Technocrats, State Agency, and the Rise and Continued Expansion of the Shadow Banking System
Scholar in Residence Lecture Series 2025
Shadow banking, a system of credit intermediation outside of the banking regulatory perimeter, captures the imagination of political economists. It is seen as a driver of financialization and a central pillar of the credit-led growth regime that dominates in the US – the epitome of the financial dominance that financial markets exert over central banks in the current era. Political economists’ notions of the reasons for its growth after WWII and its untrammeled expansion after the financial crisis, however, tend to reproduce a separation of markets and politics, which overplays the cunning of private actors and underplays the role of public agents. To fully capture the phenomenon, the lecture series seeks to correct for this shortcoming, focusing on the one hand on the moment of the initial set-up of this system of credit creation in the 1950s and 1960s and on the other on the failure to contain it after the Great Financial Crisis.
April 29, 2025 | 16:00–17:30
The Conventional Wisdom Regarding the Rise of Shadow Banking and the Neglect of Financial Stability Concerns: Strengths and Weaknesses
This introductory lecture lays out the main object of study of the lecture series, the shadow banking system, its wider importance for the understanding of the contemporary political economy, and the dominant explanations for its rise as well as its positive and detrimental effects. The shadow banking system – the generation and trading of credit outside of the banking system, financed with short-term deposits – and its rise after WWII, is identified in the contemporary literature as a major factor in the process of financialization that unfolded from the 1970s and in the diffusion and impact of the Transatlantic Financial Crisis as it unfolded from 2007. As such, it is closely linked to the central banks’ rise to the heights of macroeconomic policy and the credit-based growth model associated with it that dominates the US.
With respect to the rise of shadow banking, the conventional wisdom maintains that an unruly elite group of the capitalist class engaged in regulatory arbitrage to circumvent the rules established after WWII to constrain finance, an activity that was condoned by the US and the UK. Yet, this image of duped public officials who are behind the curve and come to approve of financial innovations post-factum, often after a crisis, has several weaknesses. On the one hand, it portrays the state as a monolithic actor, rather than a set of distributed agents with contradictory interests, including the Treasury and the Central Bank; on the other, it ignores the potential proactive agency of actors within the state apparatus which was laying the foundations of the shadow banking system. With respect to the fallout after the crisis, the conventional wisdom overplays the degree of ignorance and underplays the degree of dependence of central banks, both factors that limit the system’s regulation.
May 6, 2025 | 16:00–17:30
Foundations of the Rise of Shadow Banking in the US in the 1950s and 1960s: Acts of Commission and Acts of Omission by the Fed and the Treasury
The second lecture pursues the theme of agency of state actors in an attempt to explain the rise of the shadow banking system in the US by focusing on the establishment of the core market for liquidity provision to the shadow banking system, namely the repo-market in the US after WWII. It introduces the crucial concept of the liquidity triangle between the fiscal agent, the central bank, and private market-makers in order to develop the reasons that drove state actors to lay the foundations for the expansion of the shadow banking system. It documents how the Federal Reserve consciously and against prevalent legal interpretations started to enter into the provision of liquidity to broker dealers via the repo-market.
Using archival data, in particular the archive of James Robertson, the only dissenting member of the Federal Reserve Board, the lecture documents the statecraft that went into this exemption, allowing the Fed to provide liquidity to non-banks and the driving forces behind it, namely the convergent interests of central bank, treasury, and broker dealers. I subsequently trace how this financial innovation moved to the banking sector and weakened the Federal Reserve’s control over the liquidity available to the banking system. The documentation of inter-agency conflict in the 1950s and 1960s allows me to show not only the different historical junctures at which the regulation of the shadow banking system could have taken a different route, but also the dominant coalition of public and private actors that persistently pushed for its expansion.
May 13, 2025 | 16:00–17:30
Technocratic Myopia and the Time Inconsistency Problem Revisited: The Struggle Post-2008 to Integrate Financial Stability in Monetary Policy at the Fed
After the Great Financial Crisis, central bankers were alerted to the inherent financial stability risks of the shadow banking system, its endogenous tendency for overexpansion in boom phases, and its tendency for strong contraction during bust times. These experiences led to an attempt to control the shadow banking system in a regulatory manner – an attempt which in its essence failed to materialize in the post-crisis decade. Incapable of convincing market regulators and facing stiff opposition from shadow banks, among them asset managers demanding evidence of such tendencies, central bankers in their attempts never reached the momentum needed to seriously limit the system. In this context, central bank policymakers, in particular at the Federal Reserve, started to question if and to what extent monetary policy should take the shadow banking system into account and lean against the wind when its expansionary tendencies threaten future turmoil. Based on extensive transcripts of the Open Market Committee of the Fed, expert interviews, and an analysis of the evolving technocratic literature, this lecture documents “technocratic myopia.” Incapable of calculating the trade-offs between the mandated variables of inflation and unemployment on the one hand and expected future financial instability on the other, central bank agents chose to abstain from raising rates in the face of rising financial imbalances. Although they were keenly aware of the dangers inherent in letting low rates last too long, the fear of politicization over unpopular policy measures, as well as the fact that such policies contravened long-established monetary policy orthodoxy, led to their inaction.