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Kindle Notes & Highlights
by
Adam Tooze
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February 17 - April 15, 2022
“[T]he present intervention,” Fernández pointed out, was not just “the largest in memory,” it was being “made by a State with an incredible trade and fiscal deficit.”4 If this was to stand, then the “Washington Consensus” of fiscal and monetary discipline to which so much of the emerging world had been subjected was clearly dead.
The question that hung over the dispensation of “neoliberalism” was whether the same rules applied to everyone or whether the truth was that there were rules for some and discretion for others.27 The events of 2008 massively confirmed the suspicion raised by America’s selective interventions in the emerging market crises of the 1990s and following the dot-com crisis of the early 2000s.
The financial system does not, in fact, consist of “national monetary flows.” Nor is it made up of a mass of tiny, anonymous, microscopic firms—the ideal of “perfect competition” and the economic analogue to the individual citizen. The overwhelming majority of private credit creation is done by a tight-knit corporate oligarchy—the key cells in Shin’s interlocking matrix. At a global level twenty to thirty banks matter.
Conservatism might have been disastrous as a crisis-fighting doctrine, but events since 2012 suggest that the triumph of centrist liberalism was false too.
As this book will show, what the history of the crisis demonstrates are truly deep-seated and persistent difficulties in dealing “factually” with our current situation. It isn’t just those denounced as populists who have a problem with truth. It goes far wider and far deeper and it affects the center as much as the margins of mainstream politics.
The availability of foreign funding negated Fed efforts to raise interest rates. At the same time it reduced the pressure on Congress to tighten fiscal policy.
But to promote the IMF as an arbiter had serious implications. China could not be expected to take advice from the IMF until it had representation on the IMF’s board that was commensurate with its size. Furthermore, Beijing would expect IMF monitoring to apply to the United States as well. That wasn’t likely to appeal to a Republican White House.
The crisis that will forever be associated with 2008 was not an American sovereign debt crisis driven by a Chinese sell-off but a crisis fully native to Western capitalism—a meltdown on Wall Street driven by toxic securitized subprime mortgages that threatened to take Europe down with it.
The simple answer is that real estate may be mundane, and McMansions may be nondescript, but they account for a huge share of total marketable wealth worldwide. By one estimate, the share of American real estate in global wealth is as much as 20 percent.1 American homes account for 9 percent of the total.
It was an end not just to inflation but to a large part of the manufacturing base in the Western economies, and with it the bargaining power of the trade unions. No longer would they be able to drive up wages in line with prices.
This was powerful mobilizing rhetoric for the Republican base. But as an explanation of the crisis that was brewing in 2006, this political critique is wide of the mark. Fannie Mae and Freddie Mac set a high minimum standard for the quality of loans they would buy. The GSEs didn’t support the kind of low-quality, subprime loans that were beginning to fail in droves in 2005–2006.
But as a new range of actors entered the mortgage market with a more dynamic and expansive agenda, their principal business model was not to disaggregate and to spread the risk but to integrate every step of the process, including the holding of large quantities of securities on their own balance sheets.25 It was this growth model, based on integration, not disintegration, that would blow the system up.
The subprime mortgage boom of the early 2000s led to a financial crisis because, contrary to the professed logic of securitization, hundreds of billions of private label MBS were not spread outside the banking system, but were stockpiled on the balance sheets of the mortgage originators and securitizers themselves.44
This was the truly lethal mechanism at the heart of the crisis. Funds from money market cash pools were channeled into financing the holding of large balance sheets of MBS.
Remarkably, under the bank regulations prevailing until the early 2000s, assets parked off balance sheet in the SIV could be backed by a fraction of the capital that would be required if they were on balance sheet. Inflating the balance sheet was risky but it raised rates of return on capital.
From 2004, fully half the subprime mortgages being fed into the system had incomplete or zero documentation, and 30 percent were interest-only loans to people who had no prospect of making basic repayment.
Fitch, which applied a risk assessment model that generated fewer of the coveted AAA-rated securities, found itself largely cut out of the subprime securitization business.53 As later congressional inquiries revealed, the ratings agency staff at Moody’s and S&P were clearly aware of the monster they were creating. As one ratings expert remarked to another in an e-mail in December 2006: “Let’s hope we are all wealthy and retired by the time this house of cards falters. :o).”54
Rajan worried that the dramatic expansion of modern financial intermediation was building up a dangerous new appetite for risk. At Greenspan’s farewell party, the message was not welcome. Rajan was slapped down by Larry Summers. Wielding his full authority as former Treasury secretary, Summers introduced himself as “someone who has learned a great deal about this subject from Alan Greenspan . . . and . . . who finds the basic, slightly Luddite premise of this paper to be largely misguided.”
