Ten Years on from the Global Financial Crisis, Where Does Power Now Lie?

Financial saviours? Treasury Secretary Tim Geithner;
US President Barack Obama; and Federal Reserve Chair Ben Bernanke 

Review: Adam Tooze, Crashed: How A Decade of Financial Crises Changed the World

It is ten years since the great crash of 2008. Amid the retrospectives, thoughts are turning to the future. Presumably not wanting to throw the baby of financial profit out with the bathwater of dodgy practices, the Economist notes gratefully that regulation is receding while the riskiest sources of funding are curbed. Not everyone has been so measured: a ‘golden age’ of banking is once again on the horizon, according to Jamie Dimon, the CEO of JPMorgan Chase. Nevertheless, where banks were once left largely to their own devices, the Economist opines, now the whole business of regulation is unavoidably ‘politicised.’ Surveying the financial scene it is clear that little has really changed since the disaster of 08. For perhaps the world’s most influential pro-market serial or at least its oldest, the lesson of the crisis is that public ‘authority can expand’ to fill the private vacuum. This is, if anything, an understatement for what happened in the wake of the crash, when the US Federal Reserve arguably became the linchpin of the financial system and the political nerve centre of global capitalism, with profound repercussions.

Adam Tooze has written a compelling account of how this played out. Crashed: How a Decade of Financial Crises Changed the World tells a two-part story in many chapters: there is, first, a technical economic narrative based on the mortgage securities boom of the 2000s and its eventual, historic crash. Then there is the long story of the various geopolitical repercussions that have followed in its wake. It takes in the technicalities of money market funding, the botched crisis management of the Eurozone, China’s unprecedented fiscal stimulus, Russian revanchism, and - perhaps pivotally - the novel rescue efforts of the US Federal Reserve. 

This was not for Tooze a crisis of the ‘real economy’ - there is scant regard for the long term stagnation of wages that is familiar from leftist critiques of neoliberalism. Rather Tooze’s is a story whose backdrop, laid out in the opening third of the book, is a relatively apolitical technology of finance. The force that determines the fateful collapse of financial activity in 2007-08 is not, in Tooze’s telling, the acquisition of risky assets (mortgage backed securities or collateralised debt obligations, etc.) per se, but the liability or funding access of the big investment banks, which was heavily skewed towards short-term money markets and had largely divorced itself from the prosaic traditions of bank deposits and productive investment. What Tooze calls a ‘modern bank run’ involves large money funds simply refusing to lend to those whose balances are cluttered with risky debt. The panic led investors away from risk and straight towards Treasury bills, bunds, and other safe sovereign assets. This stampede out of private securities markets and into safe public sector debts was presided over by political regimes of varying technical ability and differing ideological baggage. In its turn this would decide whether an economy recovered (China), stagnated (the US) or burned (the eurozone).  

Tooze’s construction of agency is one of feedback between economic structure and political agency, with each driving the formation of the other. He is admirably critical of the type of technocratic governance produced by the neoliberal era, less so of its ontological assumptions. In its sheer technicality, it inevitably lacks reforming passion. Aditya Chakrabortty has accused the book of being ‘brilliant, but bloodless’. The criticism is largely misplaced; a certain forensic skill is inherent in the form. More apposite would be to say there is a certain entering into the Lebenswelt of those who made the crisis and a empathy with its particular Weltanschauung. It’s a cliche to say that empathy underlies historical understanding. Yet to impute a kind of Weberian critical method of Verstehen to the book would be to place a more complete emphasis on individual Zweckrationalität than he really offers. At the project's base, and despite its insistence on the real centrality of great power politics, is an apolitical set of financial mechanisms that just... emerge. Perhaps what Tooze really shares with his subjects is a narrative framework of understanding in which politicians and officials improvise in the face of vast, unforeseen, and largely accidental conflagrations.  

On the spark that caused the bank runs and the liquidity crunch - or the widespread refusal of banks and financial institutions to lend - one could quibble with Tooze on a technicality. If these short term money lenders were refusing to lend to over-leveraged banks, they must have been doing so on the basis of certain signals. And all the signals suggested that the wave of mortgage defaults that was sweeping the US would soon hit the MBS markets. The funding model used by the banks was to borrow at relatively low rates from money markets and invest in higher rate securities. The trigger may not have been collapsing subprime securities, but the rising uncertainty caused by the obvious chaos in the US mortgage sector. Since the entire lending structure of the financial system – indeed, the investment structure of capitalism per se – is based on the psychology of expectations, any bank run will be caused not by present losses but precisely by expected ones. The funding collapse was no different. The system saw the defaults coming and anticipated its own demise.

