Governing the Unknown: The Regulation of Financial Risk

Financial markets play an increasingly significant role in the global economy. While the advantages flowing from this development are numerous and palpable, recent events have also demonstrated the significant potential downsides associated with the systemic risks introduced by irresponsible or inadequately monitored speculation made possible by the development of novel financial instruments. The global financial meltdown of 2008 has thus put financial markets into sharp focus among academics concerned with economic inequality. Yet despite the growing acknowledgement of the centrality of financial markets to modern political economies, there is little consensus regarding the appropriate role that regulation should play in harnessing their enormous power for egalitarian ends.

Some scholars, proceeding from a neo­-Hayekian perspective (often termed “minimalist”) and emphasizing the centrality of ignorance and uncertainty to financial markets, argue that the only prudent response is to create structures ensuring more “skin in the game”: insisting that actors in markets bear the responsibility for the choices they make and the risks they accept. On this view, it is futile to seek to improve regulation by paying closer attention to the details of ABS­-valuation or the minutiae of the practices of rating agencies. The more complicated the regulation, the claim goes, the greater the chance of exploitation by a knowledgeable insider. The only conceivable safeguards are thus procrustean and preventative: clawback provisions for CEO and trader compensation, limitations on firm size, and caps on salaries available to anyone working at banks or firms deemed “too big to fail”. Other scholars, however, working within the broad approach to governance labeled “experimentalist”, have argued that the presence of pervasive and ineliminable uncertainty is precisely what calls for more intensive, collaborative, and proactive forms of risk-sensitive governance. Drawing on techniques developed in fields dealing with high­-risk, complexly interdependent systems like nuclear power production and offshore oil­-drilling, these theorists present an alternative approach that focuses on continuous monitoring and updating of rules and objectives. Such an approach emphasizes the collaborative detection and correction of error (even when what counts as “error” is difficult to specify in advance), linking actors throughout a “supply chain” in a process of continuous learning from “weak signals” and anomalous outcomes as a means of avoiding catastrophic episodes.

This paper intervenes in this debate by interrogating and clarifying what is fundamentally at stake in disagreements between the two rival approaches to the regulation of financial markets. Drawing on recent academic inquiries into the problems of knowledge and performativity central to the 2008 financial crisis (e.g. MacKenzie 2011), the paper offers an analysis of the extent to which the errors that led to such worldwide exposure to systemic risk are corrigible by the forms of governance recommended by each perspective and further specifies what gaps in our knowledge prevent us from adjudicating decisively between them.