Crashed: How a Decade of Financial Crises Changed the World

by Adam Tooze

Whereas the US crisis involved overextended banks and mortgage borrowers impelled by greed and financial excess, the eurozone crisis would revolve around quintessentially European themes of public finance and national sovereignty.

The decisive force in European politics for the next decade and beyond would be German Christian Democracy and its leader, Angela Merkel.

Merkel has come to be seen as the figurehead of Europe’s political center—oscillating between conservative stances on economic and financial policy and cultural modernization.16 When she first emerged on the political scene her profile was harder edged. In the 2005 election that brought her to power, Merkel ran on a strong promarket platform. It was unpopular and she subsequently softened her stance. But there is little doubt that the 2005 agenda expressed the chancellor’s basic personal vision. It can be summarized in three numbers: 7, 25 and 50. As Merkel is fond of pointing out, Europe has 7 percent of the world’s population and 25 percent of global GDP. But it is responsible for 50 percent of global social spending.17 This, as Merkel sees it, is not sustainable. Germany’s growth is steady, but slow at best. Germany’s population, along with that of much of Europe, is aging. What has to give is government spending. Fiscal consolidation is the deep continuity of Merkel’s administrations. As she announced in her first speech at Davos in January 2006: “To understand the social market economy as a NEW social market economy in the twenty-first century we must first of all reorder the priorities of politics toward an understanding of politics that is directed ahead, toward future generations. For us in Germany

that means first of all clearing up our financial situation, our budgets. We have a demographic problem. We know that we have too few young people and nevertheless we live at the expense of the future by running up debts. That means that we rob future generations of their room for investment and development and that is immoral.”18 Needless to say, this was music to the ears of business lobbyists concerned to see taxation and state spending held in check. But Angela Merkel’s first government was a grand coalition with the defeated SPD.19 Fiscal consolidation, like Hartz IV, commanded a consensus across the center ground of German politics. The finance ministry was claimed by Peer Steinbrück, an acolyte of the legendary SPD chancellor of the 1970s and 1980s, Helmut Schmidt.20 Steinbrück was profoundly committed to a supply-side, anti-Keynesian vision of economic policy. For him restoring “fiscal room” was not merely a matter of financial stability. The ossification of the government budget under the impact of quasi-automatic entitlement spending and interest payments was indicative of a broader problem affecting the developed world: the crisis of democratic politics and democratic...

2006, as Merkel’s grand coalition took office, the mood in the western Länder, and particularly the rich southern states, was resentful. They had been conscripted into a gigantic act of solidarity with the East. Now they had had enough. Capping deficits was a not-so-covert promise to the rich southern states to rebalance priorities away from the needy and indebted eastern and northern members of the Bund. Fatefully for the future of the eurozone, the problem of fiscal control was cast by German politics already from the early 2000s as one of equity within a federal transfer union. Well before the Greek crisis broke, the most prosperous regions of West Germany had made clear their refusal to take responsibility for other people’s debts, German or otherwise. The argument that the debts “shouldered by the West” to pay for spending “in the East” had generated huge orders for West German business—in effect exports within Germany from West to East—cut no ice. After 2010 the same argument would cut no ice at the European level either. What the most influential voters and voices in German public opinion wanted was simple: discipline all around. In 2006 a commission was set up to devise ...

The rise of China and the funding problems of the modern welfare state were common challenges. The Bush administration might have been political poison in Europe. But in the late 1990s, Clinton’s Democrats had been an inspiration

for Gerhard Schroeder’s Red-Green coalition.24 Merkel was nothing if not an Atlanticist. But if there was a common agenda, there were common blind spots too. For all the focus in the eurozone on the need to make labor responsive to the demands of global competition, for all the calls for common fiscal discipline, there was an almost total lack of recognition of the destabilizing forces unleashed by global finance. In Europe, as in the United States, it was politicians, workers and welfare recipients who were seen as the problem, not banks or financial markets.

If Europe did not have a common fiscal policy or labor market policy, it did at least have a common monetary policy. Its guardian was the ECB,

To prevent it from being put to work as a vehicle of fiscal policy, it was banned from monetizing newly issued government debt.

