Crashed: How a Decade of Financial Crises Changed the World

by Adam Tooze

Following the Bear Stearns crisis, it was not just ABCP but the collateralized repo markets that shut down. In the summer of 2008 the Fed, therefore, stepped into the breach, setting itself up as a repo dealer of last resort, offering twenty-eight-day repo against prime collateral (single-tranche open market operations, or ST OMO). A total of $855 billion were lent by December 2008, of which over 70 percent was taken by foreign banks, with five European banks dominating the entire program. Just one bank, the Swiss giant Credit Suisse, was the recipient of 30 percent of the liquidity the Fed provided.

The PDCF offered the key operators in the repo market discreet and unlimited access to overnight Fed liquidity in exchange for a wide range of collateral. Not surprisingly, the dealers took ample advantage.

When the crisis in the money market funds knocked the last remaining support out from under the commercial paper market, the Fed took the unprecedented decision not just to backstop banks and the mutual funds but to enter the lending business directly.

Crucially, what the Fed was doing was not just pumping liquidity into the system. It was also absorbing onto its balance sheet the maturity mismatch, which had done such damage in markets like ABCP. The Fed took the long-term asset in exchange for immediate liquidity.

Quantitative easing, or QE, is generally thought of as the quintessential “American” policy, the symbol of the Fed’s adventurousness. It would earn Bernanke regular scolding by conservative policy makers in Europe. But after what we have already said, it will come as no surprise that 52 percent of the mortgage-backed securities sold to the Fed under QE were sold by foreign banks, with Europeans far in the lead.

Not everyone in the network of Atlantic finance could take advantage of the facilities that the Fed offered to the top tier of international banks in New York. Nor did everyone have the kind of collateral the Fed demanded. To have lent to the most fragile European banks without adequate collateral would have exposed the Fed to serious risk. But to deny the weakest banks liquidity assistance was to court disaster.

To manage the fixed currency system in the 1960s the central banks had developed a system of so-called currency swap lines that allowed the Fed to lend dollars to the Bank of England against a reverse deposit of sterling in the accounts of the Fed.18 Having gone out of use in the 1970s, the swap lines had been briefly revived in 2001 to deal with the aftermath of 9/11. In 2007 faced with the implosion of the transatlantic banking system, they were repurposed and expanded on a gigantic scale to meet the funding needs not of sovereign states but of Europe’s megabanks.

The European central bank needing the dollars deposited the required amount of local currency in an account in the name of the Fed. The Fed credited the European central bank with the equivalent amount in dollars. The two sides agreed to reverse the trade at a future date at the agreed exchange rate. The terms were spelled out with a minimum of fuss in a contract running to no more than seven pages.

In the aftermath of the disastrous Paribas announcement in August 2007, the Fed was seeing regular early-morning spikes in European dollar funding costs that were causing disruption when the US markets opened in the middle of the European trading day.

As one American journalist put it, the Fed’s proposal “ran up against a strong effort,” on the part of the ECB, “to pin the Great Panic on the United States.” The ECB’s reply to the Fed was blunt: “[I]t’s a dollar problem. It’s your problem.”22 As Bernanke was later to remark, the ECB “had some difficulty coming to the realization that Europe would be under a great deal of stress and was not going to be decoupled from the United States.”23

The total amount outstanding on the network of dollar swap lines reached its peak in December 2008 at $580 billion. Briefly, the swaps touched 35 percent of the Fed’s balance sheet.

The essence of the swap line was to provide easy access to short-term dollar funding. With the New York Fed and its counterparts across the world working on a hectic schedule, new dollar funding was flushed into the system on a daily basis. In a single week in late October 2008, as dollars previously sourced from American money markets hemorrhaged out of the global banking system, the Fed lent $850 billion through the swap lines.

But for the swap facilities, between September 2008 and May 2009, monthly demand for dollars at the auctions organized by the ECB would have wiped out its reserves several times over.

The absence of a euro-dollar or a sterling-dollar currency crisis was one of the remarkable features of 2008. It was no accident. It was the swap lines that did the trick.

The scale of the compensating credit flow was staggering. By September 2011 total lending (and repayment) under the terms of the swap facility came to $10 trillion at varying lengths of maturity. Standardized to a twenty-eight-day term, the sum was equivalent to $4.45 trillion in one-month loans.