At a less technical and more historical level, Tooze’s account implies but does not explore a critique of the political economy of homeownership in the US: the private mortgage system that had made two thirds of US citizens into property owners was not originally profitable. Thirty year fixed interest rate mortgages that could be refinanced at favourable rates meant ruin – especially in the era of high inflation – for the large system of small banks who offered mortgages in the postwar era. So government sponsored enterprises (GSOs) like Fannie Mae were created as public sector entities that would buy up mortgages from the small commercial and savings and loans banks. After the semi-privatisation of Fannie Mae during the fiscal squeeze of the Vietnam War, new revenue streams were found by selling on the mortgages as assets to investors. ‘Originate and distribute’ and the subsequent invention of mortgage-backed securities, which pooled mortgage products into high and low risk tiers, was in part a result of the search for profit in a lopsided and dysfunctional private housing system. 

This covers the asset side, but what about bank liabilities? Where was the cash sourced? Formerly respectable investment banks – Merrill Lynch, Goldman Sachs, Morgan Chase and so on – came to specialise in MBS, but what was their funding model? They had no depositors, so instead they would draw on pools of funds managed by the so called money market mutual funds (MMF). The role of commercial banks as middle men between those with cash and those willing to invest it disappeared. Wealthy individuals lent directly to the funds and these were drawn on by speculative investment banks. These were later joined by commercial banks following the abolition of New Deal banking regulations in the Clinton era. In this way, investment banks, commercial banks and mortgage lenders would break free of the patrician mortgage system of the New Deal era and build their business models around each stage of the MBS circulation system. The low interest rates of the early 2000s allowed this private circuit of capital to fully unleash its potential and to really dominate the semi-public GSEs. The move into subprime tranches of mortgage debt followed the break with the GSEs: the sale of ever more risky and exotic mortgage products was enabled by the growth of the ratings agencies as well as the spread of insurance facilities like credit default swaps (CDS), which covered the holder in the event of default. CDOs repackaged and reorganised “mezzanine” debt tranches so as to further spread the risk. The process of risk spreading itself was taken to warrant an AAA rating by the now infamous ratings agencies. 

The granting of AAA ratings to such assets may have been ill-considered at best, but that didn’t stop surging demand for assets from the newly globalised economic system. The trade surpluses of developing countries hoovered up Treasury bills. The large institutional investors of the financial markets were left with agency-rated private debt – especially MBS – to put on their books. Thus, Tooze argues, while everyone in the US worried that China would one day sell off its dollar-denominated Treasurys, the real risk went unnoticed: the huge growth of private sector debt in financial markets that was funded by extremely volatile and risk-sensitive money markets. The latter was, for Tooze, the “fully lethal mechanism” of the 2007-08 crisis. 

Tooze does not scrimp on the detail, but this is precisely what makes the book so useful for understanding the crisis. Banks would issue asset-backed commercial paper (ABCP) via special investment vehicles (SIV). This asset-backed paper derived its value from expected future cash flows from the assets issued by the banks and relied on the reputation of the bank itself. The assets were made up of debts such as student loans, car loans, mortgages and CDOs. Thus the funding of the banks – that is, their access to the liquidity that could keep the whole system moving – was reliant on the reputation of their assets unlocking short-term borrowing. The SIV could hold large amounts of riskier, higher yield assets while issuing ‘safe’, low yielding ABCP. The incentive was thus to expand the balance sheet and profit from the spread between the high yield assets and the low yield payments it made on ABCP. After 2004, Tooze explains, the SIVs that issued the ABCPs on behalf of investment and large commercial banks were required to hold just 10% of the capital that their ‘parent’ banks had to hold. The repo (or repurchase) markets were the ‘most elastic’ form of funding: investment banks would purchase a security and immediately resell it in a repo market. When reselling the security (often t-bills), it would commit to buying it back at a fixed price on a very short term basis – usually over night. Investment banks selling securities on repo markets would accept a cost (an interest payment as well as a ‘haircut’ or discount on its nominal value) in order to access liquid cash belonging to either other investment banks or to money market mutual funds. Tooze explains that in exchange for $100 million in Treasurys, a bank would receive only $98 million in cash. This meant that in the initial securities purchase the bank was accessing 98% of its funding via repo and fronting only 2% of its own capital. What would make the difference, however, was a sudden sharp increase to the 2% haircut, which would increase the bank’s own capital requirements. The risk for under-capitalised, over-leveraged banks is clear enough, yet the repo markets were not much monitored or regulated. When the haircut rose steeply, as it would in 08, banks were simply cut off from funding.

It was by no means only US banks that were involved in this process: as Tooze explains, the European financial system had by the mid-00s become an appendage of the US system. European banks held half of nongovernment money market funds by 2008 – a total of $1 trillion. It was often European assets that made up the collateral used by SIVs in the issuance of commercial paper. Tooze makes clear the extent to which Transatlantic finance is a fully-integrated, transnational system. Supposedly ‘inter-continental’ flows of securities purchases, ABCPs and repo transactions between the US and Europe would simply be moved from one Wall Street office to another. This was an extraordinary means for what David Harvey, echoing Marx, called the annihilation of space through time. Cross border bank claims between the US and Europe more than doubled in the boom of 2002 to 2007. Moreover, Asian money tended to go through Europe first before it entered the US economy. This was a global financial system with the US and Europe at its heart.

