Crashed: How a Decade of Financial Crises Changed the World

by Adam Tooze

As money market mutual funds, repo, ABCP and AIG’s credit default swaps all came into question, the shock waves spread far beyond the United States. Among the investments most favored by the money market funds were European bank debts.

A measure of their desperation was the price that they were willing to pay to borrow in euro, sterling, yen, Swiss francs and Australian dollars, and then to swap those loans into dollars. Normally, since these were close to risk-free transactions, the premium was zero. As dollar funding shut down, it soared to 2–3 percent. Applied to balance sheets running into the trillions of dollars, that spread was enough to threaten an avalanche.

Meanwhile, on the other side of the Atlantic, the impact of the funding crisis on a string of big European lenders was devastating. HBOS and RBS in Britain, Fortis and Dexia in the Benelux, Hypo Real Estate in Munich, Anglo Irish Bank, UBS, Credit Suisse and dozens of others all faced failure. Given that there weren’t any deposits, no one needed to run. You just stopped transacting in money markets and pulled in your horns.

In Europe no less than in the United States it was the crisis of 2008, not the later eurozone debacle, that marked the decisive break in investment, consumption and unemployment. From the second half of 2007, as banks great and small in Germany, France, Britain, Switzerland, and the Benelux began to acknowledge the scale of their losses, lending collapsed. The banking sector felt the pressure first because it was most dependent on the daily churn of vast volumes of credit. But soon the crunch extended to nonfinancial corporations and households too. In the eurozone, after running at between 10 and 15 percent, growth in new lending plummeted to zero. It wasn’t the sovereign debt crisis of 2010 that halted Europe’s growth, it was the transatlantic banking crisis of 2008.

As new mortgage borrowing contracted, the slide in the housing market accelerated. Falling house prices and collapsing financial markets slashed personal wealth. In Spain net wealth per person fell by at least 10 percent between 2007 and 2009. Within five years personal wealth would plunge by 28 percent, or 1.4 trillion euros, more than a year’s worth of output.

These were severe shocks, but for sheer scale the US crisis trumped them all. An early IMF estimate in the summer of 2009 put US household wealth losses at $11 trillion.38 By 2012 the US Treasury would raise that to $19.2 trillion.

Independent estimates put the figure closer to $21–22 trillion—$7 trillion from real estate, $11 trillion in the stock market and $3.4–4 trillion in retirement savings.40 From their peak in 2006, by 2009 US house prices had fallen by a third.

At the worst point in the crisis more than a quarter of US homes had negative equity.

Between 2007 and 2010 the mean wealth of American households fell from $563,000 to $463,000. But those figures are elevated by the huge fortunes of the very wealthy. If we look instead at the median household—the household that sits at the 50 percent mark in the wealth distribution—it saw its net worth halved from $107,000 to $57,800.

as bad as these figures are, the experience of America’s minority populations was worse. The median wealth of the Hispanic population, which had participated particularly actively in the housing boom, plunged by 86.3 percent between 2007 and 2010.43 The median African American household saw virtually its entire housing wealth wiped out, and African American home owners were twice as likely to suffer foreclosure as white borrowers.

And as minority home ownership collapsed, the result was resegregation along racial lines.45

With households suffering, in America’s economic downswing of 2008 it was consumption that led the way.46 As demand fell, so did production and employment. In the Central Valley in California, which witnessed a collapse of 50 percent in home values, consumption was cut by 30 percent.

For America’s long-ailing motor vehicle industry it was the coup de grâce. Car and light vehicle sales plunged from an annual rate of 16 million units in 2007 to as few as 9 million per annum in 2009. By December 2008 it was clear that both Chrysler and General Motors would fail.

The imminent failure of GM and Chrysler was an exclamation point on the long-running decline of the American auto industry. One version of the American Dream was dying. But Detroit’s crisis sent shock waves around the world.

Under the NAFTA free trade system, interconnected production systems, known as value chains, had been stretched from one end of North America to the other. As a result, Mexico’s dependence on the United States was overwhelming.

In 2007, 80 percent of Mexico’s exports were sent to the United States. As the American crisis hit, Mexico’s GDP fell by almost 7 percent, a worse contraction even than during the homegrown financial crisis of 1995—the so-called Tequila Crisis.

