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LRB, Vol. 40 No. 20 · 25 October 2018
Bait and Switch
Simon Wren-Lewis
Crashed: How a Decade of Financial Crises Changed the World by Adam Tooze
Allen Lane, 706 pp, £30.00, August, ISBN 978 1 84614 036 5
In 2007, Alan Greenspan, the former chair of the Federal Reserve, was
asked by a Swiss newspaper which presidential candidate he was
supporting. He said it didn’t matter: ‘We are fortunate that, thanks to
globalisation, policy decisions in the US have been largely replaced by
global market forces. National security aside, it hardly makes any
difference who will be the next president. The world is governed by
market forces.’ This was the ultimate hope – the ultimate delusion, as
it turns out – of one of the architects of neoliberalism. Over the next
two years market forces inflicted major damage on the global economy,
and politics was forced back into the picture, though it had never
really gone away. In Crashed, Adam Tooze sets himself the mammoth task
of making sense of the Global Financial Crisis (GFC) and its
consequences over the last ten years. By and large he succeeds brilliantly.
The origins of the GFC are usually traced to the sub-prime housing crash
in the US, or to the problems facing the countries on the periphery of
the Eurozone. Tooze argues that these might have been the triggers for
the crisis, but they were not its cause. The cause was transatlantic –
because that is what the major US and European banks had become – and
that’s the reason its consequences were felt in most countries that had
close financial ties to the West. What the West experienced in 2008 was
a global bank run, a complete collapse of interbank credit. It is
commonplace to hear the great recession of 2008-9 talked about as if it
were a more modest version of the Great Depression of the 1930s. That
may be true, looking back, but at the time the crisis of 2008-9 had the
potential to be far worse. ‘Never before,’ as Tooze writes, ‘not even in
the 1930s, had such a large and interconnected system come so close to
total implosion.’ Ben Bernanke, chairman of the Fed at the time, calls
the GFC the worst financial crisis in global history.
The reason the GFC was more globally co-ordinated than the Depression is
that it was caused by interconnected global banks. Tooze notes that
every one of the 104 countries for which the World Trade Organisation
collects data experienced a fall in imports and exports between the
second half of 2008 and the first half of 2009. It was only the often
frantic interventions of central banks and governments that mitigated
the impact of the crisis. In the 1930s, the Great Depression had not
been moderated in that way. To a very limited extent, the GFC shows that
we can learn from history.
The implosion was triggered by events in the US, but the proximate cause
could equally well have been some other mishap involving the loans made
by the big banks. The more fundamental reason for the collapse was that
the transatlantic banking system, which is in practice a ‘tight-knit
corporate oligarchy’ of around 25 global banks, had left itself without
buffers sufficiently robust to cushion it against local shocks. The
banks had become highly leveraged: they had loaned far too much money
compared to their capital and so they couldn’t cover the total amount of
loans going bad. And it didn’t make much difference which loans went
bad, because the global banks had become more and more intertwined.
Tooze argues that conventional macroeconomics, which focuses on the
workings of single economies, was ill equipped to handle let alone
anticipate a global crisis. I think that is only partly right. A good
example of where it does hold true is the UK. It is taken for granted by
many that the collapse of the UK banking system reflected a crisis
originating in UK borrowing, and that people and governments before the
GFC must have indulged in overspending. That is simply not the case. The
UK banking system got in trouble because it had far too little capital
compared to the size of its loan book, and the loans that went bad were
not to UK residents or firms. Northern Rock collapsed not because the
people to whom it had lent mortgages stopped paying, but because it got
the money for those loans from short-term borrowing on the global
interbank market rather than from domestic savers, and in 2007 that
market dried up.
