Crashed: How a Decade of Financial Crises Changed the World

by Adam Tooze

The message that this communicated down the food chain was simple: We want more mortgage debt to process, and the worse the quality, the better. By the magic of independent probabilities, the worse the quality of the debt that entered into the tranching and pooling process, the more dramatic the effect. Substantial portions of undocumented, low-rated, high-yield debt emerged as AAA. In any boom, irresponsible, near criminal or outright fraudulent behavior is to be expected. But the mortgage securitization mechanism systematically produced this race to the bottom in mortgage lending quality. It was the difference between the high yield of the underlying securities included in the collateral pool and the low interest that was paid to the investors who bought the AAA-rated asset-backed securities that generated the profit.

At the hedge funds and private equity groups, individuals could earn hundreds of millions, or even billions, of dollars per annum. In 2007 the six top hedge fund managers earned at least a billion dollars each in compensation.

In August 2005 the theme of the conference was not the crisis brewing in the US housing market but a celebration in honor of the outgoing Fed chairman, Alan Greenspan. Most of the presentations were appropriately upbeat. But one rang an off note. It was given by Raghuram G. Rajan, an Indian by birth but a fully paid-up member of the American economics elite, professor at the Chicago Booth business school and chief economist at the IMF. His paper bore the heretical title “Has Financial Development Made the World Riskier?”57 Rajan worried that the dramatic expansion of modern financial intermediation was building up a dangerous new appetite for risk. At Greenspan’s farewell party, the message was not welcome. Rajan was slapped down by Larry Summers. Wielding

The rise of China dominated contemporary perceptions of early twenty-first-century globalization. And the axis of imbalance that attracted most attention was that between China and the United States. Worries about geopolitics, Larry Summers’s balance of financial terror, Ben Bernanke’s savings glut, all pointed the finger in that direction. But if we map not annual flows but cross-border banking claims, this gives further proof of how one-sided the Sino-American view of the buildup to the crisis was. The central axis of world finance was not Asian-American but Euro-American. Indeed, of the six most significant pairwise linkages in the network of cross-border bank claims, five involved Europe.

In the process, the European financial system came to function, in the words of Fed analysts, as a “global hedge fund,” borrowing short and lending long.16

If it is misleading to construct our image of financial globalization around the Sino-American trade balance, to imagine it as centered on US securitization with outsiders being “sucked in” misses the point too. In fact, the entire structure of international banking in the early twenty-first century was transatlantic. The new Wall Street was not geographically confined to the southern end of Manhattan. It was a North Atlantic system. The second node, detached from but integrally and inseparably connected to New York, was the City of London.17 In the nineteenth century, in the age of the gold standard and the British Empire, London had been the capital of global finance in its own right. From the 1950s, the City of London made a new role for itself as the main hub for offshore global dollar financing.

Britain’s native banking industry under intense competitive pressure, Tony Blair’s New Labour government set about further streamlining the City’s regulatory system.24 Nine specialist regulators were combined into a single agency, the Financial Services Authority (FSA). It set a new low bar for financial oversight. Tony Blair’s chancellor, Gordon Brown, boasted that the FSA offered “not only light but limited regulation.”25 The FSA was mandated to achieve its “goals in the most efficient and effective way.” “[N]ot damaging the competitive position of the United Kingdom” was its top priority.26 The FSA was required to apply cost benefit analysis to its own interventions and benchmark its operations against other countries.27 Perhaps not surprisingly, given this mandate, the FSA’s staff was a fraction of that of its US counterparts. As Howard Davies, the FSA’s first chair, put it in the libertarian language of the day: “The philosophy of the F.S.A. from when I set it up has been to say, ‘Consenting adults in private? That’s their problem.’ ”28 The sort of thing that you could do in London but not in New York is exemplified by “collateral rehypothecation.”