Every cent of this staggering flow of funds was repaid in full. Indeed, the Fed made profits of c. $4 billion on its swap lending in 2008–2009.

Responding to the crisis in an improvised fashion, the Fed had reaffirmed the role of the dollar as the world’s reserve currency and established America’s central bank as the i...

The Fed’s programs were decisive because they assured the key players in the global system—both central banks and large multinational banks—that if private funding were to become unexpectedly difficult, there was one actor in the system that would cover marginal imbalances with an unlimited supply of dollar liquidity.

Prior to the crisis, the transatlantic offshore dollar system had lacked a manifest center of leadership. Indeed, it had developed “offshore” so as to avoid national regulation and control. After 2008 it was openly organized around the Fed and its liquidity provision.

Not the least remarkable thing about the Fed’s crisis response was its politics, or rather the lack of explicit political legitimation. The emergency liquidity provision to the international economy by the Fed between 2007 and 2009 was shrouded in as much obscurity as possible. In July 2009, when Bernanke was challenged by campaigning Democratic congressman Alan Grayson of Florida to explain “who got” the swap line money, the chairman of the Fed could reply “I don’t know.”

The Fed used every legal means at its disposal to prevent detailed information about its support programs to both domestic and foreign banks from leaking to the general public. The vociferous libertarian and gold standard advocate Congressman Ron Paul ran a vigorous campaign for Fed transparency, which Bernanke did his best to ward off. Only in June 2009 did the Fed begin publishing regular reports on the uptake of swap lines. The fuller records of the Fed’s emergency programs, on which this chapter is based, were not opened to the public until December 2010 and March 2011.

At the top of the Fed’s list were Citigroup and Bank of America and the two highly stressed US investment banks, Merrill Lynch and Morgan Stanley, with their respective London operations. Then came a comprehensive list of the big European and American players in the global dollar banking business.

European banks and the London operations of the major US investment banks accounted for 23 percent even of the overnight primary dealer credit facility. When this support is added to the gigantic swap line facilities provided for the European central banks, the conclusion is inescapable. What the Fed was struggling to contain in 2008 were not two separate American and European crises but one gigantic storm in the dollar-based North Atlantic financial system.

These data are explosive not only in revealing what was required by the Fed to keep a globalized financial system on the rails. They are remarkable also for the light that they shed on the politics of the bailouts in Europe.

The banks might have avoided state-sponsored recapitalization, but every major bank in the entire world was taking liquidity assistance on a grand scale from its local central bank, and either directly or indirectly by way of the swap lines from the Fed. Using the Fed’s records we can track the liquidity support provided to a bank like Barclays on a daily basis, revealing a first hump of Fed borrowing during the Bear Stearns crisis and a second in the aftermath of Lehman.

Advocates of reform argued that at the root of global financial instability was the overreliance on the dollar as a reserve currency. This conferred on America an exorbitant privilege, which it exploited irresponsibly, running up deficits and borrowing abroad.

Two months later, President Sarkozy declared ahead of the G20 summit, “I am leaving tomorrow for Washington to explain that the dollar—which after the Second World War under Bretton Woods was the only currency in the world—can no longer claim to be the only currency in the world. What was true in 1945 cannot be true today.”

For avowed skeptics and critics of American power it was an unmissable opportunity to score points against Anglo-Saxon finance. But given the extraordinarily heavy dependence of both individual banks, such as Deutsche and Paribas, on Fed support and the huge swap line facility provided to the ECB, it is hard to see how either Steinbrück or Sarkozy could have been more out of touch with reality.

By the early twenty-first century, the dollar’s dominance did not rest on the Bretton Woods Agreement of 1944 or the institutions, like the IMF, that issued from it. The foundation of the global dollar was the private banking and financial market network, materialized in the Wall Street–City of London nexus. This was a cocreation of American and European finance, deliberately erected beyond state control.

What happened in the fall of 2008 was not the relativization of the dollar, but the reverse, a dramatic reassertion of the piv...

Steinbrück and Sarkozy may perhaps be forgiven for failing to recognize the significance of the moment, because the Fed had acted without fanfare and without seeking public legitimacy either at home or abroad. The sporadic global debate about alternatives to the dollar was the price that the Fed paid for keeping its stabilization campaign below the radar.

