Crashed: How a Decade of Financial Crises Changed the World

by Adam Tooze

But S&P had delivered just one more demonstration of how broken the ratings agencies were. It was their AAA certifications, handed out to hundreds of billions of subprime MBS, that had helped to precipitate the crisis in 2008. It was their serial downgrades that were setting the pace of the crisis in the eurozone. But it turned out that they could not even get their sums right on the US budget.

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.

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.

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.

Estimates vary, but protesters in at least nine hundred cities around the world staged sympathy demonstrations.

But despite their tiny size and ramshackle appearance, the obvious and unsettling fact was that the anger of the radical minority was shared by a wide swath of US public opinion.

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.

Market-conforming codetermination—was this what European democracy had been reduced to by the autumn of 2011? Was this the hidden agenda of the troika programs, imposed not only on the parliaments of Greece, Ireland and Portugal but on the Bundestag as well—to make them market conforming?

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 was dictated, first and foremost, by the willingness, or not, of the ECB to buy bonds.

Neither Spain nor Italy had applied for a troika program, but that did not stop the ECB from demanding huge cuts to government spending and increased taxation. In the Italian case, Trichet and Draghi called for the privatization of local public services, a proposal that had recently been decisively rejected in a nationwide referendum.

Perhaps not surprisingly, legally minded members of Berlusconi’s cabinet wondered whether it was their malodorous prime minister or Draghi and Trichet who posed the greater risk to the rule of law.

To escape insolvency Greece needed a haircut far larger than that squeezed out of the bankers over the summer: not 21 percent but something closer to 50 percent. If this was not to cause panic, it would need to be framed by a solid Franco-German agreement on the future governance of the eurozone.

The politics of extend-and-pretend might have the benefit of deflecting attention from the creditor banks to the bankrupt government borrowers. It was the citizens of the troika-supervised countries who paid the price. But it also allowed European policy makers to avoid getting to grips with the underlying problems of financial stability.

The banks, of course, defended what they took to be their own interests. Never one to shrink from alarmism where bank regulations were concerned, the Institute of International Finance estimated that Basel III plus national regulations would force banks worldwide to raise their capital by $1.3 trillion by 2015.

What Geithner proposed was standard American maximum-force firefighting doctrine. “The firewall you build has to be perceived as larger than the scale of the problem. You can’t succeed by shrinking the problem to fit your current level of financial commitments. . . . It’s more dangerous to escalate gradually and incrementally than with massive preemptive force.”

It was the Europeans who invited Geithner to Warsaw. But in the wake of the Wall Street crash of 2008 and the congressional budget crisis of July 2011, there was probably no moment in living memory in which Europe was less willing to listen to financial advice from America.

In the first week of October, as if to demonstrate that the dark talk in Washington was not merely alarmism, a run began on the Franco-Belgian bank Dexia, one of the casualties of 2008 that was most exposed to peripheral eurozone debt.

The bank had contracted a huge portfolio of interest rate swaps on which it now faced demands for tens of billions of euros in collateral. The Belgian and French governments were forced into an expensive bailout at the worst possible moment.

It was a bitter irony that it was precisely as MF Global filed for protection that the eurozone finally began to take steps toward a more decisive resolution of the crisis.

Italy thus got the worst of all worlds: the stigma of having been considered for an IMF program and the duress of oversight, without access to new money.

Three years later it emerged that something far more dramatic had transpired. Lagarde’s Italian proposal was a sideshow. The real news was that Paris and Berlin were maneuvering to unseat the Italian prime minister.

But whether the White House accepted the “suprising invitation” or not, Berlusconi’s days in office were numbered. His government was disintegrating from within.

In mid-November the governments of two eurozone members were taken over by men without democratic credentials whose main qualification was that they were undeniably market conforming.

The gutting of Greek and Italian democracy in 2011 was the result of a toxic combination of massive financial integration with Berlin’s dogged insistence on intergovernmentalism. The lack of overarching structures with which to compensate for the asymmetric effects of the crisis enforced conformity to Berlin’s vision of financial probity, one state at a time.

It was only several years later that investigative reporting established how close Merkel had come to a physical collapse under the pressure exerted on her by Obama and Sarkozy.

What defined the parameters of an acceptable solution to the eurozone crisis was the constitution of the Federal Republic, the autonomy of its central bank and the political interests of the German center-right.

The showdown in Cannes in November 2011 was an indication of how serious the stresses on Europe had become. But it left the eurozone stuck on the German roadblock and divided over its future direction.

As in Greece, bad sovereign debts would pull down the banks. Or as in Ireland, failed banks would pull down the state’s credit. Only the ECB could break this loop. It was the “missing ingredient” in all European crisis management efforts to date.

Meanwhile, even Germany was no longer immune to the virus of insecurity. On November 23, 2011, the Bund suffered a bond auction that was described by market watchers as a “complete and utter disaster,” with only 3.644 billion out of 6 billion euros’ worth of German ten-year bonds finding buyers.

