Adam Tooze on the global financial crisis

The great economic historian Adam Tooze, in his just-published book, CRASHED: How a Decade of Financial Crises Changed the World, showed me things I hadn’t known, and made me rethink things I thought I understood.

Above all, he jolted me out of thinking of the 2008 financial crisis as primarily an American crisis.  It was global in nature, its consequences are still rippling through the world economy and its basic causes have not been dealt with

It is a kind of bookend to his earlier book, THE DELUGE: The Great War, America and the Remaking of Global Order, 1916-1931. 

In the earlier book, Tooze described the continuing debt crisis following World War One, with Germans unable to pay reparations and the Allies unable to pay their war loans, and how the ongoing debt crisis shaped international relations and governmental policy in that era.

The United States, as the world’s top industrial power and top creditor nation, dominated the world financial system, but American leaders lacked both the understanding and the political means to resolve the crisis.  All the United States could think to do was lend money to Germany to keep the system from crashing.  In the end the financial system crashed anyhow..

Prior to the 2008 crash, the United States was in the opposite situation.   U.S. industrial power had been hollowed out and the United States was the world’s top debtor nation.  Economists feared the “twin deficits”—the U.S. trade deficit and government budget deficit—would cause runaway inflation.

This didn’t happen.  The U.S. dollar continues to be the medium of world trade, and the financial markets continue to consider U.S. Treasury bonds the world’s safest financial asset.

American financial leaders such as Ben Bernanke, Timothy Geithner and Larry Summers acted boldly to meet the crisis. They bailed out banks, stabilized the financial system and averted a 1930s-type great depression, which was a real possibility.

That was no small achievement.  What they failed to do was to reform the system so as to reduce the possibility of a second crash.


I had put the blame for the crash on Clinton-era deregulation, which gave free rein to speculation and to unethical and illegal (but unprosecuted) manipulation of the subprime mortgage market.   Financial markets have always been subject to cycles of expansion and recession, but removing the brakes made the crash a disaster instead of just a problem.

What I learned from Crashed is that deregulation was international.  Prime Minister Margaret Thatcher’s government completely deregulated British financial markets in 1986, in what was called the “Big Bang.”  Her hope was to make the City of London, the British equivalent of Wall Street, the world financial center, and she succeeded.  American, European and Asian banks all made London their major hub, even though they did business in dollars.   The purpose of Clinton-era regulation was to enable Wall Street to catch up with the City of London.

European banks in general were more lightly regulated than American banks and were more highly leveraged.  For example, the capital in Deutsche Bank, United Bank of Switzerland (UBS) and Britain’s Barclay’s Bank was only 1/40th the amount of loans outstanding, while the ratio for their U.S. competitors was 1/20th.   Most Western countries had real estate booms and the big European banks were invested heavily in U.S. mortgage-backed securities.

The banking crisis was a crisis not only of solvency, but a crisis of liquidity.  Banks are inherently unstable because they raise money at low interest from depositors and short-term loans, and lend it or invest it long-term at higher interest.  They can get into trouble not only when their loans and investments fail (solvency), but when depositors and short-term lenders stop providing cash (liquidity).

The emergency response to the crash was the Troubled Asset Relief Program (TARP) in which Congress authorized the U.S. Treasury Department to spend $700 billion to buy up “toxic” assets and inject cash into the banking system.  Later the Federal Reserve System started its quantitative easing (QE) program, in which the Fed simply created money and bought bonds from banks.

Tooze noted that the two largest beneficiaries of QE purchases were Deutsche Bank and Credit Suisse, not any U.S. bank.  Nos. 8, 9 and 10 were Barclay’s, UBS and France’s Paribas.  The Fed propped up these European banks not out of charity, but because their operations affected the U.S. economy.

Another liquidity problem is when a bank’s deposits and short-term borrowings are in dollars, but its investments and long-term lending are in some other currency.  To avert that, the Fed allowed the world’s main central banks to swap their own currencies for dollars.

This was not done out of charity, but because these central banks are interconnected with the U.S. financial system.  Central banks of lesser countries got no help.

Tooze noted that this currency swap was unprecedented in scope, and was done without authorization or knowledge of Congress.  He compared it to the secret workings of the National Security Agency.  The swaps would be secret to this day if not for Rep. Ron Paul’s campaign to “audit the Fed.”

He thought the European recovery would have started sooner if the European Central Bank had adopted a QE program for the euro immediately following the crash.  Instead the ECB held off intervening until 2015 by which time the European situation had become desperate.

German Chancellor Angela Merkel believed that each European country should deal with its own economic problems.  The nations of southern and eastern Europe were on their own.

