My notes on Crashed by Adam Tooze
/I have just finished Crashed - How a Decade of Financial Crises Changed the World by Adam Tooze and can recommend it.
I came across Tooze on the excellent Talking Politics podcast where David Runciman, Helen Thompson and Tooze discussed the connections between the 2008 financial crisis, the eurozone crisis and more generally, how futile it is to talk about economics and politics as separate topics. I bought his book in the hope that it would level up my understanding of monetary policy and the connections between geopolitics and financial markets. It is a dense, long read (600+pp) but I found it a real page turner.
Some of the things that I found most interesting:
How liquidity works in globalised financial markets and the connections between central banks, investment banks, money market funds, and other major financial actors like sovereign wealth funds, the IMF and insurance companies.
With the historical perspective of writing in 2019 about about the 2008 crisis, Tooze captures how the credit crisis of 2008 rumbled on for almost a decade and arguably with the 5th round of QE is still affecting financial markets.
How, In the lead up to the 2008 crisis most macroeconomists misallocated risk. Most were concerned about interstate economic relations and a potential sovereign debt crisis (primarily China’s accumulation of US treasuries, broadly as a result of China’s mercantilist trade policies and the cost of Bush’s tax cuts ($1.35 trillion over 10 years) and the Iraq and Afghanistan wars ($1-3 trillion)). This obscured the tension building up in the interbank system - in particular the exposure of European banks to both the US housing market and the balance of interbank dollar flows. Connections between banks based in different countries create systemic risks in the same way as international trade imbalances. However, unlike trade imbalances these relationships are harder to scrutinise, and can mutate much more rapidly in the event of a ‘global bank run’. Tooze gives the example of how Larry Summers “slapped down” Raghuram Rajan at Alan Greenspan’s farewell party (!) for flagging the new systemic risks as “luddite” and “misguided”.
How the financial crisis was fundamentally an Atlantic crisis “America’s securitized mortgage system had been designed from the outset to suck foreign capital into US financial markets….overall, two thirds of the commercial paper issued had European sponsors, including 57% of the dollar-denominated commercial paper...how did European banks end up owning such a large slice of American mortgage debt? The answer is that European banks operated just like their adventurous American counterparts. They borrowed dollars to lend dollars...Indeed, in 2007, roughly twice as much money flowed from the UK to the United States as from China...hundreds of billions of dollars...flowed out of the US from the branches of foreign banks in New York to the head offices of European banks, from which they returned for investment in the US, sometimes by way of an offshore tax haven...European banking claims on the US were the largest link in the system...in the process the European financial system came to function, in the words of Fed analysts, as a ‘global hedge fund’, borrowing short and lending long...the entire structure of international banking in the early twenty-first century was transatlantic...52% of the mortgage-backed securities sold to the Fed under QE were sold by foreign banks, with Europeans far in the lead”.
How ‘market based insurance’ aka financial derivatives totally failed to stabilise the system and how instead “it turned out that we lived in an age not of limited, but of big government, of massive executive action, of interventionism that had more in common with military operations or emergency medicine than with law-bound governance...the decision made by the American crisis fighters to take those questions off the table and to give absolute priority to saving the financial system shaped everything else that followed. It set the stage for a remarkable and bitterly ironic inversion. Whereas since the 1970s the incessant mantra of the spokespeople of the financial industry had been free markets and light touch regulation, what they were now demanding was the mobilisation of all the resources of the state to save society’s financial infrastructure from a threat of systematic implosion... Martin Wolf, the FT’s esteemed chief economic commentator, dubbed March 14 2008, ‘the day the dream of global free market capitalism died’...A conservative, free-market administration lead by businessmen was proposing unlimited state spending to nationalise a large part of the housing finance system”.
How despite a narrative of globalisation, the global financial system is fundamentally hierarchical with the dollar at the top, and how the availability of Fed swap lines (with 14 other central banks) during the crisis defined the next level of the hierarchy: “As two US analysts attached to the National Intelligence Council remarked at the end of 2009: ‘Artificial divisions between ‘economic’ and ‘ foreign’ policy present a false dichotomy. To whom one extends swap lines is as much a foreign policy as economic decisions”. The Fed broadly appears to have maintained this authority throughout the crisis through massive global intervention “every major bank in the entire world was taking liquidity assistance on a grand scale from its local central bank, and either directly indirectly by way of the swap lines with the Fed...what happened in the fall of 2008 was not the relativisation of the dollar, but the reverse, a dramatic reassertion of the pivotal role of America’s central bank. Far from withering away, the Fed’s response gave an entirely new dimension to the global dollar”.
