Crashed: How a Decade of Financial Crises Changed the World

by Adam Tooze

The fuller records of the Fed’s emergency programs, on which this chapter is based, were not opened to the public until December 2010 and March 2011. They were produced as a result of the Dodd-Frank legislation of 2010 and a Freedom of Information suit brought by the Bloomberg news organization and contested by the Fed and the New York Clearing House Association, a banking lobby group, all the way to the Supreme Court.

In Europe, the bullish CEOs of Deutsche Bank and Barclays claimed exceptional status because they avoided taking aid from their national governments. What the Fed data reveal is the hollowness of those boasts. The banks might have avoided state-sponsored recapitalization, but every major bank in the entire world was taking liquidity assistance on a grand scale from its local central bank, and either directly or indirectly by way of the swap lines from the Fed.

On Capitol Hill, while controversy swirled around TARP, there was silence about the Fed’s gigantic global liquidity effort.

By October 2008 the Fed’s swap line facilities defined a relationship of dependence and interdependence between the US central bank and an exclusive club of privileged central bank counterparties. But that posed a question. Who was in and who was out? What were the criteria of membership in the swap line club?1

As two US analysts attached to the National Intelligence Council remarked at the end of 2009: “Artificial divisions between ‘economic’ and ‘foreign’ policy present a false dichotomy. To whom one extends swap lines” is as much a “foreign policy as economic decisions.”

The Fed did everything it could to dissuade further applications. Nevertheless, two further countries did apply and were denied. Their identities are shrouded in secrecy.

There were rumors of an “all-night mandatory meeting held in the Kremlin” on September 16, the day of the AIG rescue, at which “oligarchs were ordered to plunge cash into their own faltering stocks, buy collapsing financial institutions directly, or simply fork over the cash and/or shares.”

VEB pumped $4.5 billion into Rusal, the aluminum company majority owned by Oleg Deripaska, to allow it to unwind foreign financing, which it had used to buy a 25 percent stake in mining giant Norilsk Nickel. VEB also put $2 billion into Mikhail Fridman’s Alfa Group to help it to pay off Deutsche Bank and rescue Alfa’s large stake in Russia’s number two mobile phone firm, VimpelCom, which might otherwise have been forfeited as collateral.

Relative to the size of its economy, commonly compared with that of Spain and roughly comparable to that of Texas, the Russian crisis response was one of the largest in the world, dwarfing those undertaken by West European governments.

What would happen if an oligarch failed in his responsibilities was demonstrated in June 2009 when Putin descended on Pikalevo, a small town south of St. Petersburg dominated by the metallurgical empire of Oleg Deripaska. Deripaska, who had once been listed as the richest man in Russia, with a fortune estimated at $28 billion, had seen it reduced to $3.5 billion. But that was no excuse for not paying wages.20 Indignant workers were blockading the Moscow highway, causing a 250-mile traffic jam. In front of the TV cameras Putin upbraided Deripaska. Tossing him a pen, the premier demanded that the oligarch sign the paychecks there and then. It was economic management by personal intimidation of the telegenic tub-thumping variety.

As Medvedev remarked on September 10, 2009: “Can a primitive economy based on raw materials and economic corruption lead us into the future?”

And if Russia was hard hit by the 2008 crisis, the impact on Eastern Europe was even worse. The shock to the most highly leveraged transition states of the former Communist bloc was staggering.

The pattern was not uniform. Poland, notably, escaped largely unscathed.26 But all the most severe casualties of the 2008–2009 crisis are to be found among the transition economies of the former Eastern bloc.

Individually, the East European states are not big economies. But taken together they formed a substantial unit comparable in economic heft to France or the state of California.

The situation was made even worse, however, by the source of the capital that fueled their growth: the overleveraged banks of Western Europe.

With the Fed having used swap lines to stabilize a core group of economies in which American interests were undeniable, one might have expected the ECB to extend similar support to the East European neighbors of the eurozone. Certainly this was the expectation of the Fed.

With Sweden and Denmark the ECB established publicly announced swap lines. Their banks would supply liquidity to Eastern Europe. Meanwhile, the central banks of Poland and Hungary were fobbed off with repo arrangements that treated them no better than stressed commercial banks in need of extra liquidity.

The IMF was their last resort. This was traumatic. No one in Eastern Europe wanted to relive the bitter aftermath of the collapse of communism, with which the IMF was indelibly associated.

The first and most desperate application for assistance from within the EU was Hungary’s.35 On October 27, 2008, Budapest reached agreement with the IMF and the EU (as opposed to the ECB) on a $25 billion loan package. At 20 percent of Hungarian precrisis GDP, it was a very substantial commitment and an unusually generous multiple of Hungary’s IMF capital quota.

In 2010 the right-wing Fidesz party would reap the benefits with a crushing electoral victory, setting Hungary on the path to a self-declared illiberal democracy.

Thanks to the IMF and EU intervention, an immediate meltdown was avoided on the East European periphery of Europe in the fall of 2008.

On a case-by-case basis the Vienna Initiative extracted pledges from the leading lenders that they would maintain their lines of credit to the region, thus preventing an even more dramatic credit stop.46 UniCredit and Banca Intesa of Italy, Raiffeisen of Austria and Swedbank of Sweden all participated. Commerzbank of Germany and Deutsche Bank did not.

With 80 percent of credit outstanding sourced from their European neighbors, any substantial depreciation was likely to trigger wholesale default. The cost of servicing their debts in euros would simply have become prohibitive.

For the IMF, the standard prescription for a country in Latvia’s position was a one-off devaluation followed by debt restructuring or rescheduling. But the European Commission dug in its heels. Latvia was en route to eurozone membership. It must stay the course. If it needed to rebalance its current account it must do so through deflation and austerity.