Merkel and her Christian Democratic party believed that Germany and other European countries could not longer afford their high wages and generous social benefits, in the light of international competition and the aging of the European population.

Adoption of the euro meant that nations with trade deficits, such as Greece, could no longer adjust by allowing their currencies to depreciate, which would make their exports cheaper and imports more expensive.  Instead they were expected to bring their government budgets into balance by privatizing public spending, cutting public spending and raising taxes.

Adam Tooze

Merkel’s response to the 2008 crash was pretty much the same as President Herbert Hoover’s and Treasury Secretary Andrew Mellon’s response to the 1929 crash:  Endure short-term economic pain, allow the economy to sort itself out and keep politics out of it.

The problem with this philosophy is that cutting back spending in time of recession makes an economy contract further and sends a country into a downward spiral.

Among economists, there are two broad philosophies of how to deal with recessions.  One is monetarism, which was advocated by Milton Friedman.   Monetarists attempt to stabilize an economy by adjusting the money supply and interest rates, but not directly tampering with private business.  Although Tooze didn’t say so in so many words, this was the Bernanke-Geithner-Summers approach.

By holding interest rates down to near-zero, they succeeded in reviving the financial markets.  This is unsustainable in the long run.  But every time they attempted to taper QE off, stock market investors panicked.  Meanwhile low interest rates enabled borrowing to finance corporate mergers and stock buybacks as against investment in the real economy.

The other philosophy is Keynesianism, which was advocated by John Maynard Keynes.   Keynesians believe that when an economy is stuck in recession, it can be jump-started by means of government spending to put people to work and create new economic activity.   Keynesians also advocate unemployment insurance and other social safety net programs that kick in when the economy goes down.

President Obama attempted a Keynesian stimulus program, a mixture of tax reductions and government spending programs, which was more than any European government did.

Tooze regarded Obama’s program as less than ideal, but better than nothing.   It was China, not the United States, that carried out a stimulus program on the scaled that Keynes would have advocated.

The Chinese government engaged in a massive infrastructure program, while Chinese businesses expanded.  Just one Chinese province, with a population the size of the UK and an economy the size of Greece, spent more to simulate its economy than the whole Obama stimulus plan.

The Chinese stimulus was indirectly helped by the Fed’s QE program, which helped keep worldwide interest rates down.  Of course there was nothing to stop the United States from also taking advantage of low interest rates to finance a big infrastructure plan.

The Chinese did run into some trouble.  Some of the business expansions failed, some of the infrastructure projects were apparently unnecessary and they had a serious downturn in 2015-2016.   But they rode it out and the Chinese economy kept on growing anyhow.


In the years immediately prior to 2008, many Western leaders thought it was possible to insulate economic policy from politics.  Institutions such as the International Monetary Fund, the Federal Reserve System or the European Central Bank supposedly operated according to neutral economic criteria, which could not be questioned.

The years following showed how wrong this was, Tooze wrote.  Politics returned with a vengeance, and “vengeance” is the right word.  It took two forms, a left-wing revolt against big business and high finance and a nationalist revolt against international institutions.   It’s impossible to say how this will turn out.

Tooze said Democratic Party in the United States is a prime example of a responsible, conservative pro-business party.   Nancy Pelosi, Harry Reid, Barack Obama and Hillary Clinton were the ones who supported President Bush’s TARP plan; they were the ones who supported Bernanke, Geithner and Bush’s Treasury Secretary Hank Paulson.

But there is no progressive, pro-labor party for balance.  Instead, Tooze said, the Republican Party is controlled by its Tea Party wing, which is incapable of governing and is willing to shut down government to get its way.  Based on the record of the past 10 years, “it is incapable of legislating or cooperating effectively in government.”  President Trump does not tell the truth and does not make sense, Tooze wrote; he is “unmoored from the basic values of reason, logical consistency and factual evidence.”

What happens if there is another crisis as serious as in 2008?  Will the Trump administration be able to deal with it?  Will anyone?


Adam Tooze home page.

Adam Tooze blog.

Trans-Atlantic Power, Money and Politics by Adam Tooze.

Beyond the crash by Adam Tooze for The Guardian.

How the financial crisis led to the West’s confrontation with Putin by Adam Tooze for MarketWatch.

Crashed: How a Decade of Financial Crises Changed the World – review by Yanis Varoufakis for The Guardian.

In “Crashed,” Adam Tooze argues the 2008 financial crash never really ended by Eshe Nelson for Quartz.  [Added 8/29/2018]

How economists predicted the wrong financial crisis by Duncan Weldon for Prospect Magazine.

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