In the United States, under regulations that went back to 1934, such rehypothecation of collateral was strictly limited to no more than 140 percent of the collateral being held. In the UK there was no limit on rehypothecation. As a result, according to investigations by a team of analysts from the IMF, the City of London came to function as a “platform for higher leveraging not available in the United States.” The scale of this activity was enormous. According to the IMF team, trading in and out of London the main European and US banks achieved a collateral multiplication of 400 percent, amounting to roughly $4.5 trillion in additional funding, effectively out of thin air.29

For the resilience of a bank in the face of losses on its loan book, capital is the crucial criterion. The more capital a bank has, the more it is able to absorb losses. However, the larger a bank’s book of loans relative to its capital, the higher the rate of return it will be able to offer investors. That was the point of the elaborate legal structures designed to hold securitized assets off balance sheet, to minimize the capital invested and to maximize its leverage. Capital ratios were, therefore, one of the neuralgic points of bank governance.

Northern Rock had minimal exposure to US subprime. But that didn’t matter, because it sourced its funding from markets heavily used by banks that did. The bad news from Paribas on August 9 was enough to shut down the interbank lending markets and the market for asset-backed commercial paper. It was the seizure in the funding market that poleaxed the entire securitization business and in particular the European side, which had been most actively involved in the issuance of ABCP. Given Northern Rock’s extreme dependence on wholesale funding, it took only two working days after the markets dried up for the bank to notify the Financial Services Authority of an impending crisis.12 But the Bank of England was in no mood to help. Governor Mervyn King took the view that the overextended mortgage lender should suffer the consequences of its irresponsible expansion. By the end of August Northern Rock’s liquidity problems had become life threatening. But it wasn’t until September 13, after the BBC reported the story and the government acted to address the crisis by announcing a guarantee, that the retail depositors panicked. After that, the main damage to Northern Rock’s balance sheet was done by online withdrawals. The elderly savers queuing in the streets made for alarming TV footage. But it was not their panic that was bringing down the bank. It was a bank run operating on an altogether different scale at the speed of computer terminals in money markets across the world. It was a ...

When news of a new round of mortgage failures hit the markets in March 2008 and hedge funds began emptying their prime brokerage accounts, quite suddenly the haircuts Bear Stearns faced in the bilateral repo market steepened and access to trilateral repo funding was shut off. A bank that in early March had easily been able to raise $100 billion overnight in exchange for good collateral could no longer fund itself. On Thursday, March 13, with its liquidity reserve down to only $2 billion, Bear’s directors were told that $14 billion in repos would not “roll” the next day and that they were at imminent risk of running out of cash. This was a modern bank failure. There were no queuing depositors. Bear did not cater to pensioners. It died, because doubts about its business led it to be cut out of wholesale funding markets.

A conservative, free-market administration led by businessmen was proposing unlimited state spending to nationalize a large part of the housing finance system. The Republican electorate was outraged by the thought of assisting undeserving mortgage borrowers and the New Deal machinery that had aided and abetted their fecklessness. But to Paulson the systemic imperative was obvious. And President Bush stood behind him. “It was a tremendous act of political courage,” Paulson gushed, “It was as if, in the last days of his administration, the president were suddenly switching sides, supporting Democrats and opposing Republicans on matters that went against the basic principles of his administration. But he was determined to do what was best for the country.”25 Paulson was registering a basic rift within American conservatism.

early in the morning of September 30 the Dublin government announced that for fear of dying it would commit suicide. As Europe turned on the morning news it learned that the Irish government was fully guaranteeing not just the deposits but all the liabilities of six major Irish banks for a period of two years. No other government had been advised in advance, nor had the ECB, nor had the Irish taxpayers.66 It stopped the run, but it left Ireland, with a population half the size of New York City, guaranteeing 440 billion euros in bank liabilities. The losses the banks incurred would bankrupt the Irish state. They would become the telltale link connecting the banking crisis of 2008 to the eurozone sovereign debt crises of 2010. But that was music of the future. The issue on September 30 was the immediate impact on the rest of the world. If Ireland was offering a safe haven, would the run now extend to the rest of Europe?

