Crashed: How a Decade of Financial Crises Changed the World

by Adam Tooze

For the emerging markets the funding boom was over. The exchange rates of what Morgan Stanley dubbed the “Fragile Five”—Turkey, Brazil, India, South Africa and Indonesia—declined precipitously. Western investors pulled their money.18 Interest rates went up to counter the “vacuum cleaner” effect of Fed policy.

Four different interpretations: Fed politics, Fed weakness, Fed forecasting error, Fed game playing. Which was it? How were markets to know, and without knowing, how were they to react?

For the past five years, under the influence of massive Fed stimulus, investor strategies had come to resemble one another, leaving them to second-guess themselves, one another and the central bank: “What are you thinking? What are you feeling? What have we done to each other? What will we do?—a refrain equally applicable to a concerned policy maker as a nervous husband. . . .

On October 31, 2013, in the weeks following the September taper pullback and the congressional budget standoff, the Fed, the ECB, the Bank of Japan, the Bank of England, the Bank of Canada and the Swiss National Bank made a low-key, joint announcement: “[T]heir existing temporary bilateral liquidity swap arrangements are being converted to standing arrangements, that is, arrangements that will remain in place until further notice.

The standing arrangements will constitute a network of bilateral swap lines among the six central banks.

In December Japan doubled the swap line facilities it offered to Indonesia and the Philippines and announced that it would be looking to negotiate similar bargains with Singapore, Thailand and Malaysia.47 Japan’s enormous reserve holdings of dollar assets, second only to those of China’s, gave it the means to offer such facilities. And in the event of a crisis, the Bank of Japan could always draw on the Fed. Thus dollar liquidity would percolate out through the entire system.

In 2008 the expansion of the EU and NATO in the face of Russian opposition had added another dimension of risk. Georgia and Russia had clashed and Moscow had approached Beijing to mount a joint attack on America’s fragile finances. Beijing had held back.

Putin, biding his time in the number two position as prime minister watching footage of Gaddafi’s horrible fate, became morbidly preoccupied. The same Western powers that had shamelessly courted the Libyan dictator had turned on him, bombing his military and delivering him to the vengeful mob. One would be a fool to trust them.

The instruments of the EU’s Eastern Partnership were EU Association Agreements. These were complex documents harmonizing regulations, liberalizing trade and the movement of workers.

In 2008 the IMF had provided emergency assistance. But the program came with demands for changes in taxes and benefits that made it impossible for a government to sustain legitimacy.

In Kiev there was outrage. “We could not contain our emotions, it was unacceptable,” Ukraine’s permanent representative for NATO told Reuters. When his country turned to Europe for help, they “spat on us. . . . [W]e are apparently not Poland, apparently we are not on a level with Poland. . . . [T]hey are not letting us in really, we will be standing at the doors. We’re nice but we’re not Poles.”41 Fortunately for Kiev, or so it seemed, Moscow had an alternative plan. On November 21, 2013, Putin offered, and Yanukovych accepted, a gas contract on concessionary terms and a $15 billion loan. The condition was that Ukraine, like Armenia, would join the Eurasian Customs Union.

The comprehensive economic, political and diplomatic clash between the West and Russia that had been foreshadowed in the proxy war in Georgia in 2008 was now unleashed on an altogether more significant stage. With Ukraine’s territorial integrity at stake, on April 13, 2014, the provisional government in Kiev launched an “antiterrorist” operation to take back control of the Donbass. In Washington and at NATO headquarters there were those calling for immediate military aid for Kiev and a full-throated return to the cold war. McCain and other Republican hawks would have loved to have rallied a war party.

As the oligarch Petro Poroshenko took office as Ukraine’s president in the last week of May 2014, he faced the impossible challenge of implementing an IMF austerity program while fighting a war; a war, moreover, that Russia would not let Ukraine win.

In July a vigorous offensive by Ukraine’s forces was on the point of overwhelming the Donbass rebels. Moscow’s response was to resupply the breakaway militia with heavy weapons. A conflict of small-scale skirmishes was escalating into a more or less openly declared war involving the mobilization of tens of thousands of men, mass displacement and thousands of casualties.

Oil politics are a rich field for conspiracy theory. There certainly are back channels between Washington and Riyadh. Secretary of State Kerry was in the gulf in the fall of 2014. The Saudis had every reason to act, if not over Ukraine then over Syria.66 Along with Iran, Russia was the main backer of Assad’s die-hard regime.