Faced with the double crisis of 2008 the reaction of Eastern Europe was not uniform. The Baltics stayed the course. Hungarian nationalism rebelled. But nowhere was the double shock more jarring than in Ukraine.

The route to the Ukraine crisis of 2013 was twisted. But the path that it would travel down was mapped out already five years earlier.

As in Russia, public opinion in China was indignant. Why was poor China financing America’s excess? As a sign of its impatience, Beijing allowed its spokesmen to make dramatic and unusually frank statements. If the United States allowed the GSE to fail it would be a “catastrophe,” China let it be known.

The Fed and the Treasury had intervened on a massive scale to stabilize the financial economy, so now, Gao quipped, when the Chinese looked to the United States, what they saw was not capitalist democracy, but “socialism with American characteristics.”

The Chinese cut back their GSE holdings but they did not offload them like Russia, they merely reduced them to their level in the summer of 2007 before Gao and his colleagues had embarked on their ill-advised program of reserve diversification.

As a result, net exports accounted for a smaller share of Chinese GDP growth before 2008 than one might imagine. In fact, no more than one third of China’s growth from 1990 was driven by exports, with two thirds coming from domestic demand.7 This was a very different balance from that of a truly export-dependent economy, of which Germany was the quintessential example.

But these were pinpricks when compared with the impact of falling export orders on China’s labor market. As the winter of 2008–2009 approached, 30 percent of China’s gigantic annual surge of college graduates—5.6 million per annum—were unable to find work.

Altogether, at least 20 million, and perhaps as many as 36 million, Chinese workers were left idle.

Ever watchful for signs of domestic social unrest, Beijing knew that it had to react. Already on November 5 the State Council convened an emergency meeting to agree on a 4 trillion yuan ($586 billion) spending program. This amounted to a remarkable 12.5 percent of 2008 GDP. It was supplemental to existing investment plans and was to be disbursed by the end of 2010. It was the first truly large-scale fiscal response to the crisis worldwide.

In November 2008 fiscal policy was pushed in China with the kind of urgency that the West reserved for central bank initiatives and bank bailouts. It was Tim Geithner’s “maximum force” approach but applied to public spending rather than monetary policy.

On April 7, 2009, Beijing announced that health insurance coverage would be extended from 30 to 90 percent of China’s population and that central funds would be allocated to pay for the construction of two thousand county hospitals and five thousand township-level clinical centers. It was the largest expansion in health-care provision in world history to date and it was “inextricably interwoven with the stimulus package.”

Between 2008 and 2014 the network of rail lines suitable for traffic at speeds of 250 kilometers per hour or more was expanded from 1,000 kilometers to 11,000 kilometers. Journey times from Beijing to Shanghai were cut to 4.5 hours for an 819-mile trip, compared with the 7 hours that the Acela—the pride of America’s Amtrak—takes to cover the 454 miles from Boston to Washington,

In China the stimulus was deeply controversial. To many observers it seemed that, driven by a crisis in the West, the Chinese economy was being sucked in precisely the wrong direction. Was the stimulus a spectacular demonstration of state power, or further proof of the addiction of the Chinese power elite to an unsustainable growth model?

Though responsibility for revenue collection falls heavily on central government, government expenditure directly controlled from Beijing has amounted to no more than 4 to 5 percent of GDP since the 1990s, a very small figure by comparison with its American or European counterparts.

Taken at face value, this meant that a single Chinese province with a population the size of the UK and a GDP the size of Greece was engaging in a program of investment larger than any stimulus ever attempted in the United States.

But from an economic point of view the vital question was how it was to be financed. This is the key question in any fiscal policy “stimulus.” If spending is paid for by tax increases, this negates any increase in purchasing power. Borrowing by issuing bonds will soak up private savings, which may divert the portfolios of private wealth holders away from other investments. Credit creation is the one surefire way to fund stimulus spending if the aim is immediately to revive an underemployed economy. Beijing’s stimulus was particularly effective precisely because it combined huge government spending with a spectacular loosening of monetary policy.

When it wants to control credit, the People’s Bank of China (PBoC) not only sets the interest rates. It set quotas for credit issuance for each of the major banks.

More new credit was issued in three months than the official fiscal stimulus would provide for the next two years.

This huge additional growth boost was delivered through a variety of channels. But it was state directed from the top down and supplemental to China’s already enormous growth rate. When the entire complex is accounted for, this was an intervention comparable in scale to anything ever undertaken in the Mao era, or under Soviet communism. The Western capitalist economies had witnessed such huge mobilizations only in times of war.

Though they were not coordinated policies, they made real the vision of a G2: China and America leading the world.

By 2010 pluralities of respondents in both the United States and Europe would identify China as the “world’s leading economy.”

Treasury Secretary Geithner provoked laughter from nationalist students at Peking University when he declared that American debt was “very safe.”

China’s stimulus benefited all its trading partners, from Australia to Brazil.1 Across the world the share of China trade increased.

Most at risk in 2008 was South Korea, whose famous corporate export champions, the chaebol—Daewoo, Hyundai, Samsung—and their giant steel plants, shipyards and car factories suffered a shuddering blow.

Since the early 2000s, Seoul had promoted itself as a regional financial hub for Northeast Asia. It had liberalized currency and capital flows. A large part of South Korean banking was owned by foreign investors, and Korea’s banks had shifted to the unstable new model of wholesale funding, borrowing short term on global dollar markets to invest long term at higher interest rates in Korea.

Between the summer of 2008 and May 2009 the won plunged from 1,000 to 1,600 to the dollar, increasing the local cost of US dollar loans by 60 percent. Only tiny bankrupt Iceland suffered a more drastic depreciation.