Elizabeth A Malavet 12/30/1955

A Critique of Saskia Sassens Theory of Digital Formations as Applied to the Global Financial Markets And an Update After the Financial Crisis

The global financial crisis of 2007-2010 was the result of a wide variety of circumstances, many triggering each other. First and foremost, housing prices and loans to subprime borrowers in the United States had increased substantially in the past decade.1 Most of these mortgages were securitized, but often the security was given a rated higher than its underlying mortgages. When these mortgages failed, the securities were worth less in value. However, as the IMF points out, [i]n the year following the breakout of the US subprime crisis in August 2007, the global economy bent but did not buckle.2 The subsequent collapses of Lehman Brother, AIG and others as financial firms were required to write off these securities lead to a flight to quality and the drying up of sources of liquidity, while at the same time governments responded by providing financial guarantees to banks and other institutions.3 Does this crisis provide further support for Saskia Sassens theory of social logics in digital
1

Rex Nutting, Existing Homes Plunge to a Two-Year Low, MarketWatch, August 23, 2006.; Joint Center for Housing Studies, State of the Nations Housing 2008, (Cambridge MA: Joint Center for Housing Studies of Harvard University, 2008), pp.25.
2

International Monetary Fund, World Economic Outlook: Crisis and Recovery, (Washington, DC: April 2009), pg. 2.
3

IMF, pp. 2-6.

formations as applied to the global financial markets or does it undermine the theory? Sassen and others use the term digital formations to capture the outcome of the intersection of technology and society.4 Of particular importance in the social contexts are the deep institutional and historical trajectories that digital formations bump up against.5 In the case of financial markets, [t]he new technologies have had a deeply transformative effect, but they do not dislodge the substantive agendas organizing market actors.6 These financial markets are argued to be embedded in nation-states, in a few financial centers and are subject to the control of hierarchical organizations and powers although nonetheless been significantly shaped by the three properties of digital networks: decentralized access/distributed outcomes, simultaneity and interconnectivity.7 I will update Sassens work by considering and expanding upon the data she used in her 2004 essay while simultaneously critiquing her theory in light of the 2007-2010 financial crisis. Sassen examines the assets of institutional investors8 and notes that both the rise of types of financial institutions almost exclusively involved in [short-term] flows as well as [g]enerally a growing concentration of market power in more conservative ones such as pension funds and insurance companies. While this is accurate in general, I believe that it is as important to draw finer distinctions
4

Robert Latham and Saskia Sassen, eds., Digital Formations: IT and New Architecture in The Global Realm, (Princeton: Princeton University Press, 2005), p.29.
5

Latham and Sassen, p. 28.

Saskia Sassen, Electronic Markets and Activist Networks: The Weight of Social Logics in Digital Formations, in Latham and Sassen, p. 55.
7

Sassen, p. 54. This particular OECD publication is no longer issued, the last being in 2004.

between different types of institutional owners. The Working Group on Institutional Investors of the Bank for International Settlements has noted that: Different objectives and strategies determine the investment behavior of different institutional investors. The asset allocation of insurance companies or defined benefit (DB) pension schemes that bear investment risk could be expected to be different from that of mutual funds or DC [Defined Contribution] schemes, in which the risk is directly borne by the individual.But they may not be as able as institutional investors to identify, judge and manage investment risks. In particular, it is unclear how effectively households will cope with financial market volatility. If households were to prove unable to manage the risks in DC pension schemes effectively, or if they set aside inadequate savings to provide for future pensions, their future retirement income would suffer.9 In some economies such as the United States, there has been an increased movement towards DC schemes such as 401(k) funds with about 50 million Americans holding about $2.5 trillion.10 According to the Boston College Center for Retirement Research, more than $1 trillion worth of stock value was lost in the 12 months after the stock market peak in October 2007 by 401(k) and other defined contribution plans. 11 2007 level, it is the Although the market has to a certain extent returned to pre-

volatility and tendency of individual investors who control their own DC plans to flee the stock market after a substantial downturn that has led to concerns about the overall viability of the retirement market as it is now structured. Therefore, this particular part of the institutional model

Bank for International Settlements, Working Group of the Committee on the Global Financial System, CGFS Papers, No. 27, (Basel: BIS, February 2007), p. ii-ii. The Working Group also notes that it is difficult to generalize across nations because the mixes of insurance/DB Pensions and DC Plans vary considerably.
10

Eleanor Laise, Big Slide in 401(k)s Spurs Calls For Change, Wall Street Journal, January 8, 2009, p. A1.
11

Alicia H. Munnell, Richard W. Kopcke, Francesca Golub-Sass and Dan Muldoon, An Update on 401(k) Plans: Insights from the 2007 Survey of Consumer Finance, CRR WP-20926, Center for Retirement Research, (Boston: Boston College), November 2009, p. 26.