The following day Sberbank came under concerted attack. A million of its customers received text messages from addresses outside Russia warning that the bank was about to be cut off altogether from external liquidity. On December 18, $6 billion were withdrawn. Over the following week the total came to $20 billion.69,70 It was a spectacular bank run even by the standards of 2007–2008.

Estimates vary, but the combination of the Ukraine imbroglio, the oil price shock and the December 2014 turmoil cost the twenty richest Russians between $62 billion and $73.4 billion.71 Once again Putin called in favors and demanded action.

Since his return to the presidency in 2012, the Kremlin had been inciting nationalism to offset disappointing economic growth and disappointing poll ratings. Given the collapse in oil prices in 2014–2015, some campaign of nationalist incitement was only to be expected.

In 2014, the comprehensive crisis, both geopolitical and financial, that had threatened the post-Soviet sphere in 2008 had arrived and the verdict it delivered on the hegemony of the United States and its alliance system was ambiguous, to say the least.

Anxiously watched by the rest of the world, the 2012 stabilization of the eurozone had been based on a compromise among Germany, Italy, Spain, France and the rest. It was driven by the fear of an escalation that would take down first Spain and then Italy. A year later the acute phase of the crisis had passed. But as the second recession to hit Europe in short succession began to make itself fully felt, the EU entered a new season of discontent.

And then came the EU’s parliamentary elections of May 2014. The results rocked the European political establishment. Eurosceptic nationalist parties made dramatic gains. UKIP won in Britain. More significantly, the National Front (FN) won in France, taking 25 percent of the vote, as compared with the middle-of-the-road conservative UMP with 20 percent and the ruling Parti Socialiste with 14.7 percent. The FN drew on France’s deep strain of nationalism, anti-Semitism and postcolonial racism. But since January 2011 Marine Le Pen had run a campaign to de-demonize the party, refashioning it as a vehicle for popular nationalism pitched against globalization and the EU.

The pool of right-wing nationalist resentment on the margin of European politics was not new, though it gained new adherents and far greater credibility in light of the disastrous mishandling of the crisis. What was new was the mobilization on the Left.

Syriza had the most balanced representation of upper-, middle- and lower-class groups of any party in Greece. What drove the surge in support for the Left from 2008 was not fundamentalist opposition so much as the sense that the EU was betraying Europe’s own promise.

What if Europe was marching back not to the 1950s but to the 1930s? Was the script not hauntingly familiar? A financial crisis met with obstinate austerity led to mass unemployment and political radicalization.

The result in 2015 was a renewed political confrontation, but one in which the fronts were dizzyingly inverted, or at least so they appeared in the rendering of the Greek situation offered by its new finance minister, Yanis Varoufakis.22

Juxtaposing rational economics against conservative ideology was an effective political argument on Varoufakis’s part. It would win him a considerable international following. But it underestimated his opponents.

But in this regard, three days before Syriza took office the game was decisively changed. On January 22, 2015, Mario Draghi announced that the ECB was finally adopting full-scale QE. Two and a half years after Draghi’s “whatever it takes,” it was not a move that the ECB undertook with any enthusiasm. Between 2012 and 2014 Draghi had allowed the balance sheet of the ECB to contract. What forced his hand in 2015 was the acute threat of deflation.

Ironically, it was the ECB’s bond-buying program, long opposed by Europe’s conservatives, that freed them to fight the battle for political containment by any means necessary. With the ECB in the market there was no risk that the Greek drama would spill over into financial contagion.

Now Draghi’s deployment of QE enabled the conservative majority of the Eurogroup to lay siege to Greece’s left-wing government without fear of precipitating a general crisis.

On the books of the ECB were 30 billion euros in bonds purchased under Trichet’s SMP program. These were left untouched by the 2012 restructuring and they were under Greek law. If Greece unilaterally defaulted on those bonds, it would inflict severe losses on the ECB, highlighting the dangers involved in bond buying and more or less forcing the German right wing to reopen the question of the legality of QE. With QE’s legal foundation in question, confidence would crumble. The firewall would be down.

Schäuble’s response was blunt. Syriza had not been part of the 2012 deal with the Greek political parties. But Varoufakis needed to understand, as far as the fundamentals of the eurozone were concerned, that “elections cannot be allowed to change economic policy.”32 It was an astonishing statement on its face, but one that encapsulated the dilemma in which the eurozone found itself. As a result of the crisis, national economic policy was increasingly a matter of international agreements.