Limited by strict criteria and all necessary European oversight, there should be some pooling of European credit, shielding the weaker members behind the creditworthiness of the stronger borrowers, thus eliminating the element of market panic that was making the situation of Italy untenable.

On every possible occasion Prime Minister Cameron lectured the eurozone members on the need for deeper integration, while at the same time exempting London from any commitments.

For the eurozone what emerged from the clashes of early December 2011 was the lowest common denominator of both options on offer. Germany got its fiscal compact, although it was cast not in the form of the treaty change that Merkel had wanted but in the minimal legal form of an intergovernmental agreement outside the framework of the Lisbon Treaty.65

The only concession from Berlin was that as of July 2012 the improvised EFSF would be replaced by a permanent European Stability Mechanism with the power to intervene in secondary bond markets and the adequacy of the EU’s firewall would be reassessed as soon as March 2012.

Now, on November 30, all the major central banks of the world—the Fed, the ECB, the Bank of England, the Bank of Japan, the Swiss National Bank and the Bank of Canada—reopened the swap lines put in place in 2008 and reduced the interest rate paid. The global reach of the deal was “theatre”; Japanese and Canadian banks were not under any pressure. It was, once more, the eurozone that needed the dollars.

But what this narrative ignores is that Draghi’s ability to change the conversation in the summer of 2012 had one essential precondition: backing from Berlin.

As Draghi told the Wall Street Journal in February 2012, Europe’s social model that prioritized job security and social welfare was “already gone.” What, after all, did talk of a social model mean when 50 percent of Spanish youth were unemployed?72 Europe’s labor markets would have to be reinvented, presumably along the lines of Germany’s Hartz IV agenda.

Indeed, given Draghi’s subsequent reputation, it bears repeating that as of 2012, his first year in office, bond buying by the ECB ceased. His priority was to restore a “system where the citizens will go back to trusting each other and where governments are trusted on fiscal discipline and structural reforms.”

Already in October 2011 the ECB had announced that it would be offering liquidity to the European banking system in the form of the long-term refinancing operation (LTRO)—long-term loans at highly favorable interest rates.76 Draghi opened the spigot, offering financing at favorable rates over the unprecedentedly long term of three years and taking much lower grades of collateral.

But as in 2009, it came at a price. Rather than allowing Europe’s fragile banks to unload dubious assets in exchange for safe cash, as QE did in the United States, the ECB’s program added to their holdings of peripheral government debt.80 Spanish and Italian banks were particularly proactive. Banks and sovereigns were thus tied ever more closely together. And neither side was safe.

At the G20, outside the Cannes Palais des Festivals on November 5, Merkel had opined: “The debt crisis will not be solved all in one go, [and] it is certain that it will take us a decade to get back to a better position.”82 That was revealing as to Germany’s time horizon, but the question was, did the rest of Europe have that long?

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.

In political terms, Europe had satisfied the German insistence on austerity, which Berlin promised would open the door to further steps toward integration. But December 2011 revealed how reluctant Berlin was to actually make the next move. Meanwhile, the consensus that had been built around austerity policies in 2010 was beginning to crumble.

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.”

The place where the paradoxes of thrift were most visible was Greece.

The problem in achieving debt sustainability was Greece’s collapsing GDP as much as it was its elevated debt level. By the time of the discussions in Mexico in early 2012, it was clear that the deal hammered out three months earlier was no longer viable, not because the Greek government or the creditors were reneging but because the Greek economy was contracting too fast.3

was in early 2012 that top-secret planning began for the eventuality of a Grexit.4 Work on the so-called Plan Z would continue until August 2012, when it was finally stopped by Berlin. It was stopped because the upshot of the planning exercises was always the same. It would likely be ruinous for Greece, and the ramifications of Grexit for the rest of Europe were entirely unpredictable. They were unpredictable because Europe still had not built an adequate shield to protect the other fragile eurozone members from the fallout from a Greek bankruptcy.

On February 19, 2012, Japan and China, in a rare show of unity, declared that they were willing to back the appeal for increased IMF funding, but only if the Europeans raised the cap on the ESM stability mechanism, to which the Bundestag was clinging.5 The Europeans must help themselves first.

How were the Greeks to be nailed down? With typical forthrightness, German finance minister Wolfgang Schäuble suggested that perhaps it would be better for the Greeks not to hold elections.

The restructuring that was forced on the creditors of Greece between February and April of 2012 was the largest and most severe in history, larger in inflation-adjusted terms than the Russian revolutionary default or Germany’s default of the 1930s.9 By April 26, 2012, 199.2 billion euros in Greek government bonds were converted in exchange for 29.7 billion in short-term cash equivalent notes drawn on the EFSF and 62.4 billion in new long-term bonds at concessionary rates.

Allowing for the much later repayment of the new long-term bonds, the net present value of claims on Greece was cut by 65 percent.