Sunday September 16, 2018
The aftermath produced a lost decade for European economies and helped lead to the rise of anti-establishment political movements here and abroad.
The uplifting story of economic recovery overlooks the political consequences of financial collapse, both here and abroad. Illustration by Woody Harrington
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September 15th marks the tenth anniversary of the demise of the investment bank Lehman Brothers,
which presaged the biggest financial crisis and deepest economic
recession since the nineteen-thirties. After Lehman filed for
bankruptcy, and great swaths of the markets froze, it looked as if many
other major financial institutions would also collapse. On September 18,
2008, Hank Paulson, the Secretary of the Treasury, and Ben Bernanke,
the chairman of the Federal Reserve, went to Capitol Hill and told
congressional leaders that if they didn’t authorize a
seven-hundred-billion-dollar bank bailout the financial system would
implode. Some Republicans reluctantly set aside their reservations. The
bailout bill passed. The panic on Wall Street abated. And then what?
The
standard narrative is that the rescue operation succeeded in
stabilizing the financial system. The U.S. economy rebounded, spurred by
a fiscal stimulus that the Obama Administration pushed through Congress
in February, 2009. When the stimulus started to run down, the Fed gave
the economy another boost by buying vast quantities of bonds, a policy
known as quantitative easing. Eventually, the big banks, prodded by the
regulators and by Congress, reformed themselves to prevent a recurrence
of what happened in 2008, notably by increasing the amount of capital
they hold in reserve to deal with unexpected contingencies. This is the
basic story that Paulson, Bernanke, and Tim Geithner,
who was the Treasury Secretary during the Obama Administration, told in
their respective memoirs. It was given an academic imprimatur by books
like Daniel Drezner’s “The System Worked: How the World Stopped Another Great Depression,” which came out in 2014.
This
history is, on its own terms, perfectly accurate. In the early
nineteen-thirties, when the authorities allowed thousands of banks to
collapse, the unemployment rate soared to almost twenty-five per cent,
and soup kitchens and shantytowns sprang up across the country. The
aftermath of the 2008 crisis saw plenty of hardship—millions of
Americans lost their homes to mortgage foreclosures, and by the summer
of 2010 the jobless rate had risen to almost ten per cent—but nothing of
comparable scale. Today, the unemployment rate has fallen all the way
to 3.9 per cent.
There is much more to the story, though, than this uplifting Washington-based narrative. In “Crashed: How a Decade of Financial Crises Changed the World,”
the Columbia economic historian Adam Tooze points out that we are still
living with the consequences of 2008, including the political ones.
Using taxpayers’ money to bail out greedy and incompetent bankers was
intrinsically political. So was quantitative easing, a tactic that other
central banks also adopted, following the Fed’s lead. It worked
primarily by boosting the price of financial assets that were mostly
owned by rich people.
As wages and incomes continued to languish,
the rescue effort generated a populist backlash on both sides of the
Atlantic. Austerity policies, especially in Europe, added another dark
twist to the process of political polarization. As a result, Tooze
writes, the “financial and economic crisis of 2007-2012 morphed between
2013 and 2017 into a comprehensive political and geopolitical crisis of
the post–cold war order”—one that helped put Donald Trump in the White
House and brought right-wing nationalist parties to positions of power
in many parts of Europe. “Things could be worse, of course,” Tooze
notes. “A ten-year anniversary of 1929 would have been published in
1939. We are not there, at least not yet. But this is undoubtedly a
moment more uncomfortable and disconcerting than could have been
imagined before the crisis began.”
In
the years leading up to September, 2008, Tooze reminds us, many U.S.
policymakers and pundits were focussed on the wrong global danger: the
possibility that China, by reducing its huge holdings of U.S. Treasury
bills, would crash the value of the dollar. Meanwhile, American
authorities all but ignored the madness developing in the housing
market, and on Wall Street, where bankers were slicing and dicing
millions of garbage-quality housing loans and selling them on to
investors in the form of mortgage-backed securities. By 2006, this was
the case for seven out of every ten new mortgages.