In the final analysis, it was convenient to make the case at the level of macroeconomic aggregates. It was particularly easy to demand that a Republican president change his course. It was far less comfortable to question the house price boom and the giant Wall Street edifice erected on top of it.
By 2008 roughly a quarter of all securitized mortgages were held by foreign investors. Fannie Mae and Freddie Mac funded $1.7 trillion of their portfolio of $5.4 trillion in mortgage-backed securities by selling securities to foreigners.
According to the IMF team, trading in and out of London the main European and US banks achieved a collateral multiplication of 400 percent, amounting to roughly $4.5 trillion in additional funding, effectively out of thin air.29
The regulators were utterly subservient to the logic of the businesses they were supposed to be regulating. The draft text of what would become the Basel II regulations was prepared for the Basel Committee by the Institute of International Finance, the chief lobby group of the global banking industry.
When asked later how he justified such minimal reserve holdings prior to the crisis, one of the most outspoken central bankers of the period paused for a minute, smiled at a point well taken and then said quite simply: “Given our long history of relations with the Fed, we didn’t expect to have any difficulty getting hold of dollars.” In other words, there was a presumption that collaboration would be forthcoming and in an emergency the Fed would provide Europe, and London in particular, with the dollars it needed.
Worryingly, there was plenty of self-congratulation in Brussels in the early 2000s but little urgency about building the overarching mechanism of fiscal redistribution and burden sharing that would be necessary to see the eurozone through a recession, let alone a major financial crisis.
It may fly in the face of conservative assumptions about “democratic deficits” and the spendthrift habits of irresponsible politicians, but the formation of the eurozone without an ironclad fiscal constitution did not lead to a festival of unrestrained sovereign borrowing. The backdrop to the eurozone crisis was, indeed, a gigantic surge in debt, but it was in the private, not the public, sector. The eurozone played host to the same runaway, market-driven process of credit creation that European banks were contributing to so actively in the North Atlantic economy.
But Europe’s chief problem was not the lack of a fiscal fire code. Its problem was the lack of a financial fire department.46 The failure of state building that mattered most was not fiscal union but the failure to build the capacity to handle a banking crisis. Coping with highly integrated financial capitalism requires a state that is disciplined, has the capacity to act and has the will to do so.
Any public pronouncement on irrational exuberance in the Baltic was blocked by the Europeans on the IMF board. They wanted to keep the Baltics on track for euro membership and did not want to risk an IMF warning unleashing a chain reaction of uncertainty across Eastern Europe. The Swedes in particular were deeply concerned. Their banks had lent so heavily to Latvia that a crisis could easily spill back across the Baltic. Over the winter of 2007–2008, the Scandinavian representative on the IMF board went so far as to block the dispatch of the IMF delegation to Riga to complete Latvia’s regular
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But Merkel conceded that the summit should issue a statement endorsing the aspirations of Georgia and Ukraine and boldly declaring, “These countries will become members of NATO.”51 It was a fudge, and a disastrous one at that. It invited the Russians to ensure that Georgia and Ukraine were never in a fit state to take the next step toward NATO accession. It invited Georgia, Ukraine and their sponsors to force the pace. Ambiguity was a formula for escalation. And both sides responded accordingly.
Northern Rock had minimal exposure to US subprime. But that didn’t matter, because it sourced its funding from markets heavily used by banks that did. The bad news from Paribas on August 9 was enough to shut down the interbank lending markets and the market for asset-backed commercial paper.
It did not produce the memorable imagery of the 1930s Dust Bowl, but the housing crisis that began in 2007 forced the largest mass movement of people in the United States since the Great Depression. And as minority home ownership collapsed, the result was resegregation along racial lines.45
Among the African American population the surge was particularly dramatic, with unemployment rising from 8 percent in 2007 to 16 percent by early 2010.69 Young black workers were particularly hard hit, with their unemployment rate surging to 32.5 percent by January 2010. 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.
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.77 In the second half of 2008 capital flows between rich countries plunged from $17 trillion to barely more than $1.5 trillion.
As he was to affirm on several occasions afterward, for Bernanke, “September and October of 2008” was clearly the “worst financial crisis in global history, including the Great Depression.”79 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. The speed and force of the avalanche was unprecedented.
Politics is set aside as we anxiously watch our heroes struggle to rescue us from disaster. There is no time to ask why this is happening. 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?
Amid a global catastrophe, did it really matter which way the arrow of causation was pointing? Amid the intensity of the financial crisis, why should anyone care? Because 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.