How important differences between central banks can be - he analyses the fundamental differences in mandate and agency between the Fed, the Bank of England and the ECB and the consequences for how the US, the UK and the Eurozone handle the crisis: “What the ECB did not have was a mandate to concern itself with the economic health of the eurozone or its member states in any broader sense...The Fed never took such a narrow view. It had a mandate both to preserve price stability and to maximise employment”.
How geopolitical the ‘economic’ decisions are - one example is how Paulson described his rationale for bailing out Freddy Mac and Fannie May as a result of them being “too Chinese to fail”. The Ukraine crisis of 2013 emerges partly as a result of the unexpectedly weak support the IMF and EU offered to a Ukraine split between EU and Russian interests (“25% of Ukraine’s exports went to the EU, but 26% went to Russia”) and the resulting economic shock. Putin captures this pithily with his line “geopolitics is geoeconomics”.
How, in a era where ‘elite’ bashing has become part of populist political rhetoric, Tooze argues that ‘elite closure’ (where government treasury staff, heads of investment banks and central bankers share common backgrounds and are tightly networked) enabled certain countries (the USA, France) to more rapidly take aggressive, coordinated actions and move past a stage of the crisis faster than other where the financial actors found it harder to coordinate.
How poorly the various commercial rating agencies perform in determining the risk associated with different securities and one possibility as to why: “since the 1980s it was issuers of debt who paid the ratings agencies to make their classifications, not the subscribers to their information services. Payment by the issuer created a conflict of interest”. During the heart of the crisis “effectively the Treasury and the Fed would make themselves the credit-rating agencies in chief - the ‘United States of Moody’s’ - official arbiters of private creditworthiness”.
How quietly, subtly and profoundly regulation is be rewritten in favour of finance, “in July 2004, as subprime was really hitting its stride, the regulators agreed to provide a permanent exception that effectively allowed assets held in SIVs to be backed by only 10% of the capital that would have been required if the assets were held on the balance sheets of the banks themselves….It was following that regulatory shift that the ABCP market exploded from $650b to in excess of $1t....More than the grand gestures of deregulation, like the 1999 act, it was this kind of apparently small-scale regulatory change that unfettered the growth of shadow banking”.
How powerfully defaults can act: “automatic stabilisers are the unsung heroes of modern fiscal policy. In the US, no more than one third of federal government spending is discretionary. The rest is made up of mandatory expenditures required by existing ‘entitlements’....these tend to increase in a recession...Between 2007 and 2011, demand in the world economy was stabilised by the largest surge in public debt since WWII.”
How and why the Eurozone coped so poorly with the crisis - broadly because it was a “monetary union that unified financial markets but provided none of the institutions of governance required for a banking union”.
How major economic policy decisions are often driven by narratives grounded in sloppy, simplistic analysis. He gives the example of austerity decisions which were based on research from “ultrarespectable...former IMF economists Reinhart and Rogoff…In January 2010 they launched a research paper...this purported to show that as public debts passed the threshold of 90% of GDP, economic growth slowed...to avoid this fate it was necessary to take action sooner rather than later. On closer inspection Reinhart and Rogoff’s analysis turned out to be riddled with errors. Once their Excel spreadsheet was properly edited, there was no sharp discontinuity at the 90% markt and the case for emergency action was far weaker than they made out. But in early 2010 their arguments ruled the roost...Earlier and more sharply than in any other recession in recent history, the fiscal screw was turned. On both sides of the Atlantic the result was to stunt the recovery...The Reinhart and Rogoff meme had reached Europe. Finance minister Schäuble invoked the menacing 90% threshold”. Another stark example is some dodgy economic modeling by the IMF that “systematically underestimated the negative impact of budget cuts. Where they had started the crisis believing that the multiplier was on average around 0.5, they now concluded that from 2010 forward it had been in excess of 1. This meant that cutting government spending by 1 euro, as the austerity programs demanded, would reduced economic activity by more than 1 euro…It was a staggering admission. Bad economics and faulty empirical assumptions had lead the IMF to advocate a policy that destroyed the economic prospects for a generation of young people in Southern Europe.”