Tooze does a
competent job of guiding readers through the toxic alphabet soup of
mortgage-based products that Wall Street cooked up: M.B.S.s, C.D.O.s,
C.D.S.s, and so on. He looks askance at the transformation of commercial
banks like Citigroup from long-term lenders into financial
supermarkets—“service providers for a fee”—in the decades before 2008,
and he rightly emphasizes the enabling role that successive
Administrations played in this process, not least Bill Clinton’s.
But
the great merit of Tooze’s tome—it runs to more than seven hundred
pages—is its global perspective. Tooze maps the fallout as far afield as
Russia, China, and Southeast Asia. He lays out the role played by
European banks and cross-border flows of financial capital. And he
provides a detailed account of the prolonged crisis in the eurozone,
which, he maintains, “is not a separate and distinct event, but follows
directly from the shock of 2008.”
The
subprime fever originated in the United States, but soon spread to
European behemoths like Deutsche Bank, HSBC, and Credit Suisse: by 2008,
close to thirty per cent of all high-risk U.S. mortgage securities were
held by foreign investors. Although the major international banks were
domiciled and regulated in their individual countries, they were
operating in a single, integrated capital market. So, when the crisis
struck and many sources of short-term bank
funding dried up, the European banks were left tottering. In some
respects, they were in even worse shape than the American banks, because
they needed to roll over their dollar-denominated mortgage assets, and
Europe’s central banks and lenders of last resort—the European Central
Bank, the Bank of England, and the Swiss National Bank—didn’t have
enough dollars to tide them over.
Paulson and Bernanke didn’t
predict any of this when they made the fateful decision, on September
14, 2008, to let Lehman fail. Paulson, in particular, was keen to escape
the label of “Bailout King,” which he had been saddled with earlier in
the year after orchestrating a rescue of Bear Stearns. An international
banking disaster was avoided only because the Fed agreed to provide its
European counterparts with virtually unlimited dollars through
currency-swap arrangements, and to give troubled European banks access
to various emergency lending and loan-guarantee facilities that it
established in the United States. “The U.S. Federal Reserve engaged in a
truly spectacular innovation,” Tooze writes. “It established itself as
liquidity provider of last resort to the global banking system.”
But
the Fed hid much of what it was doing from the American public, which
was already choking on the U.S. bank bailout. It wasn’t until years
later, as a result of the Dodd-Frank financial-reform act and a
freedom-of-information lawsuit filed by Bloomberg News, that the details
emerged. The sums involved were huge. According to Tooze’s tally, the
Fed provided close to five trillion dollars in liquidity and loan
guarantees to large non-American banks. It also provided roughly ten
trillion dollars to foreign central banks through currency swaps. As
with the seven-hundred-billion-dollar bailout for domestic banks,
practically all this money was eventually repaid, with interest. But,
had the full scope of what the Fed was doing emerged at the time, there
would have been an uproar. Fortunately for the policymakers, there was
no leak. An official at the New York Federal Reserve, which helped enact
many of the covert lending programs, told Tooze that it was as if “a
guardian angel was watching over us.”
Many
of the politicians who came to be associated with the financial crisis
and the bank bailouts weren’t so lucky. In 2009 and 2010, the
center-left parties that occupied positions of power in the United
States, Britain, and Germany all suffered electoral setbacks. In Berlin
and London, new center-right governments committed themselves to
slashing budgets and reducing deficits, which rose sharply as jobless
rates went up and tax revenues went down. Keynesian economists warned
that the recovery was too fragile to withstand austerity measures, but
many conservative economists strongly supported them. Germany itself
recovered even after it passed a balanced-budget amendment to its
constitution and enacted the deepest spending cuts in the history of the
Federal Republic. Yet the refusal of Europe’s largest and most powerful
economy to act as a locomotive, and to help offset deflationary forces
elsewhere, was to have some very negative consequences for the eurozone
as a whole.