Against the backdrop of the TARP debacle and the shambles in Europe, Gordon Brown’s scheme looked like a breakthrough. From New York, Paul Krugman lavished praise on Britain’s Labour government. Britain’s Social Democrats had figured out how to rescue financial capitalism.88 It certainly helped that the Labour government was less averse to nationalization than Hank Paulson was. Less charitably it might be said that since the 1990s, New Labour, like the Democrats in the United States, had entered into an enthusiastic partnership with the City of London. It was, therefore, no coincidence that it was now Labour in Britain and the Democrats in the United States who were showing such energy in the struggle to fix the banking crisis. It was a monster they had helped to create. In any case, given the enormous burden that UK taxpayers were going to have to bear in supporting HBOS and RBS, it was hard to see that there was ever any alternative to nationalization.

Every cent of this staggering flow of funds was repaid in full. Indeed, the Fed made profits of c. $4 billion on its swap lending in 2008–2009. But this sober accounting understates the drama of this innovation. Responding to the crisis in an improvised fashion, the Fed had reaffirmed the role of the dollar as the world’s reserve currency and established America’s central bank as the indispensable central node in the dollar network. Given the even vaster volume of daily transactions in global financial markets, it is not the sheer size of the effort that mattered. The Fed’s programs were decisive because they assured the key players in the global system—both central banks and large multinational banks—that if private funding were to become unexpectedly difficult, there was one actor in the system that would cover marginal imbalances with an unlimited supply of dollar liquidity. That precisely was the role of the global lender of last resort.

At the top of the Fed’s list were Citigroup and Bank of America and the two highly stressed US investment banks, Merrill Lynch and Morgan Stanley, with their respective London operations. Then came a comprehensive list of the big European and American players in the global dollar banking business. Of the liquidity on one-month or three-month terms that the Fed provided to big banks, European banks took the majority. European banks and the London operations of the major US investment banks accounted for 23 percent even of the overnight primary dealer credit facility. When this support is added to the gigantic swap line facilities provided for the European central banks, the conclusion is inescapable. What the Fed was struggling to contain in 2008 were not two separate American and European crises but one gigantic storm in the dollar-based North Atlantic financial system.

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. Using the Fed’s records we can track the liquidity support provided to a bank like Barclays on a daily basis, revealing a first hump of Fed borrowing during the Bear Stearns crisis and a second in the aftermath of Lehman.

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.21 The message was clear. Ten years on from the humiliation of 1998, there were men in charge who would see to it that things “got done.”

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. If we compare the forecasts for 2010 made in October 2007 with the expected outturn two years later, we see how radically the crisis changed the outlook for the worst-hit countries in the region. The most extreme case was Latvia. One year into the crisis, in October 2009, the IMF’s forecast for Latvia’s GDP in 2010 was 39 percent lower than it had been in October 2007. Over the same two-year period, Estonia’s and Lithuania’s GDP expectations were revised downward by a whopping one-third. Slovenia, the Czech Republic, Slovakia, Hungary, Bulgaria and Romania all experienced downward shocks of between 15 and 18 percent, more than twice that suffered by the United States. In the adjoining post-Soviet Commonwealth of Independent States (CIS), the downward revision of growth expectations ranged from 18 percent for Russia to 32 percent for Armenia. 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.

“Latvia may be a small country but it has vast repercussions.”52 One Central European minister of finance, who preferred to remain anonymous, predicted that the chain reaction across Central and Eastern Europe would take down at least half a dozen European banks. Latvia would play the role of a Lehman, or, even more ominously, that of the infamous Austrian Kreditanstalt in the financial crisis of 1931, the failure of which had precipitated Weimar Germany’s final slide toward disaster.

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. The results for Latvia were drastic. By the summer of 2009 house prices had plunged by 50 percent. Civil servants, including one-third of the country’s teachers, were fired and public salaries were slashed by 35 percent. Unemployment surged from 5 to 20 percent.53 Remarkably, Latvia clung on, as did its neighbors. In mounting its defense, Latvia received aid totaling 32 percent of its precrisis GDP: 3.1 billion euros came from the European Commission; the IMF provided 1.7 billion; 0.8 billion came from the World Bank and the European Bank for Reconstruction and Development; and 1.9 billion came from Sweden, Denmark, Finland, Norway and Estonia.54 They all preferred to fight the crisis in Latvia rather than bailing out their banks at home. Significantly, the ECB absented itself from the crisis-fighting coalition.