Allowing for only minimal losses, the capital of both Fannie Mae and Freddie Mac would be completely wiped out. If they folded they would take down the last remaining lenders in the mortgage market and put in doubt the credit of the United States. They would put in jeopardy a huge portfolio of securities widely held by foreign investors. In the summer of 2008 foreign investors held $800 billion in debt issued by the GSEs. Fannie Mae and Freddie Mac were, as the influential blogger Brad Setser quipped, “too Chinese to fail.”
The US Treasury secretary was desperate to reassure foreign bondholders. Beijing was increasingly alarmed.23 In his memoirs, Paulson recorded: “I was talking to them [Chinese ministers and officials] regularly because I didn’t want them to dump the securities on the market and precipitate a bigger crisis. . . . And so when I went to Congress and asked for these emergency powers [to stabilize Fannie and Freddie], and I was getting the living daylights beaten out of me by our Congress publicly, I needed to call the Chinese regularly to explain to the People’s Bank of China, ‘listen this is our
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“What was worrying was that it was becoming more evident that the US Treasury was reluctant to provide the financial support to make the deal work. I was not entirely surprised. . . . I didn’t think he had enough political capital to persuade the Republicans to nationalize another bank.”
In any case, the subsidy to the counterparties and their clients clearly ran into the billions. Nor was it only the American financial system that benefited. In the course of the bailout, the Fed made sure to leave in place the insurance contracts that AIG had offered to European banks to provide “regulatory relief.” If they had been voided, the Americans estimated that the European banks would have faced calls for at least $16 billion in additional capital.
Perversely, the ailing banks resisted to the bitter end. None of them wanted to become a ward of the state. On the brink of failure they were still angling for whatever margin of advantage they could extract.
The path from Lehman to TARP was less one of a sovereign state rising to a crisis than of a dysfunctional power struggle within the social and political network that tied Washington, DC, to Wall Street and to the European financial system beyond. In September political and commercial considerations had prevented a deal to save Lehman. It took a month of panic, political confusion and unprecedented financial turmoil to reach the point in mid-October when the barons of Wall Street would listen when Paulson thumped the table and declared that everyone must take the Treasury’s money.
For critics of the bailout, like Sheila Bair of the FDIC, it seemed that the entire process was a smoke screen put up to hide a bailout of Citigroup.112 The Clinton-era network was still at work. Citi was not just too big to fail. It was too well connected. Whatever one thinks of this interpretation, it is undeniable that as soon as the extreme panic of early October had passed, the pretense of equal treatment was dropped.
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.
Hungarian politics polarized as the austerity program bit. The nationalist daily Magyar Hírlap described Hungary as being slowly garroted by a “credit noose around our necks.”37 For the extremists of Hungary’s Far Right it was a short step back in time from the “neocolonialism” of the EU and the IMF to the Treaty of Trianon, which had eviscerated Hungary after World War I. In 2010 the right-wing Fidesz party would reap the benefits with a crushing electoral victory, setting Hungary on the path to a self-declared illiberal democracy.
But the European Commission dug in its heels. Latvia was en route to eurozone membership. It must stay the course. If it needed to rebalance its current account it must do so through deflation and austerity. The results for Latvia were drastic. By the summer of 2009 house prices had plunged by 50 percent. Civil servants, including one-third of the country’s teachers, were fired and public salaries were slashed by 35 percent. Unemployment surged from 5 to 20 percent.
One of the reasons why Fed officials advocated a swap line for South Korea was that they did not believe Seoul was willing to have recourse to the IMF any longer. Better to welcome South Korea discreetly to the top table rather than to risk a politicized clash that might upset fragile global markets.
As the story is told, the list was drawn up by Summers’s assistant, Timothy Geithner (then in charge of international affairs at the Treasury), and Caio Koch-Weser, former managing director at the World Bank and then at the German finance ministry. With data for GDP, population and world trade to hand, they went down the list “ticking some countries and crossing others: Canada in, Spain out, South Africa in, Nigeria and Egypt out, Argentina in, Colombia out, and so on.”
What decided the issue was politics, or rather the self-censorship of the economics team in the name of politics. Second-guessing the attitude of Chief of Staff Rahm Emanuel and his political operatives, Larry Summers, as head of the National Economic Council, was convinced that he and Romer would lose all credibility if they suggested anything even close to the figure she thought necessary.
There was no run against Treasurys. The bond vigilantes were a spook. America’s households were rebuilding their savings. Mutual funds were shifting out of risky mortgage bonds. Everyone wanted Treasurys. These were the kinds of systemic macroeconomic and financial mechanics that all too often escape fiscal hawks, who view the public budget like that of a private household.
If the German federal government was issuing no new bunds, where were German savers to invest the 120 billion euros that they sought to put aside every year? Because the German corporate sector was also generating a financial surplus, they could not on balance invest their funds in German businesses. Rather than funding investment at home, Germany’s savings would out of necessity flow into investments abroad.
