Crashed: How a Decade of Financial Crises Changed the World

by Adam Tooze

Luddite

The Treasury had a clearer view of the mechanics of the crisis. It wanted more capital, less leverage, more liquidity. And it wanted centralized powers in the Treasury and the Fed to deal with the next disaster.

As Paul Krugman remarked from New York: “It’s one thing to be intimidated by bond market vigilantes. It’s another to be intimidated by the fear that bond market vigilantes might show up one of these days.”

By “starving the beast,” they would lift the curse of big government and revive the American dream.

For Berlin it was more important to achieve the 3 percent deficit rule specified by the eurozone’s Stability and Growth Pact than it was to honor its commitment to NATO to spend at least 2 percent of GDP on defense.

PSI

Greece would receive an additional 109 billion euros, meeting its financing needs through 2014 and enabling the IMF to continue as part of the troika. The interest it paid on its loans would be lowered to 3.5 percent. Maturities would be extended and, through a menu of PSI options, Greece’s creditors would make a contribution, though the precise amount remained to be determined. The ECB would be indemnified for any losses it suffered. If the Greek banks suffered irreparable damage they would be recapitalized out of troika funds.59 Most important, the governments stated emphatically that PSI applied only to Greece. It was the only insolvent eurozone sovereign. All others would honor their obligations without fail. To contain contagion the EFSF would be beefed up and at the behest of the ECB it would be empowered to enter the secondary market and to establish credit lines for nonprogram countries, such as Spain and Italy. The EFSF would no longer act only as an ultima ratio, as Merkel had insisted since March 2010, but as a preemptive agency, helping to stabilize markets to forestall any threat arising.

These, finally, were the elements of a workable solution—buy-in by the Greeks, debt restructuring, further loans, cooperation with the ECB and backstopping by a newly empowered EFSF. There was even partial recognition of the need for bank recapitalization. The general structure was fine. But did the sums add up? And who was to pay?

One neuralgic point was the scale of PSI. The initial figure that had emerged from the polite negotiations wi...

The result of this compromise was that Greece would pay the reputational price for having restructured its debts, but it would gain precious little financial relief. It would be left carrying a debt burden of 143 percent of GDP, which was clearly unsustainable. As one Goldman Sachs analyst commented: “This tendency to ‘under-size’ otherwise good policy initiatives has been a recurrent feature of European policies.” A member of the UBS economics team was less polite: “This is fiddling around at the margins. . . . The debt needs to halve.” As to the new support facilities provided by the EFSF, Willem Buiter, chief economist at Citigroup, told Bloomberg Television, “The European Financial Stability Facility has gone from being a single-barreled gun to a Gatling gun, but with the same amount of ammo. . . . It needs to be increased in size urgently.”62 If Italy went critical, the EFSF would need not 200–400 billion but 1–2 trillion euros. Otherwise, only the ECB, with its bottomless supply of euros, could backstop the system.

If money was fleeing out of Europe, where was it to go? The answer since the onset of the financial crisis had been, paradoxically, the United States. As US subprime went bad, there had not been the panicked dollar sell-off that many had feared. Instead, investors shifted into US Treasurys, the very top of the global monetary pyramid. In 2008 the dollar surged and US interest rates fell. Successive waves of QE reversed that trend. The dollar slid against its major trading partners. This imposed losses on investors and made US bonds marginally less attractive. By the summer of 2011, however, something far more ominous was on the horizon.

On May 16 the permissible ceiling of federal debt was reached, at $14.3 trillion. With tax revenue covering only 60 percent of current spending, Washington had hit the limit of its legal right to borrow. The Treasury was forced to adopt “extraordinary measures,” including borrowing from government cash reserves and selling assets from the civil service retirement fund.66 This would see the Treasury through until August 2. After that, the US federal government would face a choice between paying salaries or paying its creditors. America was sliding toward something even worse than concerted austerity, a chaotic shutdown risking default on its obligations to both domestic and foreign creditors.

