Crashed: How a Decade of Financial Crises Changed the World

by Adam Tooze

What the 2008 crisis exposed was a dangerous imbalance in the business model of the European banks. As the American money markets shut down, all the European banks were scrambling for dollar funding. They tried to borrow from one another, which led to a painful surge in short-term funding costs as measured by the so-called Libor-OIS spread.4 At the same time, the market for currency swaps was becoming dangerously congested, with Europeans bidding for dollar credits and ever fewer counterparties willing to take the other side of the trade. The cross-currency basis swap spread, which measures the interest rate spread that European banks were willing to pay to transfer euro or sterling funding into dollars, became strongly negative, indicating that it was extremely difficult to access dollar funding directly. When markets are functioning normally, this premium should be close to zero. In September 2008 it exceeded 200 basis points.