Unlike the Fed, which had a dual mandate for price stability and maximum employment, the ECB had price stability as its only target. All this made the ECB the most remote of all the modern central banks.26 To call it apolitical would be a misnomer, because it, in fact, entrenched a conservative bias against inflation as the unquestionable doxa of Europe. Nor would it be fair to say that anti-inflation politics were the ECB’s only ambition. It also wanted to promote Europe as a financial center and the euro as a reserve currency, and that meant actively developing European debt markets. Specifically, it meant importing to Europe the American model of a repo market for government debt. Being able to repo government securities made them much more attractive as assets.

Faced with the financial pressures exercised by Germany, France had actively promoted the market for its own debt by offering American-style repo facilities.27 The easier it was to trade French debt for instant liquidity, the more actively it would be purchased and the more accepting the market would be of France’s borrowing requirements. Over the resistance of the Bundesbank, repo was adopted as a core operational model by the ECB. Unlike the more traditional central banks, like the Bank of England or the Fed, the ECB did not hold large quantities of government debt. It managed Europe’s financial system by repoing a wide range of bonds including both private debt and public bonds.28 Rather than the ECB, it was Europe’s banks that bought their governments’ debt. But they did so with the understanding that if they needed cash in a hurry, the bonds could be exchanged with the ECB on a repurchase basis. The terms of the repo and the size of the ...

If it had wished to maximize pressure on Europe’s government to preserve fiscal discipline, the ECB could have adopted a discriminatory system of nationally specific repo haircuts, imposing tougher conditions on less credible peripheral eurozone borrowers. Haircuts in the bilateral repo market in the United States varied widely across different types of bonds. A higher haircut would require banks to hold more capital against their bond holdings and shrink their portfolios of that debt. In Europe in the late 1990s, Greece had had to offer far higher interest rates to attract lenders than had Germany. But instead of discriminating, the ECB took the view that a single currency implied a single rate. It would repo the bonds of all European sovereigns on the same terms.29 Unsurprisingly, this produced a dramatic co...

government bonds. The result was a self-reflexive loop in which the ECB relied on markets to exercise discipline over public borrowers while the markets came to assume that the ECB’s “one bond” policy implied an implicit European guarantee for even the weakest borrowers. The result was that Greece and Portugal could borrow on terms that were better than ever before in...

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.

As the Financial Times’s economic commentator Martin Sandbu has remarked, it was the euro’s “great misfortune” to be born “into the greatest private credit bubble of all time.”

In 2007 more than $500 billion in loans were securitized in Europe. In 2008 the total reached $750 billion in European asset-backed security issuance with UK and Spanish banks particularly active.

Once again, as in the case of America’s international finances, it is easy to deceive oneself about the direction of these intra-European flows. We have a clear map of the economic hierarchy of Europe in our heads. We know where the loans went—Greece, Spain, Ireland. We know that Germany was the main “surplus” and “creditor” nation. So does that mean that Germany financed the credit boom? Certainly it had the largest trade surplus and was thus the largest net exporter of capital. But as far as overall financial flows within Europe are concerned, that simple mental map is as misleading as the exclusive focus on Sino-American financial relations is on a global scale.

But if we focus on intra-European flows, it is clear that Germany, despite its export prowess, did not dominate the European financial system. Germany was the largest net lender. Its status was like that of China in relation to the US economy. But financial flows within Europe no more mapped onto trade than they did in the world economy. Germany was a champion exporter of cars and machinery, but in banking

and finance others led the field. The UK, France, the Benelux and Ireland (the latter hidden within the category “Rest of Euro area”) were the key hubs for financial flows. The City of London, home to banks from around the world, including all the leading German banks, stands out as the major financial partner for every eurozone member, even though it was not a member of the currency union. France and the Benelux were particularly important because they served as channels through which funds flowed into the eurozone from the outside. American and other lenders from the rest of the world clearly preferred to do business with well-known French, Dutch and Belgian counterparties, who then channeled the funds to the European periphery. France was a major financial hub, not because it had a huge trade surplus but because it had large, ambitious banks that were willing to borrow to lend: 445 billion euros flowed out of France and 447 billion flowed in, leaving a net imbalance of merely 2 billion euros. At the same time, 602 billion euros flowed out of the Benelux banking centers and 559 billion flowed in. The Dutch trade surplus made up the difference.

The flow of funds around Europe, as around the global economy, was driven not by trade flows but by the business logic of bankers, who sought out the cheapest funding and the best returns. The upward spiral of asset prices and balance sheets that drove the US boom was even more pronounced in Europe. Between 2001 and 2006, Greece, Finland, Sweden,

Belgium, Denmark, the UK, France, Ireland and Spain all experienced real estate booms more severe than those that energized the United States. In Ireland and Spain, the combination of credit growth and house price inflation was truly explosive.

