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.