Review: “Crashed” by Adam Tooze
Abbreviated summary: The financial collapse of 2008 demonstrated the emptiness of the claim that markets could regulate themselves. It should have led to the disgrace of neoliberalism—the belief that unregulated markets produce and distribute goods and services more efficiently than regulated ones. Instead, the old order reasserted itself.
In the United States, the bipartisan financial elite escaped largely unscathed. Barack Obama, whose campaign benefited from the timing of the collapse, hired the architects of the Clinton-era deregulation who had created the conditions that led to the crisis. Far from breaking up the big banks or removing their executives, Obama’s team bailed them out. None of the leading bankers whose fraudulent products caused the economy to crash went to jail. Obama’s tepid program provided just enough stimulus, via a modest public-spending program and cheap unlimited credit for bankers, for a slow recovery.
In Europe the aftermath was worse. Fragmented into twenty-eight member states, the EU could not pursue even the minimal policies of Obama. Germany had already spent some E1.3 trillion on the economic integration of the former DDR and was in no mood to underwrite the recovery of the entire continent.
ermany insisted that the struggling countries had to practice austerity in order to restore the confidence of private financial markets. In a deep recession, even orthodox economists at the International Monetary Fund soon recognized that austerity was a perverse recipe for economic recovery.
There have been hundreds of illuminating books on the great financial collapse. Crashed, written to mark its tenth anniversary, will stand for a long time as the authoritative account. In his masterful narrative, the economic historian Adam Tooze achieves several things that no other single author has quite accomplished. Tooze has managed to explain a hugely complex global crisis in its multiple dimensions, and his book combines cogent analysis with a fascinating history of the political and economic particulars.
In Tooze’s account, the survival of neoliberalism is one of several related ironies. Before the crash, economists had thought that the next crisis would be caused by America’s budget deficit and its trade deficit, as well as the shakiness of its codependency with China, which both benefited from the trade deficit and bought Treasury bonds to offset it. But when the collapse came, it was “a financial crisis triggered by the humdrum market for American real estate.”
The US housing bubble was pumped up by subprime mortgage derivatives that allowed lenders to sell off high-risk loans homeowners were unlikely to pay back. These were invented on Wall Street beginning in the 1980s, accepted by US regulators, and disseminated like financial toxins globally. And this raises a further irony. The crisis was thought by many Europeans to have shaken American financial hegemony and the dominant status of the US dollar. Tooze begins his tale at the annual convening of the UN General Assembly in New York on September 23, 2008, a week after the collapse of Lehman Brothers. “One after another, the speakers at the UN connected the crisis to the question of global governance and ultimately to America’s position as the dominant world power,” he writes. Yet as Tooze explains, the collapse reinforced the financial supremacy of Washington and New York.
Distilled to its essence, the crisis was an implosion of bank balance sheets. Commercial and investment banks had gotten overleveraged—carrying too much debt—and were borrowing money in overnight markets to invest in exotic securities that were themselves overleveraged. When the entire structure of borrowed money collapsed, the losses more than wiped out all the capital of the banking system—not just in the US but in Europe, because of the intimate interconnection (and contagion) of American and European banks. Had the authorities just stood by, Tooze writes, the collapse would have been far more severe than the Great Depression: “In the 1930s there was no moment of such massive synchronization, no moment in which so many of the world’s largest banks threatened to fail simultaneously.”
Fed Chairman Ben Bernanke, a scholar of the Great Depression, understood the stakes. While insisting to Congress that the emergency response was mainly to shore up US finance, Bernanke turned the Fed into the world’s central bank. “Through so-called liquidity swap lines, the Fed licensed a hand-picked group of core central banks to issue dollar credits on demand,” Tooze writes. In other words, the Fed simply created enough dollars, running well into the trillions, to prevent the global economy from collapsing for lack of credit.
Tooze is especially good at explaining the many Fed inventions that pumped trillions of dollars into every obscure corner of the financial industry. He demystifies the impenetrably technical contrivances used by both private companies and central banks. Tooze computes the staggering sums, running into the tens of trillions of dollars. Using deposit guarantees, loans to banks, outright capital transfers, and purchases of nearly worthless securities, the Fed and the Treasury recapitalized the banking system. To camouflage what was at work, officials invented unlimited credit pipelines with disarmingly technical names.
The Term Auction Facility, for instance, provided banks with funds they could no longer get in the frozen market for commercial paper—unsecured, short-term corporate loans—eventually committing a total of $6.18 trillion. To restart that market, the Fed invented the Commercial Paper Funding Facility, which pumped $737 billion into it. The largest beneficiary was the Swiss bank UBS. Virtually unlimited capital also guaranteed funding for retail stockbrokers and much more. The blandly named policy of quantitative easing, which drove interest rates down to almost zero, was a euphemism for Fed purchases of immense quantities of private and government securities.
The crisis, Tooze writes, “was a devastating blow to the complacent belief in the great moderation, a shocking overturning of the prevailing laissez-faire ideology.” And yet the ideology prevailed. Homeowners, both those defrauded by subprime mortgages and millions of others whose houses were suddenly worth less than their debt, were the real victims of the collapse. But they got little help. Banks were permitted to invent complex provisional loan “modifications” with opaque terms that favored lenders, rather than using their government subsidies to provide refinancing to reduce homeowner debts.
The Dodd–Frank Act, passed in 2010 and meant to limit abuses in the financial industry, was too weak to begin with, and its implementation was largely crippled by the industry’s influence, years before Donald Trump’s deregulatory crusade.