It was these credit-fueled booms that drove the trade and fiscal imbalances of the eurozone, rather than the other way around. The huge influx of credit from all over the world to a hot spot like Spain inflated economic activity there. This generated healthy tax revenues for Madrid, which proudly boasted a fiscal surplus. It also generated export orders for Germany. Foreign demand gave a boost to the languishing German economy, raising incomes and profits.38 But German households and businesses did not want to spend their income increment in Germany, on either consumption or investment. The German government borrowed, but not enough to soak up the difference. Through interbank markets, surplus liquidity in the north helped to fund business ventures around Europe. Some of that, not surprisingly, went to Spain. At the end of the day the accounts balanced. Germany’s savings appear as the counterpart to Spain’s trade deficit. But accounting identity is not the same as causal relationship. It wasn’t Germany’s excess savings, or its exports, that produced the boom in Spain. It was the lopsided credit-fueled boom that produced the demand imbalances, the trade flows and the savings imba...

It would later be said that the ECB should have done more to dampen the boom in Ireland and Spain. And it is clearly true that this was made more difficult by the fact that it set one interest rate for the entire eurozone. In effect, by setting low rates, the ECB prioritized the need to stimulate the German economy over restraining the boom in the periphery. It was a reasonable decision. Germany’s economy is far bigger. Furthermore, given the rates of return that beckoned in the hot spots of the European economy, it is wishful thinking to imagine that the ECB could have curbed the boom with a rate hike. If the EU’s business statistics are to be believed, investment in Spanish tourism and real estate offered rates of return of 30 percent or more. Little wonder that investment crowded in.39 In a world of globalized finance, the ECB could no more limit the flow of funds to such a hot spot than the Fed could choke off the capital inflow to the United States. Ireland’s banks were a case in point. They sourced their funding wholesale in the City of London, outside the ECB’s immediate purview.40 To have slowed the booms would have required not a mild tweak of ECB interest rates but a full-scale economic policy mobilization by the governments of the boom countries. This might have included tougher lending rules, throttling back growth in the banking system and even tighter fiscal policy. In the case of Spain, the larger, internationalized banks were, in fact, held on a tight leash...

Banco Santander were emerging as global players. Fashion giant Zara made its owner Amancio Ortega the richest billionaire in Europe. Prime Minister José Luis Rodríguez Zapatero was lobbying for Spain to be invited to join the top table in an expanded G8. With lean social services and booming tax revenues, Spain’s public budget was in far better shape than that of France or Germany. Why put the brakes on such a healthy-looking burst of private sector growth?

Among Ireland’s tiny political elite a similar spirit of ebullience prevailed. Coddled by EU investment and incestuously connected with bankers and developers, politicians boasted of the global attractions of Dublin’s International Financial Services Center. Ireland’s tax system enabled foreign corporations to spirit hundreds of billions of dollars in profit past tax authorities in the United States and the rest of Europe.

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. Coping with a banking crisis on the scale that was brewing in Europe required a very capable state indeed.

How badly such a facility was needed becomes clear only when we put together the local and global activities of Europe’s banks, to get a full view of their spectacularly overinflated growth. America’s banks were very big and very important to global finance. But it was in Europe that bank finance had grown most disproportionately.47 Europe’s banks had always been large. Unlike the United States, where equity and bond markets were the main sources of business finance, Europe’s economies had long relied heavily on bank lending. But spreading out across the EU and feeding off the transatlantic financial circuit, the European banks had grown to gargantuan size. In 2007 the three largest banks in the world by assets were all European—RBS, Deutsche Bank and BNP. Combined, their balance sheets came to 17 percent of global GDP. The balance sheet of each of them came close to matching the GDP of its home country—Britain, Germany and France—the three largest economies in the EU.48 In tiny Ireland the situation was far more extreme. The liabilities of its banks added up to 700 percent of GDP. France and the Netherlands rivaled each other, with liabilities at 400 percent of GDP. The banks of Germany and Spain had liabilities amounting to 300 percent of GDP. By this standard every member of the eurozone was at least three times more “overbanked” than the United States. Furthermore, Europe’s banks were far more dependent on volatile “wholesale,” market-based funding than their US counte...