It would be wrong, though, to argue that a global perspective was needed
in order to anticipate and even prevent the GFC. Although banks may be
global, and therefore vulnerable to shocks from around the world, their
vulnerability is quite obvious to domestic regulators. Each global bank
is accountable to a single national regulator, and to a government that
will or will not bail it out if things go wrong. The Bank of England,
for example, had data concerning the rapid increase in the leverage of
UK banks in the few years before the GFC, but did little about it beyond
talking euphemistically about changing attitudes to risk. Perhaps the
fact that it was an international trend persuaded regulators to let
things pass, since to act alone would, initially at least, have hurt the
profitability of their own country’s banks. It is not as if the
possibility of a banking crisis hadn’t been considered, but there was no
appetite for what we now call stress-testing. The possibility of a joint
UK-US analysis was mooted at the Bank of England after the 1990s, Tooze
reports, but it never got off the ground because no one thought it a
priority. The GFC was a regulatory failure not just in the sense that an
overleveraged transatlantic banking system was allowed to develop in the
first place, but also in the sense that the warning signs in the
mid-2000s were ignored.[*]
Once the crisis arrived, it was down to national governments and central
banks to deal with it, and here Tooze is correct to suggest that those
who thought in global terms did rather better than those who didn’t. The
ways in which different governments responded when their banks crashed
forms a large part of his discussion. The Fed and the US Treasury may
have misjudged the devastating market reaction to the Lehman bankruptcy
in 2008, which many mark as the beginning of the GFC, but once the
extent of the problem became clear they not only bailed out their own
financial institutions, but the Fed also provided dollars on a huge
scale to European central banks, which fed them to their own banks.
In contrast, and despite the help they were getting, too many Eurozone
politicians in 2008 were happy to present the GFC as an Anglo-American
crisis, preferring not to acknowledge that their own national banks too
were deeply involved. Later on, in making an example of Greece, these
European politicians preferred to talk about a government debt crisis
rather than a banking crisis. It was, as Mark Blyth wrote in Austerity:
The History of a Dangerous Idea (2013), the biggest bait and switch in
history. Pretending the crisis was about government borrowing rather
than banking led to the widespread adoption of austerity policies in the
Eurozone. This in turn was the main cause of a second Eurozone recession
in 2012, which ‘through wilful policy choices’ drove up unemployment
across Europe. Tooze does not mince words about what happened: ‘It is a
spectacle that ought to inspire outrage. Millions have suffered for no
good reason.’ In the US, he writes, ‘there was a clear logic operating’
in the response to the financial crisis of 2008-9. ‘It was a class
logic, admittedly – “Protect Wall Street first, worry about Main Street
later” – but at least it had a rationale and one operating on a grand
scale. To impute that same logic to the management of the Eurozone is to
give Europe’s leaders too much credit.’ The casualties were not just the
unemployed. ‘In the battlefield of corporate competition, the crisis of
2008-13 brought European capital a historic defeat.’ In this story the
UK behaved like the US until 2010, when the newly elected
Conservative-led government switched the UK onto the Eurozone’s path of
austerity.
Sometimes the detail Tooze gives of how decisions were made during the
crisis is fascinating even to someone familiar with these events. I did
not know, for example, that the Eurozone almost managed to co-ordinate
on a joint bailout scheme in October 2008 equivalent to what was
happening in the US. But the project was scuppered by Germany and the
head of the European Central Bank (ECB) at the time, Jean-Claude
Trichet. ‘If we cannot cobble together a European solution then it will
be a debacle,’ the French president Nicolas Sarkozy remarked, ‘but it
will not be my debacle, it will be Angela’s.’ It isn’t that Germany had
no banking problems; its resistance reflected its more general
reluctance to do things at the Eurozone level if that might lead to
transfers from Germany to other Eurozone countries. Tooze quotes a
‘disillusioned British official’ remarking that the Europeans ‘didn’t
understand the economics. They did not understand how collective action
could work.’