In late July 2011, as Sarkozy, Merkel and Trichet diced with the future of the eurozone, the United States was perilously close to the edge. There was no longer any disagreement in Washington about the need for urgent fiscal consolidation.67 But there was a huge divide between Democrats insisting on a balanced approach to deficit reduction, involving tax increases as well as entitlement cuts, and Republicans focused exclusively on spending reductions. The Speaker of the House, John Boehner, was looking to assert his control over the Tea Party faction by striking a deal with the White House to achieve deficit cuts of $4 trillion over ten years. But on July 22 the talks between Boehner and the Obama administration broke down over Republican demands for slashing reductions in medical spending and the White

House insistence on a $1.2 trillion increase in taxes.68 Journalists began compiling calendars as to which bills due in August the American government should pay first. Constitutional specialists were debating the pros and cons of executive prerogative, or coining trillion-dollar platinum coins with which to repay the national debt.69 If Greece was a problem, and Italy was too big to fail, there was simply no reckoning what a US default might do. In August alone, the Treasury had to roll over almost $500 billion in debt.70 With the eurozone wobbling, the American money market funds that were pulling out of European bank bonds continued to shift into US Treasurys. But appearances were deceptive. Investor demand for US government debt held up, but above all in lower-risk, short maturities. The average maturity of US Treasurys held by the MMFs declined from ninety...

Prior to 2008 the market for US Treasury CDS had not existed. What would have been the point of insuring the risk-free asset class on which the entire global financial system rested?

in the course of 2011 the niche market for CDS on US Treasurys sprang back into life. In the last days of July just over a thousand contracts were outstanding, with spreads running to 82 basis points. It was a fraction of what investors in Greek debt paid, but it was astonishing that the market existed at all. On July 31, 2011, Washington pulled back from the abyss. A budget compromise was reached that would impose automatic austerity if the two warring parties could not agree on cuts by the end of the year. Reluctantly, sufficient Tea Party radicals were won over to the Republican leadership’s position for the deal to go through.

On August 3 China’s Dagong ratings agency was the first to draw the obvious conclusion. It downgraded the United States from A+ to A. As Dagong remarked: “[A]t this crucial juncture, neither the Democratic Party nor Republican Party has shown any consideration for the general interest in order to argue for their own partisan interest; they had a hard time making the correct choice in a timely manner leaving the world in terror, which highlights the negative role of the US political system on an economic basis.”75 The US political system, the Chinese analysts concluded, “cannot resolve the fundamental influence of low economic growth, high deficit and increasingly higher debt to the debt service capability through increasing real wealth creation, with the declining national solvency irreversible. It is natural that QE3 monetary policy will be enabled for the next step, which will throw the world economy into an overall crisis; the status of [the] US dollar will be essentially shaken in this process.”

The year ended with a big sell-off of US government debt by Beijing.

The long buildup of Chinese claims on the US taxpayer had ended. But the portfolio stabilized at between $1.2 trillion and $1.3 trillion. Criticism from China was only to be expected. More surprising was the fallout at home. On August 5 the unthinkable happened. One of America’s own ratings agencies, Standard & Poor’s, downgraded the United States from AAA to AA+. S&P cited the “political brinkmanship of recent months” and the mounting evidence that “America’s governance and policymaking” was “becoming less stable, less effective, and less predictable.”76 It also pointed to the supposedly unsustainable level of US debt and the speed of its accumulation, which would take it well over 90 percent of GDP by 2021—the notorious Reinhart and Rogoff threshold. But when the US Treasury was handed the explanation for S&P’s decision, it became clear that the ratings agency had committed an elementary mistake. By applying the figures for debt growth to the wrong benchmark scenario, it had wildly overstated the deficit to be expected over the next ten years. Even more surprisingly, when this error was pointed out, S&P did not retreat. It left the downgrade in place as well as the explanatory...