It was a monetary union that unified financial markets but provided none of the institutions of governance required for a banking union. If there was one urgent reason why Europe truly did need a fiscal constitution it was to provide the financial underpinning for a giant deposit insurance and bailout fund. In the late 1990s, as European Monetary Union approached, Larry Summers had the temerity to ask an international gathering of financial experts: “Could the Europeans here explain to me what happens if a bank in Spain gets into serious trouble? What are the respective responsibilities of

the Spanish supervision authorities, the Spanish central bank, the ECB, and Brussels?”

No one in the United States wanted to think about bank failures either, not in 1997 and not in 2007.

The difference was that when the unthinkable happened, the United States had a structure of federal government within which to improvise a response. The misfortune of the EU was that when the crisis struck, it not only lacked such structures. The crisis came at a moment when the EU’s efforts to build a more robust constitutional framework had run up against basic political limits.

Up to the early 2000s, the EU operated against a backdrop of what political scientists called a “permissive consensus.”51 Europe’s population accepted the gradual push for ever closer union without enthusiasm but also without protest. The EU is not an obtrusive presence. Contrary to prevailing myth, the EU is by no means a gigantic bureaucracy. The EU employs fewer people than most medium-sized cities. But it was a sprawling, incoherent constitutional structure lacking in democratic accountability. It was clearly unsatisfactory and would become even more so once the EU expanded in 2004 to include new East European members. In December 2001 the European Council charged a European Convention with drafting a constitutional document that would ensure efficiency, clearer lines of responsibility and prepare the way for Europe’s expansion. The convention consisted of a commission of bigwigs headed by that old warhorse of French Europeanism former president Giscard D’Estaing.52 The proposal enshrined a new balance between centralized decision making by majority vote and the irreducible role of the European nation-states. It subordinated all the various institutions and treaties that had made up the pillars of European integration into a single overarching European Union. Europe’s ambition was defined as being a “social market economy” that prioritized full employment, “social justice” and “solidarity between generations” as well as the fight against “social exclusion and discrimin...

But on May 29, 2005, the constitution was rejected by popular referenda in France and then, in June, in the Netherlands. Left-wing hostility to the promarket character of the EU and nationalist hostility to Brussels united to deliver solid majorities against it. It was a profound shock. The permissive consensus was dead. Whatever the rights and wrongs of the constitution, popular democracy had asserted itself and Europe’s elite were left in disarray.54 Given the reality of increasingly close economic and financial integration and the extension of the EU to Eastern Europe, the project of reorganizing Europe could not simply be abandoned. A substitute had to be found. If a true constitution was no longer a viable proposition, Europe would have to proceed by the tried-and-tested formula of intergovernmental treaty. This gave a key role to Germany, and from November 2005 this meant Chancellor Angela Merkel.

the Lisbon Treaty of December 2007. Like the constitution it replaced, the Lisbon Treaty merged the multiple pillars of the European integration project into a single European Union with a population of 500 million. It created a new foreign and security policy for the EU. It streamlined the commission and established the principle of majority voting that was essential to make the vastly expanded structure manageable. But above all, it institutionalized the council as the representation of Europe’s national governments and created a presidency of the council as its standing representative. It ended any pretension on the part of the European Commission and its president to executive leadership.57 Many of the key provisions of the original constitutional treaty were thus maintained. But the defeat of 2005 left a lasting mark. The paramountcy of Europe’s national governments was reaffirmed. For the foreseeable future there would be no further steps toward federal integration. Policy in Europe would be made not centrally by Brussels but by intergovernmental bargain.

The Lisbon Treaty enshrined intergovernmentalism and Europe’s voters had shown their willingness to exercise a veto over steps beyond that. How, given this disequilibrium, the EU would respond to an unforeseen crisis was anyone’s guess. And that observation went beyond finance.

If one compares American and European policy discussion in the early 2000s, one sees that they shared many preoccupations. Policy experts on both continents were focused on fiscal discipline and international competitiveness, supply side incentives, efficient government spending, deficits, evidence-based welfare policy, education reform and flexible labor markets. These were the shibboleths of the watered-down, supply-side market economics inherited from the days of Reagan and Thatcher and the Washington Consensus of the 1990s. The policy communities on both sides of the Atlantic also shared blind spots. Sharing a deep faith in markets, neither realized the threat posed by the new, market-based model of banking. On both sides of the Atlantic they were oblivious to the risks accumulating in overleveraged banks, relying on vast quantities of wholesale funding. Why, then, did both sides find it so hard to recognize the risks that they shared? And why have crisis narratives on either side of the Atlantic diverged so sharply since 2008?