underemphasizes the role of the individual, who is able to almost instantaneously change his/her asset allocation in response to market changes. Sassen recognizes but downplays this role in her discussion of the power of financial electronic markets.12 Additionally, Sassen speaks of the rise of short-term flows but does not provide much in the way of evidence. However, an examination of the turnover volume of global stock exchanges might show such short-term flows. According to the World Federation of Stock Exchanges, shares traded on their member exchanges rose from $5.7 trillion annually in 1990 to $49.8 trillion in 2000 to $80.9 trillion in 2009.13 And these numbers do not include derivatives, such as stock options, index options and index futures which according to the WFE rose from $11.9 trillion in 1995 to $149 trillion in 2009.14 Sassen does discusses derivatives by noting that digitalization has had a qualitative effect by contributing to the multiplication of types of derivatives and a sharp increase in the complexity of these types of derivatives.15 Sassen also notes the role of hedge funds as institutional investors with extremely

12

Sassen, p. 54. World Federation of Exchanges, Annual Statistics of Shares Traded.

13

14

WFE, Annual Statistics of Derivatives. The above figures do not include Stock Option Futures, Exchange Traded Fund Options, Short and Long-Term Interest Rate Options and Futures, and Currency and Commodity Options and Futures, for which figures were not available from 1995.
15

Sassen, p. 62. Sassen does note that commodity futures were traded as early as the 17th Century in Amsterdam. Later in this essay I will examine the effects of the financial crisis on the regulation of derivatives. It appears that we may have come full circle, where the technical ability to computerize mathematics to create complex financial instruments may once again be running up against regulatory concerns about the wisdom of allowing such technical ability to do so.

speculative investment strategies, differentiating them from other institutional investors.16 Even after the financial crisis, hedge funds are estimated to number 9000 funds globally, a loss of about 2000 funds.17 However, in terms of assets, conventional institutional investors far outweigh hedge funds, with an estimated $71 trillion in assets as opposed to $1.7 trillion in hedge funds. In the current
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financial climate, however, there has been a great deal of argument about the role of hedge funds in the volatility of the markets, for example, and in particular the crude oil market.19 But since hedge funds, for the most part, are not required to disclose their trading, or even their stock holdings as regular asset managers must do quarterly, it is difficult to prove the argument one way or the other. Another instance where globalization has arguably been greater than even that of derivatives is the rise, particularly in the last decade, of sovereign wealth funds. And an even more noteworthy characteristic of these funds is the fact that many, if not most, arise from nations such as China and the oil-wealthy nations of the Middle East. China alone holds close to $2.5 trillion in foreign exchange reserves, of which about half is estimated to be in the form of US Treasury securities.20 Thus, the distance between the financial instrument and the actual underlying asset, has come to favor not only the developed nations that Sassen cites, but the emerging ones as well.

16

Sassen, p. 61. Kattie Benner, A Banner Year for Hedge Funds, Fortune, February 15, 2010. TheCityUK, Fund Management 2010. Amanda Cantrell, The Blame Game: Hedge Funds & Oil, CNNMoney.com, April 26, 2006. Chinability.com, Chinas Foreign Exchange Reserves, 1977-2010.

17

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19

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The second set of issues that Sassen considers in examining the transformative nature of digitalization is the limits of technologically driven change,[or] the point at which this global electronic market for capital runs into the walls of its embeddedness in nondigital conditions.21 Are global capital markets nonetheless still embedded in subnational as well as national and global environments? And do these markets remain concentrated in a small number of powerful financial centers? Comparing the list of top stock exchanges by market capitalization for 2003 found in Sassens essay with a similar ranking for November 2010, several characteristics are noteworthy. First, the NYSE, or New York Stock Exchange, continues to vastly outrank the other exchanges but has also been merged since 2006 with the fifth ranked Euronext. Secondly, three of the remaining six exchanges are located in Asia, not in North America or Europe.22 Merger of exchanges is not the only indicator, though. The second-ranked Nasdaq also acquired the OMX or Nordic Exchanges, while ultimately acquiring a 25 percent stake in the LSE, or London Stock Exchange.23 Sassen accurately notes the connection of these select groups of financial markets, although at the time she was writing, they were more in the nature of alliances and not full mergers. Finally, Sassen examines the nature of the leading global financial centers. Has digitalization allowed such centers to become denationalized without becoming decentralized, or perhaps
21

Sassen, p. 63. Sassen, p. 66 and WFE, Monthly Statistics, 2010. BBC News, NYSE and Euronext in $20bn Merger, June 6,2006.