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. With slow domestic investment and consumption, the vast majority of Germany’s growth after 2000 was accounted for by foreign demand. In China, far and away the main driver of growth was its enormous wave of domestic investment. As China’s cities expanded and its infrastructure modernized at a staggering rate, the physical reconstruction of the country sucked the entire Chinese economy up with it.

Central Document No. 18 energized the networks that linked the Communist Party, local government and business interests. It was precisely this nexus that over the last generation had combined to supercharge China’s spectacular economic growth. But it was that same combination that also went a long way to explaining the lopsided character of China’s growth. To meet a central target or quota, there was always some regional highway connection, housing complex, bridge or industrial park to be built and profits to be made doing so. When the stimulus was launched it was precisely this chain reaction that worried those who advocated a more balanced model of growth. The centrally ordained stimulus would unleash the bulldozers of the infrastructure machine. The results confirmed the critics’ worst fears. In Hubei province, with a population of 57 million and a regional GDP of $225 billion in 2009, there were projects under construction by 2010 notionally costed at $363 billion.28 A further $390 billion and $450 billion were planned for 2011 and 2012. 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. Across China, within a month of the State Council’s November initiative, eighteen provinces had proposed projects with a total budget of 25 trillion RMB, six times greater than the original proposed stimulus,...

Clearly the impetus for spending was massive. 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.

If we add the government deficit at all levels to the growth in bank credit beyond the 15 percent per annum expansion that had been the norm in China over the previous years, we get a measure of the true scale of China’s stimulus. In 2009 its dimensions were extraordinary—950 billion yuan in deficit, 467 billion in additional bond finance and 5 trillion in bank loans beyond the previous growth norm, for a total stimulus of 6,487 billion RMB, or 19.3 percent of GDP.36

Despite the radical expectations projected onto him, Obama was by inclination a bipartisan centrist. What he had not reckoned with was the sheer violence of the conservative hostility toward him. There was no possibility of bipartisanship. Whereas at least a minority of Republicans had voted with the majority of the Democrats to pass the Fannie Mae and Freddie Mac bailouts and TARP, in January 2009 in the House of Representatives not a single Republican voted for the American Recovery and Reinvestment Act, despite the tax cuts with which it was festooned.5 In the Senate only three did. It was a warning of the depth of partisan hostility the Obama administration would face. From the outset of his presidency, a large section of Republican opinion effectively denied the legitimacy of Obama’s leadership. At the grassroots this expressed itself in the “birther” conspiracy, doubting Obama’s status as a natural-born citizen. In Congress it manifested itself in a stance of absolute opposition. America’s right-wing think tanks mobilized in force to denounce the bailouts and to discredit the stimulus and the financial regulations to come. By the spring the wave of antigovernment indignation that dubbed itself the “Tea Party movement” would roil the base of the Republican Party and hog the television news cycle. In the background, billionaire “dark money” donors, led by the Koch brothers, stirred the pot.

Nevertheless, it was substantial. In absolute terms it was on a par with the spending of the New Deal. Though it was smaller in relation to a much larger national economy, the Obama stimulus was concentrated over a shorter space of time.10 In 2009 it placed America alongside the Asian states in the league of activists, outstripping any discretionary fiscal measures taken in Europe. And it worked. Despite the protestations of “freshwater” free-market economists and the complex economic arguments directed against “naïve” Keynesian “pump priming,” every reputable econometric study found that the Obama stimulus had a substantial positive impact on the US economy.11 Estimates by Obama’s Council of Economic Advisers put the number of jobs created at 1.6 million per year for four years, for a total of 6 million job-years.12 The multiplier was positive and above 1. This implies that the effect of government spending on the economy was not just positive. More private economic activity was stimulated than the government originally contributed. So the impact of the government’s spending was to shrink the government’s share in overall economic activity. But if this was the case, if the stimulus worked, why didn’t the Obama administration ask for more?13 There were political risks in asking for a figure bigger than $1 trillion. But there were risks to undershooting as well. By 2010, America’s unemployment was still stuck above 10 percent. Foreclosures and forced sales were destroying e...