Trillions of dollars of debt were losing their status as safe assets. The US Treasury was accused by the German finance minister of interventionist tendencies akin to communism. NATO was squabbling over Libya. The loose monetary policy of the Federal Reserve was blamed for fomenting revolt in the Middle East. The EU was locked into a self-deceptive nonsolution to the Greek debt crisis, and when it was not engaged in extend-and-pretend it was openly and unabashedly lying. Both Italy’s prime minister and the managing director of the IMF were up on sex charges. Washington was willfully toying with bankruptcy. The ratings agencies could not do their

arithmetic. Millions of people were in the streets, protesting, demanding a “rupture,” unable or unwilling to pay debts they had contracted or that had been contracted in their name.

Over the weekend of August 6–7, as the world digested the downgrade of America’s sovereign debt, heads of government, central bankers and Treasury officials interrupted their summer vacations for a frantic round of telephone conferences. But all that emerged were lame communiqués, which did nothing to inspire confidence. On Monday, August 8, rocked by bad news from both sides of the Atlantic, stock markets sold off sharply. President Obama was left to remark: “We now live in a global economy where everything is interconnected,...

On August 19, 2011, representatives of the New York Stock Exchange met with agents of the FBI for an unusual conference.79 Trawling the Internet for suspicious activity, the FBI had got wind of an “anarchist” network dubbed “Occupy Wall Street.” Its aim was to spread the protest movement that had gained such scale in Europe to the United States. The occupation of Zuccotti Park right next to Wall Street was scheduled for September 17. The US media at first ignored the story. The first to cover it were Agence France-Presse and the Guardian.80 But within weeks the tiny encampment that lodged itself within hailing distance of Wall Street would become headline news around the world.81 Given the scale of the social media storm it unleashed, it is important to put Occupy Wall Street in perspective. It was tiny compared with the gigantic antiausterity mobilizations in Europe. The global Occupy demonstrations that took place on October 15, 2011, attracted perhaps as many as a million demonstrators in Spain, 200,000 to 400,000 in Rome, tens of thousands in Portugal. In New York between 35,000 and 50,000 protesters marched. But the New York occupation had a symbolic significance far in excess of its modest scale. It articulated radical opposition at the very heart of US capitalism. Imitation camps sprang up across the United States, in Philadelphia, Oakland, Boston, Seattle, Atlanta, L.A., Denver, Tucson, New Orleans, Salt Lake City and many other cities. Further afield there were no...

In October 2011 a poll conducted for the New York Times and CBS News found that almost half those questioned felt that the FBI’s “anarchist camp” reflected the views of most Americans.83 Two-thirds thought wealth should be distributed more evenly—nine out of ten Democrats, two thirds of Independents and even one third of Republicans agreeing with that sentiment. But only 11 percent of Americans trusted their government to do the right thing, 84 percent disapproved of the Congress that had threatened to bring the US federal government to its knees and 74 percent thought their country was on the wrong track. Since January 2009 the Obama administration had been straining every muscle to put the lid on popular discontent. Rather than seeking to mobilize the indignation simmering in American society, it had found one technocratic fix after another. Two years later the result was a spectacular delegitimization from both the Left and the Right.

Asked about the question of parliamentary control over the European Financial Stability Facility, recently mandated by the German constitutional court, Merkel deadpanned: “We do live in a democracy and we are pleased about that. It is a parliamentary democracy. That means that the budget is a key prerogative of parliament. Thus we will find ways to organize parliamentary codetermination in such a way that it is nevertheless market conforming, so that the appropriate signals appear in the markets. I hear from our budget specialists that they are conscious of this responsibility.”

Market-conforming codetermination—was

“neoliberalism.”

“We spoke about the financial markets and the fact that politicians should have the power to make policy for the people, and not be driven by the markets. . . . This is a very, very big task in today’s time of globalization.”3 In their flailing generality, these statements are symptomatic of the depth of the crisis by the autumn of 2011. In the space of barely three weeks,

the German chancellor managed to tell the press that politicians should be responsible to markets and to tell the pope that politicians should make policy for “the people” regardless of those markets. Was it a contradiction? Or was she implying some kind of synthesis? If so, was it a matter of finding the market-conforming mode of expression that would allow politicians to slyly exert their power or, more ominously, a matter of hammering democracy into such conformity that no market ever need fear the policy parliament might make? Did anyone in Berlin know? No surprise that Gregor Gysi, the sharp-tongued spokesman of Die Linke, should lash Merkel’s handling of the eurozone crisis as an engine of chaos and confusion.