Ultimately, the Fed had to justify its measures in terms of benefits to the US economy. There were economies that were too small to warrant action.

But it was point 2, with its stress on “prudent policy,” that offered the scope for political discrimination. What was a prudent policy was very much in the eye of the beholder.

“Artificial divisions between ‘economic’ and ‘foreign’ policy present a false dichotomy. To whom one extends swap lines” is as much a “foreign policy as economic decisions.”

They were “two very different problems,” as Medvedev told the Federal Assembly in November 2008, but they had “common features” and a “common origin”: the presumption of an American government that “refuse[d] to accept criticism and prefer[red] unilateral decisions.”5 This played well with the nationalist gallery in Russia, but there was not much dissent from the European side either.

What he did not mention was that whereas France’s banks could count on limitless dollar liquidity from the Fed, the Russians were on their own.

If Moscow’s increasing assertiveness had been buoyed by oil prices surging to $145 per barrel, the crisis was a severe setback. By the end of 2008 oil prices had plunged, reaching their nadir at $34 on December 21. With natural resource rents accounting for 20 percent of Russian GDP, the impact of the commodity price crash was devastating. Tax revenue per metric ton of oil fell by 80 percent.

At their peak, Russia’s foreign currency holdings were estimated at $600 billion. It was not the state but Russia’s globalized business sector that was in trouble.

Was it truly globalized though?

According to one widely quoted estimate, Russia’s oligarchs saw their combined wealth slashed from $520 billion at the beginning of 2008 to a mere $148 billion by early 2009.8 What was spooking investors, apart from oil, was the likely impact of a sharp ruble devaluation on Russian balance sheets.

By the third quarter of 2008, Russia’s banks, raw material producers and industrial conglomerates had run up external debts of $540 billion, half owed by Russian industrial corporations and the rest by banks. This debt mountain matched Russia’s official reserves and was roughly equivalent to Lehman’s balance sheet.

Apart from the banks, the list of stressed dollar borrowers included all the major Russian oligopolies: Gazprom ($55 billion), Rosneft ($23 billion), Rusal ($11.2 billion), TNK-BP ($7.5 billion), Evraz ($6.4 billion), Norilsk ($6.3 billion) and Lukoil ($6 billion).

a slide in the ruble would put even heavier pressure on those that billed in local currency rather than dollars—a major issue for Gazprom, Russia’s largest gas supplier.

To some it seemed that the Kremlin was bent only on saving the skins of its cronies at the expense of the Russian taxpayer.10 On this reading, the Russian story was an even more corrupt and brutal version of the drama played out in America.

But putting events in Russia side by side with those in the United States or Europe, one is struck less by the self-dealing of Russian crisis management than by the frankness with which the question of power was ventilated in Russia and the obvious willingness of President Medvedev and Prime Minister Putin to use the occasion to shift the balance in their favor.

Now Medvedev and Putin were turning the screw. They offered financial protection, but they exacted a price.

In the first phase of the crisis, the central bank deployed its ample foreign currency reserves to stem the fall in the ruble. As a result, as oil prices plunged by 64 percent between October and December 2008, the ruble lost only 6 percent against the dollar.

Like any successful rearguard action, it came at a price. The central bank burned $212 billion of its reserves, 35 percent of the total, to slow the slide. But by so doing it bought time, allowing dollar-exposed borrowers to pull in their horns and giving the state some time to launch its own response.

Following this “bail-in” of the oligarchs, the government targeted takeovers and bailouts at the smallest and weakest Russian banks. Coordination was provided by state-owned Vneshekonombank (VEB), where Putin, as Russian prime minister, served as chairman of the board.

As investment plunged and domestic economic activity began to spiral downward, unemployment rates doubled. This was particularly worrying in the so-called monotowns—the urban legacy of Stalinist industrialization.16 On October 16, 2008, Igor Sechin, Putin’s right hand, convened an industrywide brainstorming session on the car industry at Togliatti, the company town of AvtoVAZ, the bankrupt inheritor of the Soviet car industry.

Relative to the size of its economy, commonly compared with that of Spain and roughly comparable to that of Texas, the Russian crisis response was one of the largest in the world, dwarfing those undertaken by West European governments.18 It was heavily skewed toward the largest, best-connected corporations that were included in a list of 295 nationally important corporations and 1,148 regionally important firms.