Together with the surging violence of the drug wars, the recession led more than 100,000 desperate workers and their families to abandon Juárez. As unemployment surged north of the border, remittances dried up and hundreds of thousands of migrants returned home, making the situation of the poorest Mexicans progressively more desperate.

For decades GM’s great global rival was Toyota, and 2008 would be the year in which Toyota claimed the title of the world’s leading car producer. It paid a heavy price. In 2009 Japan was rocked by a “Toyota shock” as its national champion reported its first loss in seventy years and cut global production by 22 percent.53 From a profit of $28 billion in 2007–2008, Toyota slid to a loss of $1.7 billion in 2008–2009.

Japan’s investment industries stopped in their tracks. Hitachi, the giant producer of capital goods and electronics, was worst hit, facing a record loss for a Japanese industrial company of $7.87 billion.56 Consumer electronics icon Sony announced a loss of $2.6 billion. Toshiba expected to lose $2.8 billion, Panasonic $3.8 billion.57 All in all, in January 2009 Japan’s economy contracted at a rate of 20 percent per annum and exports by 50 percent year on year.

As the shock of 2008 revealed, with supply chains synchronized to perfection, “factory Asia” responded within a matter of weeks to any hesitation of demand in Europe and America. Nor were they the only ones to be hit. Germany suffered a 34 percent fall in exports between the second quarter of 2008 and 2009, with its machinery and transport equipment sector taking a deep dive.

By the first quarter of 2009, Turkey’s GDP was falling by 14.7 percent on an annualized basis. Unemployment rocketed from 8.6 percent in the summer of 2008 to 14.6 percent in the first winter of the crisis. It was the worst affected of any of the emerging markets outside Eastern Europe. Turkey had not seen a situation so bad as this since the disastrous financial crisis of 2001.

What made the collapse of 2008 so severe was its extraordinary global synchronization. Of the 104 countries for which the World Trade Organization collects data, every single one experienced a fall in both imports and exports between the second half of 2008 and the first half of 2009. Every country and every type of traded goods, without exception, experienced a decline.

In the worst six months of 2008, oil prices fell by more than 76 percent. That in turn wreaked havoc with the budgets of the petrostates. Saudi Arabia swung from a budget surplus of 23 percent of GDP in 2008 to a substantial deficit.63 Kuwait was rocked by the crisis at Gulf Bank, which faced losses on currency trades.64 But nowhere was worse affected than the boomtown of Dubai.

By February 2009 Dubai’s rip-roaring six-year construction boom had come to a halt. Half of a portfolio of $1.1 trillion in construction projects being undertaken in the Gulf Cooperation Council was canceled in a matter of months. Luxury cars were abandoned in droves as Western contract workers scuttled to the airport to escape debtor’s prison.

As both household consumption and business investment plummeted, of the sixty countries that supply the IMF with quarterly GDP statistics, fifty-two registered a contraction in the second quarter of 2009.67 Not since records began had there been such a massive synchronized recession.

Though it was dazed bankers with boxes of belongings stumbling out of office towers in London and New York that attracted the TV cameras, it was young, unskilled blue-collar workers who suffered the worst.68 In the United States, the epicenter of the crisis, the month-on-month fall in employment over the winter of 2008–2009 was breathtaking. In the worst period, the monthly rate of job losses topped 800,000.

Among the African American population the surge was particularly dramatic, with unemployment rising from 8 percent in...

At the very bottom of the pile were young African American men with no high school diploma. In New York City in 2009 their unemployment rate was more than 50 percent.70 Precisely how many people lost their jobs across the global economy depends on our guess as to joblessness among China’s giant migrant workforce. But reasonable estimates range between 27 million and something closer to 40 million unemployed worldwide.

The Great Depression of the 1930s was not confined to the United States, and neither was the crisis that struck in 2008. On a global level, industrial output, stock markets and trade were all falling at least as fast in 2008–2009 as they had in 1929.

On the morning of September 20, the US Treasury secretary alerted Congress to the fact that unless they acted fast, $5.5 trillion in wealth would disappear by two p.m. They might be facing the collapse of the world economy “within 24 hours.”

Across the world before the crisis hit, inflows and outflows of capital came to just under 33 percent of world GDP. The vast majority of this was accounted for not by transactions between the advanced world and emerging markets but by flows between advanced economies. At the height of the crisis, between the last quarter of 2008 and the first quarter of 2009, those flows collapsed by 90 percent to less than 3 percent of global GDP.