Tooze dwells at length on the European transition from
stabilization to austerity, which coincided with the emergence of a
sovereign-debt crisis in three peripheral members of the eurozone:
Greece, Ireland, and Portugal. The “euro crisis” is often framed as a
story of spendthrift governments run amok, but the real sources of the
trouble were underlying faults in the euro system and the creation of
too much credit by private-sector banks—the same phenomenon that led to
the subprime-debt crisis in the United States.
In 1998, eleven
Continental countries adopted the euro as their common currency,
including the big three: France, Germany, and Italy. Greece followed
suit the next year. (Seven more countries have since joined.) Under the
euro system, individual countries gave up the freedom to set their own
interest rates and adjust their own currencies. Instead, there would be a
single interest rate, set by the European Central Bank, in Frankfurt,
and a single exchange rate, set by the market. Member countries were
also obliged to meet strict targets for their budget deficits.
Over
time, many of the weaker European economies came to chafe at these
restrictions. At first, though, the system seemed to be a miracle drug.
Investors had traditionally treated countries like Greece, Ireland, and
Portugal as risky bets, and demanded generous yields on the bonds those
countries issued. After these countries adopted the euro, however,
international investors loaded up on these bonds as if they were on a
par with French and German bonds, even as yields fell. Tooze points out
that, of the nearly three hundred billion euros’ worth of bonds that the
Greek state had issued by the end of 2009, more than two hundred
billion were foreign-owned.
In retrospect, the enthusiasm for this debt represented a credit bubble
every bit as glaring as the American one that had seen Moody’s and the
like conferring triple-A ratings on subprime dreck. Although Greek bonds
were denominated in the same currency as German bonds, they were backed
by the shaky Greek state. What made the situation even riskier was that
Europe, unlike the United States, had no Fed to serve as a stabilizing
force in the event of a crisis. The European Central Bank was prohibited
from buying newly issued bonds directly from member governments, and
for a long time it was reluctant to buy previously issued bonds on the
secondary markets. It also lacked some of the
lending and liquidity facilities that the Fed had set up in 2008 and
2009. Moreover, the eurozone had no centralized fiscal policy that could
help member countries that ran into trouble. When serious problems
emerged in Greece, Ireland, and Portugal, and the markets gyrated, the
European political system was gripped by paralysis.
The
quandary of how to deal with Greece was especially acute. By the middle
of 2009, it had become evident that the small Mediterranean country
wasn’t just suffering a liquidity crisis—it was insolvent. Its G.D.P.
was plummeting, its budget deficit had risen to about thirteen per cent
of the G.D.P., and the yields on its bonds had skyrocketed. “What Greece
needed to do was to restructure, to agree with its creditors to reduce
their claims,” Tooze writes. Yet many eurozone voters, notably those in
Germany, were in no mood to do any favors for the Greeks—or the Irish
and the Portuguese.
This reluctance is often attributed to a
Teutonic belief that Southern Europeans, and Greeks in particular, are
lazy and improvident. Tooze emphasizes another factor: after the 1990
reunification of Germany, the government in Berlin spent more than a
trillion dollars rebuilding and subsidizing the East. By the time Angela Merkel,
a former East German, took over as Chancellor, in 2005, the rich
southern states, including Baden-Württemberg and Bavaria, were fed up.
“Well before the Greek crisis broke,” Tooze writes, “the most prosperous
regions of West Germany had made clear their refusal to take
responsibility for other people’s debts.”
In May, 2010, the
European Union, in concert with the International Monetary Fund, agreed
to lend Greece a hundred and ten billion euros, which the country used
to retire some of the debt that was owned by foreign banks and
investors. Since the debt was retired at or near its face value, this
amounted to a disguised bailout—not for Greece, which merely substituted
one form of debt for another, but for the foreign banks that had bought
Greek bonds. Although the banks, such as France’s BNP Paribas and
Germany’s Commerzbank, got off lightly, the Greek people didn’t. In
return for the new loans, the European Commission, the European Central
Bank, and the I.M.F.—the “troika”—insisted on drastic cutbacks in
government programs. In textbook Keynesian style, these retrenchments
sent the Greek economy into an even deeper recession, further
diminishing the country’s capacity to repay its debts.
