture
3. Case Studys
   • Banking Supervision
   • Money Laundering
   • Domestic Bonds
   • Hedge Fund Regulation
   • Currency Crises
   • Liquidity Crises
4. Proposals for Reform