The very least one can deduce is that the optimistic dogma under which democracy and markets were seen as natural and necessary complements—the

was dead.

In its place the crisis had put a more realistic awareness of the potential tension between the two. But this generalization too has its risks, particularly when it is assumed that it is financial markets, not politics, that force the tension. Certainly in the course of the eurozone crisis that had not been the case. The pressure the more fragile members of the eurozone were under depended not on some inescapable clash of peoples and markets, or global capitalism and democracy.6 It wa...

not just crying out for the EU to undertake a stabilization effort but betting billions that it ultimately would. What delayed the stabilization and escalated the conflict between democracy and markets to an extraordinary pitch was the struggle among Germany, France and the ECB over the future governance of the eurozone, a question in which politics and economics were inseparably intertwined. Ironically, the result, as in 2010...

The compromise of July 21 on a new Greek aid package was supposed to be flanked by a new round of bond buying by the ECB.

Debt reduction, recapitalization and backstopping were the keys.

but before those essential technical issues could be broached, Europe had to deal with the political fallout.

By the end of October 2011, after two years of economic disaster and financial panic, the Greek political system was coming apart. Unemployment now stood at 19.7 percent, up from 8 percent in 2008. The public mood was ugly. Since the onset of the crisis the Greek opposition—on both the left and right—had consistently refused to join with the government in

facing the demand of the foreign creditors. The entire disastrous austerity program had been conducted on the strength of the majority that PASOK had won in October 2009. The party was paying the price.

In the first half of 2012 the rotating presidency of the G20 fell to Mexico. On Friday, January 20, 2012, a week after the S&P downgrade of eurozone sovereigns, finance officials from around the world assembled in Mexico City. On their agenda was a remarkable request. The eurozone members of the G20 were calling on the rest of the world to contribute $300–400 billion in additional funding to enable the IMF to backstop crisis fighting, not in an emerging market or in one of the less-developed countries of sub-Saharan Africa but in Europe. The non-European members of the G20, led by the United States, China and Brazil, considered the European request and turned it down. As Mexico’s deputy finance minister remarked to the press: “There is a recognition of the measures Europe has taken. But it’s also clear that more needs to be done.”1 Amid the din of world events, the incident barely warranted a headline. But the location of the meeting, the nature of the request and the response by the rest of the G20 add up to a remarkable historical denouement. It was also indicative of the precarious state in which the eurozone was left hanging by the bruising battles of 2011. The G20 and S&P concurred: The Europeans had not done enough. They had not squarely addressed the basic instabilities with regard to the sovereign bond market and bank recapitalization, which had sucked the IMF into its engagement in Europe back in 2010. They had eventually recognized Greece’s insolvency and were on...

The European fiscal compact of December 2011 was imposed by force of Franco-German cooperation. But Sarkozy was up for reelection in May 2012, and his main rivals for the presidency, the Socialists, were campaigning against the agreement. That was predictable. What was less so was that the IMF itself would be calling for a rethink. In its briefing for the full meeting of finance ministers and central bank governors that would convene in Mexico City on February 25–26, 2012, the IMF’s headline was stark. The “overarching risk” to the world economy was of an intensified global “paradox of thrift.” As households, firms and governments around the world all tried to cut their deficits at once, there was an acute risk of global recession. “This risk is further exacerbated,” the IMF went on, “by fragile financial systems, high public deficits and debt, and already-low interest rates, making the current environment fertile ground for multiple equilibria—self-perpetuating outcomes resulting from pessimism or optimism, notably in the euro area.”2 The place where the paradoxes of thrift were most visible was Greece.

because the Greek economy was contracting too fast.

The eurozone crisis was halted because of the enormous investment of political capital made by Europe’s governments. It was halted by the construction of a new apparatus of government: the Greek restructuring, the fiscal compact, banking union, ESM, the ECB’s OMT facility. Those who bet against the eurozone’s future misjudged the scale of the investment being made by Europe’s governments. That was the message that Draghi wanted to ram home. As Draghi said, it was a political message about the seriousness of European state building. The delays might come at

a huge cost to its citizens. But in its usual crablike fashion, Europe was moving once more toward “ever closer union.”