Part of the answer is that the transition team did not fully grasp the scale of the tsunami that was descending on the US economy. From preparatory documents circulated within the transition team in early January 2009, we know that the worst-case scenario envisioned by Obama’s staff was for unemployment to reach 9 percent with no stimulus.14 In fact, even with the largest government-spending program in American history, unemployment topped 10.5 percent. But despite this underestimate, it is clear that the top macroeconomists in the Obama transition team did, in fact, realize that the stimulus ought to be bigger. On December 16, 2008, Christina Romer submitted a report intended for the president-elect arguing that to close the “output gap” by the first quarter of 2011 would require a discretionary stimulus of $1.7–1.8 trillion. Romer’s modeling was conventional. Her figures were sound. Her proposal was a trillion dollars larger than the figure the Obama team ultimately pushed through Congress. What decided the issue was politics, or rather the self-censorship of the economics team in the name of politics. Second-guessing the attitude of Chief of Staff Rahm Emanuel and his political operatives, Larry Summers, as head of the National Economic Council, was convinced that he and Romer would lose all credibility if they suggested anything even close to the figure she thought necessary. The results of Romer’s calculation were, Summers quipped, “nonplanetary.” He did not want to j...

The great political might-have-been of the early Obama administration is why, alongside TARP and the fiscal stimulus, the White House did not start by pushing a comprehensive relief program for home owners.15 While the banks and lenders were bailed out, 9.3 million American families lost their homes to foreclosure, surrendered their home to a lender or were forced to resort to a distress sale.16 The m...

The discretionary spending component of the Obama stimulus did not begin in earnest until June 2009, at which point the labor market was close to bottoming out.20 The less commonly noted corollary is that the open-handed fiscal stance of the first year of the Obama administration was in large part an inheritance of decisions and nondecisions made in 2008, while the future president was still in the Senate.

As profits, wages and spending all declined, this automatically generated a deficit and thus an offsetting public stimulus. This puts a rather different perspective on the fiscal policy battles at the G20. Though Germany, France and Italy steered clear of the kind of stimulus package launched by the Obama administration, let alone that trumpeted by Beijing, their deficits were widening too. As the private sector deleveraged and cut its spending, they too saw huge nondiscretionary deficits. Indeed, it would have taken a heroic and truly perverse act of austerity to prevent these automatic stabilizers from coming into effect. The net result was dramatic. Between 2007 and 2011, demand in the world economy was stabilized by the largest surge in public debt since World War II.

For macroeconomists this was a cause to celebrate the stabilizing properties of the modern tax and welfare state. For fiscal hawks it was a cause of deep concern. In the long run those debts would require higher taxes to service and repay them. This would pose major political challenges. And how would capital markets react? According to the script set out by conventional fiscal conservatism, one might have expected serious and immediate repercussions. Would the debt shock trigger the loss of confidence that Orszag and Rubin and so many others had warned about? How would savers be induced to hold trillions of dollars in government bonds? Would interest rates have to rise? Would this crowd out private investment? Would bondholders get jumpy? Would the bond vigilantes of the 1990s swing into the saddle, selling government bonds, driving Treasury prices down and yields up? In the spring of 2009, as the scale of the deficit became clear, business media reported that markets were up in arms. In light of “Washington’s astonishing bet on fiscal and monetary reflation,” the Wall Street Journal looked forward to a stern response from bond markets.23

In the event, Summers and the other skeptics were proven right. There was no run against Treasurys. The bond vigilantes were a spook. America’s households were rebuilding their savings. Mutual funds were shifting out of risky mortgage bonds. Everyone wanted Treasurys. These were the kinds of systemic macroeconomic and financial mechanics that all too often escape fiscal hawks, who view the public budget like that of a private household. When the private sector is undergoing a shock episode of deleveraging, when the savings rate is surging as it was in 2009, what is needed to preserve the overall financial balance of the national economy is not for the state to cut its deficit too. Everyone cannot save at once without provoking a recession. As the proponents of “functional finance” have argued since the 1940s, the state must act as a borrower of last resort.26 In so doing it preserves aggregate demand and provides a flow of safe long-term bonds to financial markets. After the shock of 2008 the entire world was keener than ever to hold safe assets. A huge class of AAA-rated private label securities had shown itself to be far from safe, so the demand for Treasurys was huge. It wasn’t only Americans who wanted US government debt. As Treasury debt held by the public increased by $2.9 trillion between the summer of 2007 and the end of 2009, foreign buyers took more than half. Chinese holdings of Treasurys increased by $418 billion.