22

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becoming more centralized? It is here that most recent financial crisis provides us with the most telling arguments. When the financial markets and the economies to which they are closely intertwined began to falter, action was not at the global scale, but at the national level. Central banks, operating only to a certain extent in conjunction, began to bolster their own currencies, loan markets, and financial institutions. The interpretation, evaluation or judgment of information of the non-datum kind, such as risk, were no more carefully considered inside the major financial centers than elsewhere. The major ratings agencies, Moodys, Standard & Poors and Fitch were severely criticized for their failure to expose the underlying risks inherent in the securitized instruments partially comprised of subprime residential mortgages.24 In this case, it could be argued that it would not have mattered where the fundamental analysis of the securities was made, in New York or Mumbai, as long as the correct transparency had been applied. It is noteworthy that all of the ratings agencies have altered their analytic criteria and that the SEC has passed regulations to foster accountability, transparency, and competition in the credit rating industry.25 The one area of global financial markets that will again come to the fore in the light of the latest financial crisis, however, is that of regulation. According to Sassen, the deregulation of the last decade and a half removed many of [the] formal constraints on the geographic spread of the industry.
24

Eliot Blair Smith, Bringing Down Wall Street As Ratings Let Loose Subprime Scourge, Bloomberg, Sept. 24, 2008. All three agencies were criticized for giving high ratings to securitized instruments even though portions of the underlying assets were rated subprime and also for having conflicts of interest s such as being paid to rate the securities.
25

Mary L. Shapiro, Speech by SEC Chairman: Remarks at the IOSCO Technical Committee Conference, Basel, Switzerland, October 8, 2009.

However, [t]his possibility of locational and institutional spread also brings with it a heightened level and diversification of risk....[but] the geography of [this] spread is lumpy rather than seamless.26 While the set of banking rules known as Basel III had been in the works before the crisis, proposals and legislation in the United States and elsewhere are set again arguably to renationalize a good deal of this system. The Dodd-Frank Wall Street Reform and Consumer Protection Act, enacted in 2010, provides for systemic overview of the US financial markets, including SEC regulation of hedge funds, private equity funds and others previously exempt, reestablishes some of the proprietary trading prohibitions of the Glass-Steagall Banking Act and perhaps, most importantly, discarding the notion of a financial institution that is too big to fail. Still awaiting further regulation, however, are the derivatives that perhaps began to grow in substantial magnitude only with the digitalization of the electronic financial markets.27

26

Sassen, p. 59

27

Louise Story, A Secretive Banking Elite Rules Trading in Derivatives, The New York Times, December 11, 2010, p. A1. Storys article discusses a group of major banks that meet once a month to oversee the trading of derivatives, whether for good or ill is not known as the meetings are not public and minutes are not released.

REFERENCES BBC News. NYSE and Euronext in $20bn Merger. June 6, 2006. Benner, Kattie. A Banner Year for Hedge Funds. Fortune. Feb. 15, 2010. Bank for International Settlements. Working Group of the Committee on the Global Financial System. CGFS Papers, No. 27. Basel: Feb. 2007. http://www.bis.org/publ/cgfs27.htm. Blair Smith, Eliot. Bringing Down Wall Street As Ratings Let Loose Subprime Scourge. Bloomberg. Sept. 24, 2008. Cantrell, Amanda. The Blame Game: Hedge Funds & Oil. CNNMoney.com. April 26, 2006 Chinability.com. Chinas Foreign Exchange Reserves, 1977-2010. International Monetary Fund. World Economic Outlook: Crisis and Recovery. Washington, DC: IMF, April 2009. http://www.imf.org/external/pubs/ft/weo/2009/01/pdf/text.pdf.

Joint Center for Housing Studies of Harvard University. State of the Nations Housing 2008 Cambridge, MA: 2008. http://www.jchs.harvard.edu/publications/markets/son2008/son2008.pdf.

Latham, Robert and Sassen, Saskia , eds. Digital Formations: IT and New Architecture in The Global Realm . Princeton: Princeton University Press, 2005.
Munnell, Alicia H. ,Kopcke, Richard W., Golub-Sass, Francesca and Muldoon, Dan. An Update on 401(k) Plans: Insights from the 2007 Survey of Consumer Finance. CRR WP-20926. Boston: Center for Retirement Research at Boston College, November 2009. Nutting, Rex. Existing Homes Plunge to a Two-Year Low, MarketWatch, August 23, 2006. Sassen, Saskia. Electronic Markets and Activist Networks: The Weight of Social Logics in Digital Formations, in Latham, Robert and Sassen, Sassen, eds. Digital Formations: IT and New Architecture in The Global Realm . Princeton: Princeton University Press, 2005. Shapiro, Mary l. Speech by SEC Chairman: Remarks at the IOSCO Technical Committee Conference, Basel, Switzerland, October 8, 2009. http://www.sec.gov/news/speech/2009/spch100809mls.htm.

Story, Louise A Secretive Banking Elite Rules Trading in Derivatives, The New York Times, December 11, 2010. TheCityUK. Fund Management 2010. http://www.thecityuk.com/media/188154/fund %20management%202010.pdf. World Federation of Exchanges, Annual Statistics of Shares Traded. www.worldexchanges.org.