The
harsh treatment that Greece received set the template for the lending
agreements that the troika then made with Ireland, Portugal, and Cyprus,
all of which had banking crises of their own. Combined with Germany’s
insistence on adherence to fiscal targets, and its refusal to adopt a
stimulus, this policy produced a lost decade for the European economy,
and contributed to the rise of anti-establishment political parties like
Syriza, in Greece; Podemos, in Spain; and the Five Star Movement, in
Italy. Nor did this draconian approach do anything to stabilize the euro
system as a whole.
On the contrary, the markets became alarmed,
in 2011 and 2012, about the creditworthiness of several larger European
countries, especially Spain and Italy. The “spreads”—the difference
between the yields on Spanish and Italian bonds versus those on German
bonds—rose sharply, signalling distress. In Washington, Tim Geithner and
other American officials, who had learned how quickly financial
problems could spread from one region to another, looked on in dismay.
Tooze recounts how, at the annual meeting of the I.M.F. in September,
2011, Geithner warned of “a cascading default, bank runs, and
catastrophic risk” if the Europeans didn’t construct an adequate fire
wall. Behind the scenes, Geithner enlisted President Obama to exert
pressure on Merkel and other European leaders to mimic some of the steps
that the United States had taken in 2008, encouraging them to create a
proper bailout fund and turn the European Central Bank into an effective
crisis fighter. The pressure didn’t work. As the market tremors
increased, so did speculation that the eurozone might break up.
It
was left to Mario Draghi, the president of the European Central Bank,
to restore some calm. On July 26, 2012, Draghi, a worldly Italian
economist who earned his Ph.D. at M.I.T. and subsequently worked at the
World Bank, the Italian Treasury, and Goldman Sachs, gave a speech in
London arguing that markets and foreign governments had underestimated
the political capital invested in the European currency. “Within our
mandate, the E.C.B. is ready to do whatever it takes to preserve the
euro,” he promised. “And, believe me, it will be enough.”
Draghi
provided no details about what the E.C.B. might do, and some observers
were at first skeptical. “Ridiculous . . . totally impromptu,” Geithner
wrote in his memoir, which Tooze cites extensively. But the speech
proved to be a turning point. In September, 2012, Draghi announced that
the E.C.B. was now prepared to buy bonds issued by individual eurozone
countries, a move that finally created a Fed-style lender and buyer.
(He’d convinced Merkel and her finance minister that there was no
alternative.) At the same time, the members of the eurozone set up a
permanent bailout fund, the European Stability Mechanism, with a lending
capacity of five hundred billion euros. “The Draghi formula—America’s
formula—was self-fulfilling,” Tooze writes. “The markets stabilized. The
eurozone was saved by Americanization.” On either side of the Atlantic,
the enduring question was: At what price?
Underpinned by explicit and implicit
governmental guarantees, the Western financial system survived the
great crisis, and in some ways it appears to be more robust than it was
before 2008. A recent analysis from the Bank for International
Settlements, a Basel-based institution that has been at the forefront of
efforts to strengthen the lending system, noted that big banks are, on
average, now holding twice as much capital as they did before the
crisis, and have adopted various other reforms. Yet banks remain highly
indebted and highly interconnected. Everyone knows that in a 2008-style
panic they could still go down like dominoes, and that only large-scale
public intervention would be able to save them. As a result, the general
expectation is that, were another crisis to occur, governments (and
taxpayers) would again step into the breach. The too-big-to-fail problem
hasn’t gone away; it may even be more acute than before, because a wave
of mergers during the last crisis left the banking industry more
concentrated than ever.
And banks aren’t the only potential threat
to financial stability. According to the Basel report, asset managers
now control nearly a hundred and sixty trillion dollars, more than the
worldwide holdings of the banking industry. During a market sell-off,
the report warned, some of these firms could face pressures—such as a
surge of investors eager to cash out—that would lead to a downward
spiral.