As in the UK and the United States, this helped to stabilize the government debt market, but there was a crucial difference. In the United States and the UK the central banks were pushing liquidity into the banking system. By contrast, in the eurozone, it was the balance sheets of the banks that absorbed the sovereign debt.

It was not markets but the cross-party consensus on fiscal consolidation that had emerged before the crisis that dictated a decisive and irrevocable turn toward austerity. It was a decision driven by a long-term vision of competitiveness and retrenchment, the lobbying of taxpayer and business advocates and the regional interests of the rich states of western Germany.33 It was a choice that would change the politics not just of Germany but of the eurozone as a whole.

Though the Obama stimulus crested in the second year of his presidency, this was offset in 2010 by cuts to other areas of federal spending and a crushing contraction in state and local spending. Though it suited no one to acknowledge the fact, between 2009 and 2010 Germany’s deficit was actually increasing more rapidly than that of the United States.44 Though the arguments were apparently more transparent, the politics of fiscal policy in the wake of the crisis were in their own way no less opaque than those that framed monetary policy.

In Britain, the most egregious case was RBS, a now majority state-owned bank that announced in February 2009 that it intended to honor £1 billion in bonus contracts.4 In the United States the figures were far larger. In the 2008 bonus season, after suffering tens of billions in losses, Wall Street paid out $18.4 billion to its top staff. That was two and a half times the amount that Congress approved for the president’s priority of modernizing America’s broadband infrastructure. Alternatively, if it had been retained by the banks, it would have made a substantial contribution toward their recapitalization.5 But the investment banks weren’t conventional public companies. They were partnerships run primarily for the benefit of their managerial elite and they expected to be paid, whatever happened. In the 2008 bonus season Merrill Lynch alone was responsible for $4–5 billion in payments. And it made sure to pay out earlier than normal in December 2008, just after the firm revealed a fourth quarter loss of $21.5 billion and days before it collapsed into the reluctant embrace of Bank of America.6 But of all the bonus scandals, the one that really caught the public’s attention was AIG. It closed its fourth quarter of 2008 with a loss of $61.7 billion, the largest in US corporate history. Nevertheless, on March 16, 2009, the company announced that its Financial Products division, which had been at the heart of the toxic spill, would be awarding $165 million in bonuses, a figure t...

The result was a sprawling piece of legislation running to 849 pages.34 Rather than offering a single coherent thesis, the Wall Street Reform and Consumer Protection Act, commonly known as Dodd-Frank, embodied a compendium of crisis diagnoses. Was the crisis due to mass predation of poorly informed borrowers? In which case what was needed was Elizabeth Warren’s Bureau of Consumer Financial Protection (Title X). Was it opaque over-the-counter derivatives that had blown up the system? In which case the fix was transparent, market-based trading of derivatives (Title VII—Wall Street Transparency and Accountability). Was it the breakdown of responsibility in the extended chains of mortgage securitization that poisoned the well? In which case securitizers should be required to have skin in the game (Title IX—Investor Protections). Was the sheer size of banks at the root of all the problems? Were they simply too big to fail? In which case the answer was to restrict bailouts and to make the industry pay for them (Title II—Orderly Liquidation Authority) and to cap banks’ further growth (Title VI, sections 622 and 623). Had investment banks used client money to gamble? If so, the thing to do was to reinstate 1930s-style divisions between commercial and investment banking by way of the so-called Volcker rule banning “proprietary trading” (Title VI, Volcker rule). All of these theories about the crisis of 2007–2009 had major political resonance. All of them made their way into the mea...

