What happens when global watchdogs fall asleep at the wheel? This article unpacks how weak international regulations, self-serving national agendas, and blind spots in oversight left the world’s financial system exposed—ultimately paving the way for the 2007–2009 Global Financial Crisis.
[Anh is currently completing a Bachelor of Commerce and Global Studies at Monash University, majoring in econometrics and international relations. As the President of ESSA, she is passionate about fostering curiosity and dialogue around the economic issues that shape our world. With a keen interest in global politics and public policy, Anh is particularly intrigued by the role economics plays in shaping international frameworks, institutional decision-making, and the policies that affect our daily lives.]
The Global Financial Crisis (GFC) of 2007-2009 marked one of the most severe financial disruptions in modern history, triggering a global recession, unprecedented job losses, and economic shocks that reverberated worldwide (The Economist 2013). Rooted in the collapse of the US housing market, the crisis quickly escalated as subprime loans and complex financial derivatives spread toxic assets through the global financial system. In an era of deep economic interconnectedness, one might expect global governance institutions to have mitigated these risks or limited their spread, yet, these systems ultimately failed to do so.
Global governance, defined as “governing, without sovereign authority, relationships that transcend national frontiers” (Finkelstein 1995), was ineffective in preventing the crisis due to several structural weaknesses. This article thus argues that it is due to four key factors: fragmented regulatory frameworks, national interests that prioritized deregulation, the inability to recognise and address systemic risks, and the absence of an effective early warning system and global financial safety net.
Loose Rules, Big Risks: Fragmented Global Regulations
A critical factor in the global governance system’s failure to prevent the GFC was the inconsistent adoption and enforcement of global financial regulations. Historical crises, such as the 1974-1975 currency crises that led to bank collapses in the U.S. and Europe (Schenk 2014:1129–1156), as well as the 1997 Asian Financial Crisis, highlighted vulnerabilities in the global economy from cross-border bank loans and currency risks (Schenk 2020:9). In response, the Basel Accords became the primary regulatory framework aimed at strengthening international banking standards. However, the accords remained voluntary for national regulators, which limited their impact on global financial stability (Barr and Miller 2006:19). Thus, the Basel Committee lacked adequate enforcement power (BIS n.d.).
The limitations of Basel II further exemplified this issue. Under Basel II, banks could use internal models to assess their capital requirements, which compromised transparency (Barr and Miller 2006:19), allowing financial institutions to minimize their regulatory burden. The Basel Accords also depended heavily on credit rating agencies, whose assessments of risk were later found inflated, riddled with conflict of interests of the “issuer pays” model, where entities issuing bonds could also pay rating firms to rate the bonds (White 2010:214), enabling institutions to engage in high-risk practices under the guise of regulatory compliance. These regulatory gaps enabled financial institutions to engage in regulatory arbitrage, exploiting national differences to engage in riskier behaviour. For example, European Banks were permitted to use internal risk models to justify lower capital holdings for complex financial products.
Ultimately, the fragmented and inconsistent application of international regulatory frameworks came hand in hand with inadequate oversight by national regulators, allowing financial institutions to accumulate unchecked risk. In this context, the global governance system was ill-equipped to prevent the GFC, as it lacked the coordinated regulatory structure necessary to manage systemic risks on a global scale.
Markets Before Mandates: How Deregulation Undermined Global Oversight
The weak application of international regulatory frameworks didn’t happen on its own accord. National interests and the push for deregulation critically weakened the global governance system’s ability to prevent the GFC. From funding deficit spending to the pursuit of economic growth, the United States over a few decades before the GFC reduced financial regulations to attract capital and boost competitiveness, Europe followed suit, creating a race to the bottom where regulatory standards were lowered to favour financial sector expansion (Burgin 2012:1211, Helleiner 2011). This deregulatory wave was driven by neoliberal ideology, which promoted market self-regulation and minimized government intervention, under the assumption that markets could effectively manage risks on their own (Harvey 2007:73). However, paradoxically, this meant too often they funded large financial institution bailouts to minimise the impact on the economy. For instance, the hedge fund Long Term Capital Management in 1997-8, where a combination of factors including derivative trading, regulatory arbitrage and a series of unfortunate events (ei: The Asian financial crisis) (Stoham 1999:384), prompted trouble and subsequent rescue from the US government.