What Draghi was signaling was that Europe, finally, “got it.”

Implicit in this rendition of what happened in the summer of 2012 is another narrative, at odds with Draghi’s intended meaning. “Whatever it takes” was, in fact, a form of surrender. The eurozone was finally giving in to what Anglophone economic commentators had been calling for all along. If only the ECB had moved to the Fed model earlier, as Obama had spelled out at Cannes, the worst of the eurozone crisis might have been avoided. What Draghi now promised was what Geithner, Bernanke and Obama had been preaching to the Europeans since 2010: “Do it our way.” Nor was it a coincidence that it was Draghi—an American-trained economist; a Goldman Sachs associate; a paid-up member of the global financial community; a “friend of Ben”; an internationalized, urbane Italian, not a provincial German—who delivered this conclusion to the agonizing story of the eurozone crisis. The Draghi formula—America’s formula—was self-fulfilling. He spoke the magic words. The markets stabilized. The eurozone was saved by its belated Americanization.

Looking back over the course of events since 2007, if one stopped the historical clock in the autumn of 2012, the story of the North Atlantic financial crisis could thus be twisted back into a familiar shape. Faced with a crisis of historic proportions, after its own fashion, the Obama administration had delivered a twenty-first-century demonstration of hegemonic leadership. It lacked the urgency and razz...

own domestic stimulus and monetary policy programs. Through discreet diplomacy and the Fed’s massive liquidity programs, it had helped Europe across its worst crisis since the end of World War II. Americanization was the answer. Nor were the exponents of US economic policy shy about trumpeting their achievements. The Courage to Act would be the title of Bernanke’s memoir. The melodrama caused his more bashful European colleagues to wince. It was not the kind of language one associates with the recollections of an academic economist turned central banker. Other, more academic titles in the wake of the 2012 stabilization echoed the general mood of optimism. In the end, it had turned out to be a Status Quo Crisis.65 The System Worked.66 The global economy had survived and America had reasserted a new version of liberal hegemony. Europe resumed the forward march to a United States of Europe it had begun under American guidance in 1947. Among academic commentators, a cottage industry grew up on both sides of the Atlantic benchmarking Europe’s new efforts at integration against American history. Was Europe still at the Philadelphia stage, or was a Hamilton moment on the horizon?67 It ...

play in global affairs.”68 As far as international economic policy was concerned, Obama’s victory in November 2012, Bernanke’s QE3 and Draghi’s speech combined to put the seal on the narrative. Centrist liberal crisis management had prevailed. In America’s new century, div...

But this reconciled narrative of crisis resolution obscures deep tensions on both sides of the Atlantic. In Europe, the eurozone had survived. Draghi was right. An important phase of state building had emerged from the crisis. But it was at an appalling economic and political cost. The governments of Italy and Greece had been overturned. Ireland and Portugal had been put on troika tutelage and Spain had escaped by the skin of its teeth. And though the acute sovereign bond crisis was over, after two years of nail-biting anxiety, consumer and business confidence were shot. Unemployment took a huge toll on eurozone demand. Fiscal policy was constrained by the German drive to balance budgets. Perversely, Germany’s trade surplus was surging at a time of plunging aggregate demand across the continent. It was a time, if there ever was one, for an active monetary policy. But stopping the bond market panic was one thing, reviving the eurozone economy another. Unlike the Fed, Draghi had no mandate. As social misery deepened, as the sense of humiliation set in, what would be the reaction across Europe? Nor was it only the “victims” who were unsatisfied. German conservatives were indignant ...

In the United States, Obama’s reelection might energize his followers. But what exactly did his new American century consist of? What would be its priorities? In his first term Obama had been preoccupied with overcoming the legacy of Bush’s mistakes and coping with the crisis. But was the crisis really over? And even if it was, did that mean that America could face the future unencumbered? Or, having survived the crisis, did America now face the same c...