If we are looking for one crucial difference it is surely this: From the morning of September 11, 2001, America was a superpower at war. Not only that, under the Bush administration, it was a regime pursuing a global war on terror. The initial European reaction to the attacks of 9/11 was one of solidarity. The ouster of the Taliban from Kabul enjoyed general support. But over the winter of 2002–2003, as Washington and London pushed toward the invasion of Iraq, that sense of common commitment evaporated. The German and French governments came out in opposition to war, as did millions of European citizens who filled the streets in some of the largest demonstrations in Europe’s history. This was the moment in which the American neoconservative Robert Kagan coined his famous phrase that Americans were from Mars and Europeans from Venus.58 Europe’s leading intellectuals responded in kind. The unlikely pairing of Jürgen Habermas and Jacques Derrida issued a counterblast. Significantly, for them, the transatlantic divide went far beyond foreign policy. It extended to social policy and political culture. In the early twenty-first century it amounted to nothing less than a civilization divide, a bifurcation within modernity, between the chastened postimperial world of Europe and the expansive, imperially aggressive Anglosphere.

A wide gulf conventionally separates accounts of global geopolitics in the wake of 9/11 from our narratives of the genesis of the financial crisis. But if we listen closely it is clear that the quagmire of Iraq haunted the Washington policy-making elite in the early 2000s, awakening nightmarish memories of Vietnam and the crisis of American power and authority of the 1930s. The rise of China added to the sense of menace. Larry Summers’s description of the Sino-American trade balance as a balance of financial terror was telling. That was not how the Germans or the Dutch thought about their trade surpluses. The pervasive militarization of the language of national leadership in the United States would become even more glaring once the crisis began. Both in rhetoric and self-conception it would mark a fundamental transatlantic divide.

In terms of political culture the differences are undeniable. But to take the loudly proclaimed transatlantic alienation of the early 2000s at face value as a description of economic or geopolitical reality would be self-deceiving in a double sense.60 The idea that “social Europe” had deviated in any essential way from the logic of turbocharged “financial capitalism” as exemplified by America was an illusion. In fact, Europe’s financial capitalism was even more spectacularly overgrown and it owed a large part of its growth to its deep entanglement in the American boom. Furthermore, whatever the differences over Iraq, Europe’s pose of geopolitical innocence is a historically recent phenomenon. Though it balked at Iraq, France remains a hardened postcolonial war fighter. Nor does Europe only do “small wars.” As recently as the 1980s the European members of NATO had been active participants in winning the cold war and making the victory stick. Given the dramatic escalation of tension with the Soviet Union, the stakes could hardly have been higher. Particularly notable was the Federal Republic’s commitment to hard power. At its peak, the Bundeswehr had a standing strength of 500,000, with a mobilization strength of 1.3 million. The deployment of nuclear-armed cruise and Pershing missiles to Europe in 1983 was a transatlantic effort that bonded a generation of Atlanticists in the face of concerted opposition from the Left in both Europe and the United States.61 The high priests...

to deny the fact, in the post–cold war world, it was far from geopolitically inert. It entertained complex relations with its neighbors in the Mediterranean and in Eastern Europe that could not easily be disentangled from the hard power of the NATO alliance or coercive border policing. And this would matter, because whereas the EU kept its distance from the Middle East imbroglio and refused to see the rise of China as a geopolitical threat, it would be on Europe’s doorstep that a violent great power confrontation would erupt, and it did so just as the world banking ...

Russia’s return to the world stage in the early 2000s owed even more to global economic growth than did the rise of China. Russia poured oil and gas into world markets. Its banks and industrial corporations borrowed enthusiastically in Europe and the United States. Like China it held a huge reserve of dollars, but unlike China its financial and economic interrelationship with the United States was indirect. Russia did not earn its dollars by exporting to the United States. It sold its gas and oil to Europe and Asia. Furthermore, whereas the Chinese Communist Party approached the West with self-confidence, the wounds of the Soviet Union’s defeat in the cold war were still fresh. There were no fond memories of a “Nixon-Kissinger” moment in the Kremlin. It was not by accident, therefore, that it would be Russia’s president Vladimir Putin, the cold war KGB operative, who would pose the question that China and America preferred not to speak out loud. What, Putin demanded to know, were the implications of a rebalanced and reintegrated world economy for the geopolitical order? Putin not only posed the question. In so doing he exposed a deep lack of agreement within the West—inside Europe and between Europe and the United States—over what kind of international architecture should frame economic and financial development, not just in the world at large but in particular on Europe’s very doorstep, in Eastern Europe, the showcase for capitalist transition in the post–cold war world.