Another prominent example was the repeal of the U.S. Glass-Steagall Act in 1999, which had originally separated commercial and investment banking to limit risk. Removing this barrier allowed banks to use customer deposits in high-risk investment activities, including complex financial derivatives, without adequate oversight (Stiglitz 2010). Similar deregulatory moves followed globally as countries sought to align with the U.S. model, fearing they would otherwise lose competitiveness in an increasingly interconnected financial system (Mosley 2003).
Thus global governance mechanisms, intended to maintain international financial stability, could not counterbalance national deregulatory agendas. In the absence of a unified regulatory framework approach, each country’s financial sector operated under its own standards. This fragmented approach enabled unchecked risk to accumulate across borders, ultimately contributing to the GFC.
Blind to the Bubble: Systemic Risk and Global Inattention
Diving deeper into why global governance failed to prevent the GFC was its inability to recognise and address systemic risks in an increasingly interconnected global economy. As financial markets became interlinked, a crisis in one country could quickly ripple outwards, yet national regulators, let alone global governance institutions lacked the tools to monitor these cross-border risks effectively.
At this time, US mortgage-backed securities (MBS) became a source of global risk when defaults in the US subprime market triggered a cascade of losses among European and Asian banks heavily invested in these assets. American banks, driven by the profit potential of MBS, bundled high- and low-quality mortgages into these securities and sold them internationally, severing the link between lenders and borrowers (Calhoun 2011:13). This model incentivized banks to prioritize volume over quality, with little regard for long-term risk.
Though MBSs were in design, spreading risk by bundling, dividing and selling mortgages, most investors and regulators assumed that housing prices would keep rising and default rates would remain low (RBA n.d.). However, when defaults surged, these “safe” assets quickly unravelled, and the systemic risks became clear. The rise of complex financial instruments such as collateralized debt obligations (CDOs) and credit default swaps (CDS) further concealed the risks within MBS.
Thus, the global interconnectedness of financial markets created a fragile system vulnerable to shocks that could propagate worldwide. Even within national borders, assessing systemic risks posed a challenge for regulators, thus global governance frameworks like the Basel Accords were in no position to address these complexities on a global scale. Hence, the failure of global governance to assess these interconnected risks left the system doomed to manage the unfolding crisis.
Too Little, Too Late: No Early Warnings, No Safety Net
Altogether, it’s been established that global governance failed to coordinate coherent regulatory frameworks, triumph over national interest and assess systemic risks to prevent the GFC. Ultimately, some of these failures could’ve been minimised if not for the lack of an effective early warning system and the absence of a global financial safety net. Despite the International Monetary Fund (IMF) having some surveillance mechanisms, they were inadequate in both scope and depth, focusing primarily on traditional economic indicators separately rather than the complex financial risks accumulating in interconnected markets. In its self-assessment, the IMF admitted that its early warning system failed to detect systemic vulnerabilities due to this narrow focus, leaving it blind to emerging risks associated with newer complex financial products (IMF 2009:2-6).
Additionally, the absence of a global lender of last resort, a role often proposed for the IMF but never fully established, meant that when the crisis hit, countries were left to respond independently. In the absence of a coordinated international safety net, national central banks such as the US Federal Reserve had to set up emergency liquidity swap lines to stabilize foreign markets temporarily. This ad hoc response underscores the limitations of a system that relied on national banks to manage global risk. As a result, countries with fewer resources or international connections were disproportionately affected, with some developing economies left particularly exposed to capital flight and liquidity shortages (Obstfeld 2009:69). In turn, without an effective early warning system and a global financial safety net, the global governance system was unable to monitor, anticipate, or mitigate the full scope of the crisis, leaving it vulnerable to unchecked risks that spiralled into the GFC.
A Crisis Foretold, But Not Prevented
To summarise, the Global Financial Crisis exposed significant weaknesses in the global governance system, highlighting its failure to prevent systemic risk accumulation in an increasingly interconnected financial landscape. The fragmented regulatory frameworks allowed inconsistencies across borders, enabling financial institutions to exploit regulatory gaps through practices like regulatory arbitrage. National interests and the push for deregulation, driven by neoliberal ideologies, subsequently led countries to prioritize financial sector expansion at the expense of stability, further undermining global coordination efforts. Finally, the absence of an efficient early warning system and a global lender of last resort left global governance institutions, particularly the IMF, unequipped to detect and mitigate emerging threats, resulting in fragmented, reactive responses that couldn’t prevent the GFC in the first place.
Given its lack of enforcement power, coherence, and proactive oversight, was global governance ever truly capable of preventing a crisis like the GFC?
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