Shortly after the failure to agree on a joint European bailout, the
situation of the German bank Hypo Real Estate became critical. Axel
Weber, the head of the Bundesbank, talked of nuclear meltdown. What
looked like the beginnings of a German bank run forced Merkel to declare
that all savings deposits were safe. The problem was that the Eurozone
had a common currency, so other Eurozone countries with large banks were
forced to do the same (or risk money flowing from their banks to become
guaranteed deposits in German banks). The UK too was feeling the
pressure. British officials desperately tried to talk to Berlin, but
Berlin wasn’t answering the phone. No one knew quite what the German
guarantee amounted to. The basic problem was that the money markets
could co-ordinate on a global level more easily, and create a crisis
more quickly, than politicians could respond. Unlike in the US, where a
bailout had explicitly been undertaken after the Lehman collapse, in the
Eurozone bank deposits were guaranteed without a major restructuring of
the banks. As a result, the impact of the crisis was allowed to persist.
Banking problems in the countries of the Eurozone periphery continued to
bubble up – most seriously in Ireland and Spain – and the markets were
spooked each time. The ECB had not stepped up to act as the lender of
last resort for individual Eurozone countries. Because politicians were
blaming the crisis on government debt and not on the banks, everyone’s
focus was on the implementation of austerity policies in periphery
Eurozone countries. But this was not the way to solve the Eurozone
crisis. Any solution had to come from the ECB, and eventually it came
from one man: Mario Draghi, who had succeeded Trichet as president of
the ECB. Draghi was at a global investment conference in London in July
2012, where he heard lots of pessimistic talk about the euro. (‘All
those stories about the dissolution of the euro really suck,’ he later
confided in a friend. Tooze says the original Italian was more
colourful.) So in a speech at that conference he said the ECB was ready
to do ‘whatever it takes’ to preserve the euro. Back in Frankfurt the
ECB press office couldn’t answer questions about what exactly he meant,
since Draghi had only shared his ideas with a small number of people.
That select group did not include the head of the Bundesbank, who wanted
to maintain market pressure in the form of high interest rates on
individual countries’ government borrowing because this would encourage
austerity programmes to reduce public spending. But Merkel, under
intense pressure from Spain and Italy, retreated from her previous
position and backed Draghi, and the ECB went on to outline the
Eurozone’s version of unlimited purchases of government debt. The
Eurozone crisis was ended. As Tooze notes, some took Draghi’s speech as
a tacit admission that the ECB should have dealt with the Eurozone
crisis in the same way the US and UK had dealt with theirs two years
earlier.
The one country that did not get the benefit of the ECB’s new policy was
Greece, which had been the main casualty of the Eurozone’s attempt to
hide its banking crisis. A Greek default could have been enforced by the
Troika (the European Commission, ECB and IMF) in 2010, but instead it
was delayed – and when finally it did come, it was only a partial
default. The reason for the delay was to protect the national banks of
the Eurozone, which were exposed to Greek debt and remained fragile
because there hadn’t been a US or UK-style bailout in the Eurozone. As a
result, the Greek government was left with a huge level of debt, mostly
owed to other Eurozone governments. These governments, or more
specifically their finance ministers, wanted their money back, which
meant wave after wave of austerity for Greece.
In 2015, when the left-wing party Syriza was elected to govern Greece,
the OECD estimated that one in six Greeks was going hungry on a daily
basis. What Syriza’s unorthodox finance minister, Yanis Varoufakis,
wanted was debt relief on a scale that would make possible a sustained
economic recovery. His posing of rational economic arguments against the
conservative ideology of the Eurogroup won him an international
following, but the Eurogroup, with the ECB at its side, had the power,
essentially because a majority of Greeks wanted to stay in the EU.[†]
The irony, as Tooze points out, is that the Eurogroup and the IMF were
effectively expressing a preference for the political forces and
interests that had created Greece’s fiscal problem in the first place.
*
The geopolitical scope of this book is remarkable. There is a chapter on
how the GFC helped shape Russian and East European politics. To take
just one example, in October 2008 Hungary reached an agreement with the
IMF and the EU on a $25 billion loan package, on terms that the lenders
viewed as lenient but which polarised Hungarian politics and set Hungary
‘on the path to a self-declared illiberal democracy’. Also little known
but described expertly by Tooze is the reaction of China to the GFC, in
what is perhaps the only unambiguous success story of this period.