Yet it was regional policy responses which would determine the impact of the crisis. Indeed, it is in the rush to hold sovereign debt – and Europe’s failure to respond – that one strand of the eurozone crisis can be traced. As automatic stabilisers kicked in in the wake of recession (including unemployment insurance and declining government tax intake), public sector deficits naturally grew. Whether fiscally conservative or spendthrift, most governments were forced to borrow heavily. While other major central banks committed to buy up the glut of government debt that followed the recession, the ECB at first did not. Instead it extended favourable loans (LTROs) to banks and only in 2012 bought up bonds in secondary markets from financial investors themselves (OMT). Thus stressed European banks moved into sovereign debt, amply funded by ECB liquidity. The mild divergence in the yield (interest) on eurozone member states’ government debt was an initial spur. Greek bonds were denominated in euros, but earned slightly more than German bunds. It seemed like a safe enough bet. It was only as it became clear that Greece and Ireland were in serious debt trouble that the spread on government bond yields between the core of the eurozone and the periphery became problematic.

Less a question of scale, then, for Tooze, the 2008 crisis was really rooted in the peculiar conditions of the 2002-07 boom in mortgage securities lending – in particular on the funding rather than asset side. Once the refinancing boom of the early 2000s – sparked by Fed interest rate cuts – had burnt itself out, the hunt was on for the next big thing. AAA-rated MBS looked like the perfect bet: high yield, low risk, and seemingly ever-expanding. Even as the Fed gradually raised the rate in short term funds, long term rates failed to rise. But what emerges as the real spark of the crisis – the seizure of the money markets and the refusal to grant banks access to vital liquidity – is, as Tooze says, a matter of funding, not of mortgage defaults per se. Yet there was a wave of mortgage defaults, triggered by those whose rates had risen while their incomes had stagnated. The foreclosure wave had millions of victims. The job losses were in the real economy and had complex, secular causes that stretched back before the 2000s boom. 

Financialisation itself was rooted in the dollarisation of the world economy that took root during the Breton Woods era and was turbo-charged by the various shocks of the long 1970s – the Nixon Shock (ending the dollar’s gold peg and the system of fixed exchange rates); the oil shock (sudden, inflationary price hikes); and the Volcker Shock (a huge, sustained increase in interest rates to kill off inflation at the end of the 70s). The interconnections with the real economy are complex but the results are familiar: the weakening of organised labour; the decoupling of wages from productivity; the deindustrialisation of the Anglo-Saxon economies; a neo-Mercantilist Germany whose wage repression encouraged huge trade surpluses; the rise of China as the industrial engine of the world; the integration of dominant and subordinate economic groups of states into an extremely hierarchical, technocratic system of governance with central bankers at its head. The liberalisation of national economies and the ending of all kinds of capital restrictions put a fire under the development of a foreign exchange market (largely dollar based) that was already housed in the City of London. The need for dollars was pervasive and only more deeply entrenched by 2008. The most startling result of the crash was the revelation that the Fed was not merely a bit player, tidying up after the banks and smoothing the system, but was really the dominant player in the entire global financial order. Thanks to existing dollar exchange swap lines, Tooze explains, the Fed was quietly able to pump liquidity not only into US banks, but out into the entire world economy – and to an ailing Europe in particular.

There is a risk of course that such an analysis lapses into conspiracy theory. The Fed’s powers are, in a certain sense, quite accidental. Indeed, its own centrality to the global system was not officially recognised by its governing ideology. The Fed was supposed to finetune, to correct for certain imbalances, to lever this way or that by controlling the short term funds rate. When this didn’t work, however, it was clear that the capacity and willingness to intervene was there. When the private sector was unwilling to maintain the supply of dollars to the world system, it turned out there was one institution that could step in, perhaps without limits.

The latter has led to something of an epiphany among academics. Money, we have been reminded, is indeed political. In a clear break with the Friedmanite neoliberal era, the question of monetary governance is no longer seen as one simply of over or under supply. This is not to say that mainstream economists now want a break with the era of central bank independence. But for both left liberals and liberal technocrats, central banks are either the potential or really existing saviours of the financial system and the wider economy. 