For Geithner the “populist fury” of the “atonement agenda” was a dangerous distraction from the tough-minded technical business of addressing a crisis.44 But the grief and distress caused by the crisis were forces to be reckoned with. They ran through American society in waves, and early 2010, as Dodd-Frank reached a critical point in its labored passage through Congress, was one such moment. Three years since the real estate bubble burst, the full effects of the credit crunch and mass unemployment were making themselves felt. Between 2007 and 2009, 2.5 million homes had been foreclosed and the crest had not yet been reached. As 2010 began, 3.7 million families were more than ninety days past due on their mortgage payments. Millions more were struggling to make ends meet, one or two months behind on their payments. Over the next twelve months 1.178 million homes would slide into foreclosure, the worst year of the crisis. With prices still falling, ever more properties were sinking into negative equity. As one analyst remarked in early 2010: “We’re now at the point of maximum vulnerability. People’s emotional attachment to their property is melting into air.”45 In the worst-hit areas, such as Florida, fully 12 percent of properties were given up by their owners or seized by banks for foreclosure. Foreclosure proceedings were operating at such a pace that they were given over to quasi-automated legal processes that turned out to be ruinously flawed. In a nightmarish administ...

The contrast in fortunes between Wall Street and Main Street was increasingly intolerable. The big banks had been bailed out. Some of the most unscrupulous bosses might face legal action, but they were not facing personal ruin. They retired to lifestyles of wealth and comfort.46 None had gone to jail. And those at the top of the tree on Wall Street were bouncing back apparently without shame or second thought. The bonus season in 2009 was better than ever, netting $145 billion for the executives at the top investment banks, asset managers and hedge funds, as compared with $117 billion in 2008.47 Goldman made $13.4 billion in profit for its shareholders and paid its own staff $16.2 billion in compensation and bonuses.48 Astonishingly, even Citigroup, which had a loss of $1.6 billion in 2009 and survived the year only due to government action, paid out $5 billion in bonuses. The bankers were happy to leave the past behind, but the American public was not. In the spring of 2010 Wall Street’s approval rating with the general public stood at 6 percent.49

TARP, followed by the stress tests, the Dodd-Frank regime and capital planning, put the American banking system on a forced road to recovery. It foreclosed more radical options. The banks remained too big to fail. Far from downsizing or breaking them up, by 2013, J.P. Morgan, Goldman Sachs, Bank of America, Citigroup, Wells Fargo and Morgan Stanley were 37 percent larger than they were in 2008.73 The resources of the state were put one-sidedly at the service of management and shareholders. But if the aim was to get America’s banks out of the emergency ward, it worked. As Geithner insisted, the ultimate test of his policy of stabilization was the financial health of the banks, and on that score the record was pretty unambiguous. Between 2009 and 2012 the eighteen largest US banks increased their common capital from $400 billion to $800 billion. They reduced their ratio of risky wholesale funding from $1.38 per dollar of FDIC-insured retail deposits to $0.64. At the same time, they raised the share of their assets in cash, Treasurys and highly liquid instruments from 14 to 23 percent.74 The elite closure and cooperation that the Treasury and the Fed had finally managed to orchestrate in October 2008 was doing its job.

By contrast, the lack of comprehensive recapitalization of Europe’s wounded banking system was an omission that marks one of the fundamental turning points in the crisis. With the help of low-interest loans from Trichet’s ECB, many banks resorted to the makeshift of pumping up their profits by buying higher-yielding government debt. But the failure to build new capital would leave the European banks in no position to absorb any further shocks. While the United States began to stabilize, in Europe the banking crisis of 2008 would merge a year later with a new crisis: a panic in the eurozone public debt market. The connecting thread between the crisis of subprime and the crisis of the eurozone was the fragility of Europe’s bank balance sheets. Back to back, the combination of the two crises would mark one of the most significant inflections in European economic history since 1945. It would shake Europe’s politics to its foundations. It would open a stark divide within the Atlantic economy between Europe and America, and it would pose a profound challenge to transatlantic relations.