China’s rapid growth in earlier decades had been built on exports, so it
was especially vulnerable to the collapse of world trade in 2008. As
winter approached that year, 30 per cent of new graduates were unable to
find work, and unemployment was growing (in a country the size of China,
such changes involve millions of people). The Chinese government knew
there was a danger of civil unrest, so in November 2008 agreed to an
increase of spending amounting to 12.5 per cent of GDP. As Tooze sees
it, China was taking the US’s maximum force approach to dealing with the
banking crisis and applying it to public spending. Combined with an
equally strong monetary stimulus, the results were impressive. China’s
growth rate in 2009, at 9.1 per cent, was barely lower than in 2008,
while in most other advanced economies growth in 2009 was significantly
negative. In 2009, China was the chief counterweight to global recession.
Did these actions lead China into financial ruin, as many in the West
argued fiscal stimulus was bound to do? Ten years later the Chinese
economy is still strong. The Chinese panic of 2015-16 that Tooze
describes was a stock market bubble rather than a government debt
crisis. Did the stimulus impose a huge burden on future generations of
Chinese? Since the money was used to build infrastructure, with
associated technological spin-offs, it did the opposite. One of the
projects funded by the fiscal expansion was a high-speed rail network,
which has made China a global leader in railway technology and construction.
At 5 per cent of GDP, the US fiscal stimulus passed in February 2009
(despite unanimous Republican opposition) was much less than required,
but it was enough to help bring the US recession to an end. The Eurozone
crisis that began in 2010 was quelled two years later when the ECB
finally decided to act as a lender of last resort. At the time it looked
as if a potential disaster had been moderated if not completely
overcome; Tooze says he began writing his book in 2012 as a
retrospective look at a crisis that seemed to be over. But it wasn’t
over: it morphed from a financial and economic crisis into a
comprehensive political and geopolitical crisis of the post-Cold War
order. Tooze describes Brexit, the Ukraine crisis and Trump’s election
in typically incisive prose, yet here I felt the lack of an overarching
narrative. These events are still unfolding, it’s true, but it seems to
me that some elements of the story are now firmly in place.
Although US policymakers succeeded in preventing an outcome worse than
the Depression, they did so by fixing Wall Street much more than Main
Street. There was modest growth after the crisis, but much of it went to
the 1 per cent, not the 99 per cent. Main Street suffered even more in
Europe, with a second Eurozone recession caused by austerity; in the UK
austerity also led to the weakest economic recovery in at least a
hundred years. All this provided the fuel for populism to emerge as a
serious political force. Is there anything in the GFC and the reaction
to it that can help us understand why populism should have emerged in
the form of Trump and Brexit? The implementation of austerity in the
wake of the GFC involved denying help to millions of people. To carry
that off required politicians and influential parts of the media to
ignore or actively suppress expert consensus (as well as the
overwhelming evidence on which it is based) that austerity is harmful
and unnecessary. In other words, a political deceit with huge costs to
the economy was enacted in order to achieve a political or ideological
goal. That is the story of Brexit, too. In the US, meanwhile, the
Republicans who tried to stop the Obama stimulus in 2009, and imposed
subsequent cuts in the name of bringing down the deficit, found no
problem with huge increases in the deficit under Trump to fund tax cuts
for corporations and the rich. Perhaps it isn’t so surprising, after
all, that many of the same politicians and sections of the media that
argued for austerity should also have promoted Trump and Brexit.
[*] Tamim Bayoumi describes in Unfinished Business: The Unexplored
Causes of the Financial Crisis and the Lessons Yet to Be Learned (Yale,
296 pp., £10.99, September, 978 0 300 23869 3) the process by which
regulators on both sides of the Atlantic allowed the global banks to
become so enmeshed with one another, and as a consequence able to take
great risks.
[†] Varoufakis gives a full account of his dealings with the Eurogroup
in Adults in the Room: My Battle with Europe’s Deep Establishment,
discussed by James Angelos in the LRB of 27 September.
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