In Europe, unlike in Asia, the triumph of “the West” over communism was absolute. It was a triumph of both hard and soft power, military, political and economic might.

This was the backdrop against which NATO and the EU decided on enlargement to the East, stabilizing the immediate crisis, offering a future direction and permanently redrawing the geopolitical map.7 The double expansion of EU and NATO was not a coordinated affair. It was driven as much by the East Europeans themselves as by Washington, Berlin and Paris. Poland, Hungary, the Czechs and the Slovaks—the Visegrád group—began pushing for NATO membership as early as February 1991. The EU followed up with an association agreement. But the EU’s decision for enlargement did not follow until 1993, with its conditions being spelled out in detail only in 1997. While some outside observers called for a Marshall Plan to launch economic development, what the EU offered to aspirant members in Eastern Europe was technical and expert assistance as they embarked on the transformation of everything from public finances to transport infrastructure, property rights and the legal system. Focusing only on the military dimension, NATO could move more quickly. Already in 1999 the Poles, Hungarians and Czechs were admitted as full members. The really big bang came in 2004. On April 1, 2004, Bulgaria, Estonia, Latvia, Lithuania, Slovakia, Slovenia and Romania joined NATO. A month later all but Bulgaria and Romania also joined the EU. The two stragglers were judged ready for EU membership in 2007.

It took fifteen years from the end of the cold war. There were second thoughts in Washington, and many West European governments were reluctant to embark on the eastward expansion. The costs were likely to be huge. The risk of provoking Russia was obvious. In 2003 the divisions over the invasion of Iraq were deep and embarrassing.8 The East Europeans who were candidates for both NATO and EU membership had to choose. On one side stood Berlin and Paris in opposition to the war. On the other side were Washington, London and their supporters in Madrid and Rome. Eastern Europe opted overwhelmingly for war and US defense secretary Donald Rumsfeld did not hesitate to rub salt in the wounds, playing the “new Europe” against the “old,” leaving France and Germany resentful and isolated.

Prodi talked as though the EU would soon emerge as a fully featured state, combining both soft and hard power. But, in fact, the geopolitical configuration of the post–cold war world was more uncertain and ramshackle than that. The EU never developed its own hard-power capabilities. Not only was European military cooperation factious and frowned upon by Washington, but the European states all took the peace dividend. In light of Russia’s weakness, what reason was there not to run down their substantial cold war military establishments? It was this decision that laid the basis for the transatlantic divide on security policy in the 2000s. It also left the East Europeans all the more dependent on the Americans, whose military preponderance grew ever more massive as the new century progressed. At the same time, after the first round of financial assistance in the early 1990s, the United States played no more than a peripheral role in shaping the wider integration of Eastern Europe. On the ground it was the EU that set the pace in erasing the legacy of the Soviet experiment.

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.

sell Fannie and Freddie securities on the market.’”53 The fragility of America’s mortgage market was about to be turned into a geopolitical weapon.

But over the course of 2008, Russia did unload its portfolio of $100 billion of Fannie Mae and Freddie Mac bonds.

early August 2008, with Russian encouragement, irregular forces in the rebel province of South Ossetia began shelling positions of the Georgian army.56 On August 7, apparently believing that they had Washington’s approval, the Georgian government took the bait. A sudden counterstrike by Georgia’s American-trained army would subdue Ossetia and Abkhazia, settle the outstanding territorial questions and clear the way for a successful NATO membership application. As the awe-inspiring opening ceremony of the Beijing Olympics exploded across Western TV screens, Georgia launched its army and air force into an invasion of South Ossetia. Moscow’s response was devastating. In a matter of days the Russian army crushed Georgia’s

undersized forces, inflicting hundreds of casualties. According to Georgian sources, 230,000 civilians were put to flight. After a rapid advance, Russian tanks halted on the Gori-Tbilisi highway, an hour’s drive from the capital.