In public, Ben Bernanke knew it was essential for him to keep a straight face: “Financial panics have a substantial psychological component. Projecting calm, rationality, and reassurance is half the battle,” he would later opine.78 But as an economist and an economic historian, Bernanke understood the scale of what he was up against.

In the 1930s there was no moment of such massive synchronization, no moment in which so many of the world’s largest banks threatened to fail simultaneously.

We are “all in this together.” But it is precisely with that assertion that a political economy of the crisis begins.83 Which system was it that needed to be saved in the autumn of 2008? Who was being hurt? Who was included in the circle of those who needed to be protected? And who was not?

By September 2008 it was no longer individual banks but the entire financial system that had to be saved at all costs. It was entire markets and sectors—the repo market, ABCP, the mutual funds—that needed life support. It was the implosion of the financial system, imagined as something akin to a massive electrical power failure that threatened the entire economy.

It was crucial to fix Wall Street, so the slogan went, to help Main Street. The mantra was repeated in local idiom all over the world. And for the purposes of ongoing business activity, it clearly was crucial to maintain business credit.

beyond such immediate rescue measures, did the all-out focus on the financial system really serve the interests of the real economy?86 Was the inability to borrow causing a failure of investment and thus the ongoing depression?

the decision made by the American crisis fighters to take those questions off the table and to give absolute priority to saving the financial system shaped everything else that followed.

Whereas since the 1970s the incessant mantra of the spokespeople of the financial industry had been free markets and light touch regulation, what they were now demanding was the mobilization of all of the resources of the state to save society’s financial infrastructure from a threat of systemic implosion, a threat they likened to a military emergency.

The ferocity of the financial crisis in 2008 was met with a mobilization of state action without precedent in the history of capitalism. Never before outside wartime had states intervened on such a scale and with such speed. It was a devastating blow to the complacent belief in the great moderation, a shocking overturning of prevailing laissez-faire ideology.

It was a profound challenge to the basic idea that had guided economic government since the 1970s. It was all the more significant for the fact that the challenge came not from the outside. It was not motivated by some radical ideological turn to the Left or the Right. There was precious little time for thought or wider consideration. Intervention was driven by the financial system’s own malfunctioning and the impossibility of separating individual business failure from its wider systemic repercussions.

The main mechanisms for intervention were fourfold: (1) loans to banks; (2) recapitalization; (3) asset purchases; and (4) state guarantees for bank deposits, bank debts or even for the entire balance sheet. Everywhere the crisis struck, states were forced to take some combination of these measures.

As the crisis intensified it put the financial and political resilience of states to the test. Broadly speaking, this produced four types of outcome, which reflect the degree of immersion in global finance, the resources of the states at risk, the shape of the governing elite and the balance of power within the financial sector itself.

In the most extreme cases the crisis overwhelmed the state. Ireland and Iceland simply did not have the resources, the institutions or the political capacities to deal with the gigantic shock to their overgrown financial sectors. They would suffer a comprehensive crisis, as would the worst-hit emerging market economies of Eastern Europe.

Despite having a grossly overgrown financial sector, Switzerland survived intact. It did so through early, intense and unrelenting attention to its one failing megabank, UBS.3 Though it was never nationalized, it became in effect a ward of the state.

Despite the scale of the crises they faced, they had the resources to cope. They attempted comprehensive organizational and financial solutions, including abortive proposals to coordinate a common European response to the crisis.

efforts to achieve consistency and coordination were undermined by national political calculation and the uncooperative behavior of leading banks that fancied themselves large enough to survive without the humiliation of taking state aid.

Out of this trial of strength the United States emerged as the one nation-state with the capacity not only to backstop the biggest financial sector in the world but also to impose a comprehensive solution.

For inspiration he invoked the war-fighting doctrine developed in the aftermath of the Vietnam debacle by America’s chairman of the Joint Chiefs, Colin Powell: Strike with massive force and plan a clear route out.4 It was an analogy that had first been invoked by Larry Summers at the time of the Mexico financial crisis in 1994. Now it became Geithner’s mantra.

For Geithner and his cohorts it was clear that swift and decisive action paid dividends. Compared with the disastrous performance of the European economy, the United States was set back on track.5 The leadership of American finance renewed itself. Even when viewed narrowly in accounting terms, many of the Treasury and Fed support programs made a profit for the American taxpayer.