This was the basic dilemma of the eurozone debt crisis. Greece needed a write-off. The Germans were not opposed and favored haircutting the creditors. But Greece’s PASOK government did not want to pay the price for a problem in large part created by its predecessor. It wasn’t just the state’s debts that would have to be restructured but the Greek banking system too. The entire Greek social and political fabric was at stake. The French opposed a write-off and Paris had backing not just from other European debtor nations but from the ECB as well. The ECB was aghast at the prospect of a sovereign default in the eurozone. What about the risks of contagion? Surely what Greece needed was a healthy dose of financial discipline. That was a popular answer. Austerity was the medicine forced down Greek throats for years to come. But the budget adjustment required was unrealistic and its impact on the Greek economy was devastating. As restructuring was, in the end, inevitable, the question ought to have been how to make it safe, how to build a framework within which debts could be written down and losses inflicted on creditors without unleashing a general panic. The problem was that to even say this out loud was to risk triggering a run before the safety net was ready. While engaging in extend-and-pretend and denying the need for restructuring, it was hard to generate momentum for any collective European effort at institution building. And it could not be done without Germany, which, ...

If the ECB was a central bank, like the Fed or the Bank of England, there was no need for there to be a sovereign debt crisis at all. Greece had not borrowed in dollars. It had borrowed in euros and had delegated the sovereign power to print its own currency to the ECB. Its fate and that of the entire rest of the eurozone was in Trichet’s hands. All the ECB had to do to stop the destabilizing surge in Greek interest rates was to do what central banks do all over the world: buy sovereign bonds. Of course, bond buying was no long-term solution. Greece needed restructuring, fiscal discipline and economic growth. But at stake was the financial stability of a vast economic area. The Greek public debt was a tiny part of Europe’s financial system. The treaties that founded the ECB limited its right to buy newly issued Greek debt. But it could buy outstanding bonds as part of a market stabilization effort. If the ECB did not intervene it was a matter not of economics but of politics and over the winter of 2009–2010 it seemed that Europe’s central bankers were determined to take a tough line. Rather than continuing the generous liquidity provision it had offered in 2009, the ECB allowed the LTRO scheme to expire.30 Then in April 2010 it began to discuss a new regime under which it would apply graduated repo haircuts to lower-rated sovereign bonds, limiting their attractiveness to banks.31 Trichet was engaged in the high-risk gamble of substituting pressure in the bond markets for t...

But the White House made one thing clear. There could be no talk of debt restructuring. “We cannot have another Lehman,” Obama emphasized. Whether Greece’s debts were sustainable was not America’s concern. Washington’s priority was containing financial contagion. Restructuring could not be contemplated until the Europeans had found a way to stabilize bond markets and were ready to push through wholesale recapitalization of Europe’s banks. And given the Franco-German deadlock, no such agreement seemed likely.

It was from this force field of interests that the first iteration of extend-and-pretend emerged. Europe entered an emergency regime defined not by a single sovereign author, but by the absence of any such authority.35

A committee of the EU, the ECB and the IMF would make up the soon to be infamous “troika,” dictating policy to Greece and the other “program countries.” What was ruled out was restructuring. On that Washington sided with the French and the ECB. Existing Greek debt would be paid off with new loans from the troika, whether or not the result was sustainable. The IMF would have to bend its operating procedures to the occasion. To satisfy Merkel’s insistence on the Lisbon rules, the “European” component would not consist of measures taken collectively via the central institutions in Brussels or jointly funded by the member states. That would require treaty change and might violate the line drawn by the German constitutional court. Instead, it would consist of individual national credits for Athens on a bilateral and voluntary basis coordinated through the Eurogroup, the powerful but informal meeting of the eurozone finance ministers. To avoid the appearance of a bailout—banned by Maastricht—the loans would not be on concessionary terms. Interest rates would be stiff and there would be a processing fee to compensate the lenders for their trouble. Finally, and most important, the support would not be provided preemptively to forestall a loss of market confidence. It would be offered only as an ultima ratio, if and when Greece lost access to the markets. It would be up to Greece, by means of austerity, to forestall that moment for as long as possible. For ordinary Greeks this mean...

Karolos Papoulias, the grizzled president of the Hellenic Republic and veteran of the Greek resistance in World War II, declared: “Our country has reached the edge of the abyss.”50 On May 6, the Greek parliament convened to vote through what was the most draconian austerity program ever proposed to a modern democracy. That morning, the ECB board was meeting in Lisbon and reporters e-mailed the news that the imperious Jean-Claude Trichet had refused even to discuss the possibility of stepping in to buy Greek bonds.