There are several caveats to this: there can only be one Fed. Other central banks are not granted equal privileges. While the Fed can support the global system by its control of the dollar, others have more parochial concerns. They must use the old technique of mobilising their foreign reserves in the event of a currency run. There is also a question over the limits to which markets will tolerate central bank intervention in secondary sovereign debt markets to support governments’ fiscal deficits. And then there is the question of unaccountable, unelected power. In the enduring tension between economic governance and political accountability that characterises liberal democracies, the new role of a select few central banks represents an extreme kind of technocratic governance. Less the abolition of politics per se than its transference to corporatist, consensus-oriented, anti-popular elite institutions. Which inevitably provoked a backlash in the form of the extreme right of the Tea Party and the election of Donald Trump.

One wonders if what was needed in the crisis was not less politics but more. For a left liberal such as Tooze, the early moves of the Obama administration cannot but seem a missed opportunity. Had a bigger stimulus package been passed by the government – not as a technical rescue package but as a popular and populist measure to save the real economy – government would at least have taken the credit. Yet as Tooze rightly observes, the Obama administration was the inheritor of a kind of liberal macroeconomic orthodoxy. Though clearly capable of major interventions to rescue finance, it was ideologically incapable of a radical or popular break to the left.

Much of the rest of Tooze’s book is taken up with an account of the geopolitical response to the crisis. If the economics is highly technical, the politics is oddly conventional. There is nothing in the approach that could not be found in the liberal intergovernmentalist turn of 1990s international relations theory. Is there something of an elective affinity between Tooze’s left liberalism and the much more traditional, even realist assumptions of IR-influenced liberals like Moravcsik? Or is there a formal limitation of this kind of macro-economic narrative history? Then again, perhaps only a left liberal would attempt such a narrative history in the first place. The segue (or even gear change) from a structural and institutional analysis of the incentives driving the boom to, first, the improvised policy around the recovery and, finally, the subsequent social fallout may necessarily lack theoretical integration. The narrative Tooze has chosen to construct demands a focus on the strategic international environment of states, the actors who attempt to advance state interests, and the domestic, societal pressures placed on governments by interest groups. This is not necessarily a shortcoming: the sparse theoretical backdrop allows the substantial contrasts in state orientation to emerge all the more clearly. There can be no mistaking that China’s Keynesianism-on-steroids bucked the global trend and maintained growth across the entire world economy in the early 2010s. The eurozone’s catastrophic lost decade seems all the more self-imposed precisely because of its divergence from the US’s early monetary adventurism. The eurozone crisis itself emerges not as a matter of sovereign debt, nor even really one of underlying competitive imbalances between national economic blocs, but as failure of elite policy. 

Within all of this there is a hidden tension: Tooze does not regard trade and capital flows between national and regional economic units as of particular significance to the cause of the crisis. He dispenses with the conventional macroeconomic focus on national accounts, competitive imbalances, and exchange rate fluctuations. The global system as an integrated whole was in crisis. Therefore, a supposedly deracinated policy elite emerges as the central bloc of actors who are responsible for crisis resolution. And yet throughout, these responses are conditioned by regional, and yes, national and state-level views as to the scale, nature and policy implications of the crisis. Again and again the individual actors are situated in national and regional contexts. In the midst of the crisis, intergovernmental bargains once again come to the fore. The sublime world of smooth financial flows, market signals, and ‘market-conforming’ interventions is brought clattering down to earth – first, via the coarse, improvised intrusions of the rescue efforts and second, by the difficult realisation that national and sectional interests would reassert themselves against the ‘technocrats’.

Still, there is a stark lesson in all of this: the existential threat to the neoliberal order does not emanate wholly ‘from within' –that is, from those famous ‘internal contradictions’ of the capitalist system –but from the political reactions (and reactionaries) it produces. Tooze’s book points above all to a new era of intensified political competition. And indeed, for progressive challengers to the old hegemony, it is not necessarily the economic or ‘structural’ sphere that poses a threat to real reforms, but the politics of the thing. For all that the book is a measured critique of the weaknesses of the policy elite, it is quite comfortable with the machinery of the political world that has emerged from the crisis. After all, if the Fed can literally rescue the global financial system through liquidity provision, it can probably fund a long-term deficit that would finance public goods like universal healthcare. So long as a central bank is willing to keep up sovereign bond purchases, there is no reason that government debt should experience a sudden loss of value and a spike in yields. Insofar as a radical government will rely on an expansion of public debt, this is a strangely reassuring thought. Yet the crisis has also revealed the autonomy of central banks and may even have generated in them a sense of their own institutional responsibilities and interests. It is unlikely that no conservative political pressure would be brought to bear on, say, the Bank of England if there were to be a radical left Labour government. The key lesson of the book for those who do want to reform capitalism is that they may be more reliant on the loyalty of these institutions than they would comfortably like.

Tooze has produced a dazzling account of the decade of crisis that has shaped the world in which we now live. In the struggle to understand and to change that world, the book will be helpful, though not perhaps in the ways radicals might hope. As a technical description of the financial crisis it is unmatched. As an account of political action, we must hope it is not exhaustive.