Financial liberalisation in the developed countries, which was closely related to these developments, further increased funds available in the system. First, it increased the flexibility of banking and financial institutions when creating credit and making investments, as well as permitted the proliferation of institutions like the hedge funds that, unlike the banks, were not subject to regulation. It also provided the space for "financial innovation" or the creation of a range of new financial instruments or derivatives such as swaps, options and futures that were virtually autonomously created by the financial system. Finally, it increased competition and whetted the appetite of banks to earn higher returns, thus causing them to search out new recipients for loans in different economic regions.
 
The massive increase in international liquidity that followed found banks and non-bank financial institutions desperately searching for means to keep their capital moving. At first, there were booms in consumer credit and housing finance in the developed industrial nations. But when those opportunities petered out, a number of developing countries were discovered as the "emerging markets" of the global financial order. Capital in the form of debt and equity investments began to flow into these countries, especially those that were quick to liberalize rules relating to cross-border capital flows and regulations governing the conversion of domestic into foreign currency The result of these developments was that there was a host of new financial assets in the emerging markets, which were characterized by higher interest rates ostensibly because of the greater risks of investment in these areas. The greater ‘perceived risk’ associated with financial instruments originating in these countries, provided the basis for a whole range of new derivatives that bundled these risks and offered a hedge against risk in different individual markets, each of which promised high returns.
 
There are a number of features characteristic of the global financial system which evolved in this manner. Principal among these is the growing importance of unregulated financial agents, such as the so-called hedge funds, in the system. Many years back the Group of 30 had cautioned governments that these funds were a source of concern because they were prone to "undercapitalisation, faulty systems, inadequate supervision and human error". Though hedge funds first originated immediately after the second world war, they are estimated to manage close to $500 billion of investors' money. These investors include major international banks, which are themselves forced by rules and regulations to avoid risky transactions promising high returns, but use the hedge funds as a front to undertake such transactions. The operations of the now infamous Long Term Capital Management illustrate this. On an equity base of a little less than $5 billion, LTCM had borrowed enough to undertake investments valued at $200 billion or more. This was possible because there was nothing in the regulatory mechanism that limited the exposure of these institutions relative to their capital base. Yet when several of its own investments came unstuck in 1998 and LTCM therefore faced major repayment problems of its own, it had to be rescued by the US Federal Reserve, because the costs of its collapse were seen to be too major.
 
Such flows of credit to a few institutions are significant because in a world of globalized and liberalised finance, when countries are at different phases of the business cycle and characterised by differential interest rates, capital will tend to flow in the direction of higher returns in the short term. Nothing illustrates this better than the "yen-carry trades" of the period 1995 to 1997, which emerged from the wide interest differentials between the United States and Japan, in conjunction with the belief that the Bank of Japan did not want the yen to strengthen in 1996–97. These trades involved borrowing in yen, selling the yen for dollars, and investing the proceeds in relatively high-yielding US fixed-income securities. In hindsight, these trades turned out to be considerably more profitable than simply the interest differential, for the yen depreciated continuously over the two years from May 1995 through May 1997, which reduced the yen liability relative to the dollar investment that it financed. The implications of these and other flows to the US was that international liquidity "was intermediated in US financial markets and invested abroad through purchases of foreign securities by US investors ($108 billion) and by net lending abroad by US banks ($98 billion)."
 
There are a number of points to note from these examples. To start with, the global financial system is obviously characterised by a high degree of centralisation. With US financial institutions intermediating global capital flows, the investment decisions of a few individuals in a few institutions virtually determines the nature of the "exposure" of the global financial system. Unfortunately, unregulated entities making huge profits on highly speculative investments are at the core of that system. The growing consolidation in the financial sector noted by the G-10 study increases this centralisation.