How did a nominally center-left administration, elected during a financial crisis caused by right-wing economic ideology and policy, end up in this situation? Tooze reminds us of the Hamilton Project, a small unit at the Brookings Institution created in 2006 by Robert Rubin, former co-chairman of Goldman Sachs and Clinton’s treasury secretary, and his protégés. The project, which had substantial influence on Obama’s thinking, his program, and his appointees, promoted budgetary orthodoxy, no interference with Wall Street, and small-scale social investment initiatives such as retraining programs and support for small business.
Turning to Europe, Tooze explores the fatal combination of Germany’s demands for austerity with the structural weakness of the ECB and the vulnerability of the euro. In Europe, because of bad policy, the implosion of private financial assets led to a crisis of sovereign debt. Before the collapse, cheap debt caused risky investments to flow into Southern Europe. Countries such as Greece and Italy had, before the introduction of the euro in 1999, been prone to inflation because of high deficits, and the governments, corporations, and citizens of those countries had been made to offset the risk of devaluation by paying higher interest rates to lenders. But in the 2000s there was no risk of devaluation; Portugal or Greece now enjoyed interest rates that were only slightly higher than Germany’s, and markets failed to take account of the risk of default, which was more serious than that of devaluation.
After the crisis began, misguided responses compounded the damage. In Ireland, a badly corrupted government took bank losses onto the state’s own balance sheet, suddenly putting Ireland in receivership to Brussels and Berlin, which provided capital in exchange for stringent conditions. In Greece, before the crash, the budget books had been altered by a center-right government (with help from Goldman Sachs, which created special securities that allowed Athens to disguise the increased public debt). In 2009 the newly elected social-democratic government of George Papandreou and his Pasok party dutifully reported the faked books and the real numbers to Brussels and the world. Greece’s budget deficit was not 3.7 percent, as the outgoing government had falsely claimed. It was more like 12 percent, or four times the permitted limit under EU rules.
Financial markets responded by speculating against Greek sovereign debt, requiring Greece to pay much higher interest. But instead of treating the Greek situation as a crisis to be contained and helping a genuinely reformist new government find its footing, Brussels and Berlin treated Greece as an object lesson in profligacy and an opportunity to insist on punitive terms for financial aid. This mainly served to bail out Greece’s creditors and pushed the Greek economy deeper into depression. To qualify for the meager program of what Tooze terms “extend and pretend” from the EU, the ECB, and the IMF, the Greeks were made to pursue excruciating cuts in public services and pensions as well as auctions of public assets at fire-sale prices.
A central player in this tragedy was the European Central Bank. Tooze does a fine job of explaining the delicate dance between the bank’s leaders and its real masters in Germany. Since Germany opposed continent-wide recovery spending, the bank could only pursue monetary policy. The model was the Fed. Yet while the Fed has a congressional “dual mandate” to target both price stability and high employment, the ECB’s charter allowed for price stability only. In the Maastricht Treaty, which was signed in 1992 and created the euro, Germany’s requirement for giving up its cherished deutsche mark was an agreement that the euro would be protected from inflation.
As the crisis deepened, Draghi gradually expanded the boundaries of the ECB’s remit, cutting interest rates and making two rounds of loans to European banks. In 2012, Tooze recounts, Draghi, speaking off the cuff in an urgent effort to reassure markets, declared that the ECB “is ready to do whatever it takes to preserve the euro.” Nobody was sure what that meant, not even Draghi. “As usual, the inflation hawks at the Bundesbank were aghast at the idea of ECB bond buying,” Tooze tells us. “But for Merkel it was the better of two bad options.” The ECB, with the consent of the Germans, came up with one of those bland-sounding names, Outright Monetary Transactions, for its direct purchases of government bonds. But the program, at the insistence of the Germans, was restricted to nations in compliance with Merkel’s rigid fiscal terms, which limited national deficits and debts. In other words, the money could not go to the very nations where it was needed most, since the hardest-hit countries had to borrow heavily to get themselves out of the recession.
Tooze excels at explaining the byzantine political bargaining that led to policy compromises that avoided outright depression but stifled the European economy. These were the consequences of shifting alliances among national leaders, with the French, Italians, and Spanish, who were less opposed to inflation, against the conservative Germans and Dutch, as well as complex infighting within the political leadership in individual nations. The infighting was compounded by the interests of different national and international politicians and institutions, above all the banks. Much of the pressure was on Merkel, whipsawed between her own fiscal conservatism, the hostility of the German electorate to bailing out the supposedly profligate southern nations, and her need to hold the EU together. At one excruciating all-night negotiation at which she felt ambushed by other national leaders, Tooze reports, Merkel broke down and declared, “Ich will mich nicht selbst umbringen.” (I do not want to kill myself.) Reading Tooze, you realize that it’s a miracle that the EU and the euro survived at all—but they did so at terrible human cost.
Crashed does have some minor blemishes. There are some aspects of the story that are omitted or glossed over. For example, the ideal of liberalized trade, and the use of trade treaties to promote deregulation or privatized regulation of finance, is a major element of the story of how neoliberal hegemony promoted the eventual collapse. But except for a passing reference, trade and globalized deregulation get little mention here.
What, finally, are we to make of this saga? Tooze ends the book with a short chapter called “The Shape of Things to Come,” mainly on the ascent of China, the one nation that avoided all the shibboleths of economic and political liberalism, though it also, of course, does not have a political democracy.
Review by Robert Kuttner in the New York Review of Books, full review here: www.nybooks.com