Institutions and Liberalized Finance: Is Financial Stability of Capitalism a Pipedream?

The 2007/2008 crisis revealed the inefficiency of markets' selfadjustment mechanisms and the inability of related regulatory policies to keep markets on a consistent path. Something went wrong with the free market myth. From this perspective, the paper brings to the fore the regulatory roots of the crisis and highlights the importance of the cognitive bias as well as the incompatibility between micro-rationality and macro-stability in the occurrence of crises. It then analyzes the endogenous instability of finance-led capitalism in a Minskyian vein to point out the crucial role of regulatory structures for macro-stability. The paper then argues that financial stability calls for fundamental modifications of the institutional structure of markets and for new policy principles. Macro-prudential regulation must replace market-oriented supervisory approaches to prevent shortsighted speculative activities and to direct financial markets toward funding productive activities in ways other than though neoclassical market-based incentives.