Other analysts point to the dangers of lofty stock prices
and rising indebtedness among non-financial corporations, many of which
have been borrowing heavily to finance stock buybacks and other
ventures. A recent McKinsey study
showed that in the past ten years the amount of outstanding corporate
debt has tripled across the world. In the United States, the study
noted, almost two-thirds of non-financial debt is rated as junk or one
notch above junk. Roughly three trillion dollars of this questionable
credit is set to mature in the next five years. If the economy falters,
or if interest rates rise sharply, many corporations may find themselves
in the position of new mortgage holders a decade ago—unable to repay or
roll over their debts.
More than four decades ago, the economist
Hyman Minsky observed that periods of stability and investor
optimism—such as the one we have enjoyed for the past few years—tend to
amplify the dangers posed by a financial system based on easy credit. If
the benefits of financial risk-taking were plentiful and widely shared,
it might be worth society’s time to play the odds and bear the cost of
the occasional blowup. But, these days, who believes that an unleashed
financial sector is good for anybody but financiers?
In
the United States and other countries, the long-term costs of the
financial crisis and the great recession were enormous. The economic
recovery that began, according to the National Bureau of Economic
Research, in the summer of 2009 was weak and uneven. Growth in the
G.D.P., wages, capital investment, and productivity continued to lag for
most of the ensuing decade. In November, 2013, five years after the
bank bailout, Larry Summers, President Obama’s top economic adviser
during his first term, suggested that the U.S. economy had entered an
age of “secular stagnation,” a term that was coined in the nineteen-thirties but had fallen out of favor with all but a small group of Marxist economists.
With
the economy in the doldrums, the technocratic argument that it had been
necessary to save Wall Street in order to save Main Street fell on deaf
ears, and an alternative narrative gained widespread currency: the
entire game had been “rigged.” It wasn’t just supporters of the Tea
Party and Occupy Wall Street who said so. In the 2016 election, Donald Trump
and Bernie Sanders both offered versions of this story. The Democratic
Party establishment managed to overcome the Sanders insurrection, but
Trump carried disaffected Republicans, and some disaffected Obama
voters, too, through Election Day.
Resentment of Wall Street and
Washington élites was only part of Trump’s platform—fanning racial fears
and hostility toward immigrants was another key element—but it was one
of his final, enduring messages. As Tooze points out, the last
television ad that the Trump campaign aired featured head shots of Janet Yellen,
the chair of the Federal Reserve at the time, and Lloyd Blankfein, the
chief executive of Goldman Sachs, while Trump, in an alarmist
voice-over, warned that “a global power structure” had made decisions
that “robbed our working class, stripped our country of its wealth, and
put that money into the pockets of a handful of large corporations and
political entities.” A few days later, Trump won enough states to eke
out his victory. “Overshadowed by memories of 2008, the 2016 election
delivered a stark verdict,” Tooze writes.
Since then, Republicans
in Congress have eliminated some of the financial regulations that were
put in place after 2008. They have reduced capital requirements for all
but the very biggest banks and sought to weaken the Volcker Rule,
which bars any bank from speculating in the markets on its own account.
Meanwhile, Trump has adopted a neo-isolationist stance on many issues,
raising the question of how his Administration would react if another
financial crisis threatened the global economy.
Toward the end of
his book, Tooze returns to the fragile cross-party coalition that took
shape in September, 2008, in order “to hold the United States together
and provide the underpinnings for the global stabilization efforts of
the Fed and the Treasury.” Could
such a response be replicated today? With Trump in the White House and
the Republican Party controlling Capitol Hill, Tooze writes, “it is an
open question whether the American political system will support even
basic institutions of globalization, let alone any adventurous crisis
fighting at a national or global level.” Nobody can say for sure where
the next financial crisis will come from. But Trump and the G.O.P. are
busy hastening it along—even as they’re undermining the architecture
needed to deal with it. ♦