Though on issues like the fiscal multiplier the IMF had come around to a more “liberal” view, when it came to long-run economic growth the Fund cleaved to the old religion. To raise its growth rate Greece must undo labor market regulation and free restrictive business licensing. This required detailed and highly intrusive “supply side reform.”

In April, amid talk of Greek default, the yield on the few outstanding Greek bonds still traded on open markets soared to 26.2 percent.48 Back in 2012 this might have triggered anxiety in Rome, Madrid and Lisbon. But now there was no contagion. The ECB was unfazed.

The following day, Sunday, June 28, the ECB pulled the trigger. It froze its emergency liquidity support for Greece’s banks at its current level. The next day this would unleash a disastrous bank run. The ECB could have gone further. It could have terminated emergency liquidity assistance altogether and demanded repayment.

a member of the troika and chief provider of financial life support to the Greek banking system, the ECB was “judge, jury and executioner.”65 Draghi did not want to appear as though he were further escalating the tension or “deliberately worsening Greece’s financial plight.”

But at this crucial moment the IMF did not respond as one might have expected. In the summer of 2015, the dissatisfaction inside the Fund over the European approach to the Greek debt crisis finally broke into the open. Between a first blog post by its chief economist, Olivier Blanchard, in mid-June and the formal issuance of a paper on Greek debt sustainability in mid-July, the world’s leading financial authority declared the policy of extend-and-pretend practiced since 2010 both economically and politically unsustainable.

With the backing of the US board members, overriding resistance from the European representatives, on July 2 the IMF published a preliminary report outlining the full absurdity of the programs so far. Instead of the 50 billion euros in privatization receipts scheduled in 2012, Greece had received 3.2 billion. The current program and all the variants haggled over since Syriza took office were unrealistic. No one who was serious would proceed on the basis that primary surpluses of 4 percent, massive structural changes and 2 percent GDP growth per annum were a realistic scenario.

It was a nasty surprise to the Europeans that the Americans would have let this happen.

The only consideration that had justified the IMF’s involvement in the Greek bailout in May 2010 was the risk of systemic contagion. Thanks to Mario Draghi’s bond-buying, there was no longer any risk of that. The IMF could afford to voice principled opposition without fear of practical consequences.

Despite overt and massive intimidation, on July 5 a remarkable 61.31 percent voted against accepting the troika proposal. Given that the plan had by that point been repudiated as unsustainable by the IMF, the vote was not so much a wild act of political desperation as a brave and much-needed assertion of common sense.

When the climactic summit began on the afternoon of Sunday, July 12, 2015, despite the presence of the entire union, the negotiations involved only four actors: Merkel; Tsipras, who was advised by his new finance minister; Donald Tusk, as president of the European Council; and Hollande, effectively representing the wider interests of the other member states.

The European creditors had doggedly refused to discuss the only issue that mattered—debt restructuring.

The perverse effect of the ECB’s “liberating” move to QE was that it allowed extend-and-pretend and its concomitant, relentless austerity, to continue.

A majority of Greeks, it turned out, wanted eurozone membership, even at the price of continued troika oversight.

As far as Tusk, a cold war liberal and veteran of Solidarność, was concerned, it was all very alarming. “[T]oo much Rousseau not enough Montesquieu,” he told a bemused audience of financial journalists.

“I fear that the German government, including its social democratic faction, have gambled away in one night all the political capital that a better Germany had accumulated in half a century.” Germany had “unashamedly revealed itself as Europe’s chief disciplinarian and for the first time openly made a claim for German hegemony in Europe.”80

Since the 1970s EU membership had shaped the competitive modernization of the UK economy. The Tories, as much as any party, had participated in that drive. The City of London in its twenty-first-century form had emerged as one of the most important strands of the UK-EU relationship.

As it was put to a congressional committee in 2012 by a senior US regulator, the United States had allowed its risks to migrate to London only for them to “come right back here, crashing to our shores.”

In October 2014 the UK Treasury itself issued a RMB 3 billion bond.9 The United States had long borrowed from China. Now the UK would borrow in the Chinese currency.

Cameron spoke grandly of his new vision of the European future. But didn’t it all come down to irresponsible xenophobic pandering and the selfish interests of the City of London?