by Adam Tooze
As both household consumption and business investment plummeted, of the sixty countries that supply the IMF with quarterly GDP statistics, fifty-two registered a contraction in the second quarter of 2009.67 Not since records began had there been such a massive synchronized recession. Tens of millions of people were thrown into unemployment. Though it was dazed bankers with boxes of belongings stumbling out of office towers in London and New York that attracted the TV cameras, it was young, unskilled blue-collar workers who suffered the worst.68 In the United States, the epicenter of the crisis, the month-on-month fall in employment over the winter of 2008–2009 was breathtaking. In the worst period, the monthly rate of job losses topped 800,000. Among the African American population the surge was particularly dramatic, with unemployment rising from 8 percent in 2007 to 16 percent by early 2010.69 Young black workers were particularly hard hit, with their unemployment rate surging to 32.5 percent by January 2010. At the very bottom of the pile were young African American men with no high school diploma. In New York City in 2009 their unemployment rate was more than 50 percent.70 Precisely how many people lost their jobs across the global economy depends on our guess as to joblessness among China’s giant migrant workforce. But reasonable estimates range between 27 million and something closer to 40 million unemployed worldwide.71
III
The situation was clearly bad. But in historical terms, how bad was bad? Trying to find his bearings, in the spring of 2009 Paul Krugman concluded that the situation was dire. But at least as far as the industrial economy of the United States was concerned, it was less grim than it had been in the Great Depression of the 1930s.72 It was, he quipped, only “half a Great Depression.” It was not a judgment that stood for long. As critics scrambled to point out, Krugman’s assessment was deeply parochial. The Great Depression of the 1930s was not confined to the United States, and neither was the crisis that struck in 2008. On a global level, industrial output, stock markets and trade were all falling at least as fast in 2008–2009 as they had in 1929.73
Volume of World Trade: 1929 and 2008 Compared
Source: Barry Eichengreen and Kevin O’Rourke, “A Tale of Two Depressions Redux,” http://voxeu.org/article/tale-two-depressions-redux.
We now know that urgent and massive countermeasures would forestall the kind of agonizing depression that the world experienced in the early 1930s. But that relatively sanguine perspective depends on the safety of hindsight. In September 2008 the scale of the response was an index of the desperation felt by those at the epicenter of the crisis in the United States. Ben Bernanke at the Fed, Tim Geithner at the New York Fed and Hank Paulson at the Treasury all recounted the experience as traumatic. After Lehman collapsed, Paulson confronted his staff with the prospect of an “economic 9/11.”74 On the morning of September 20, the US Treasury secretary alerted Congress to the fact that unless they acted fast, $5.5 trillion in wealth would disappear by two p.m. They might be facing the collapse of the world economy “within 24 hours.”75 In private session with congressional leadership, Bernanke, who is not given to overstatement, warned that unless they authorized immediate action, “we may not have an economy on Monday.”76
World Industrial Production, Now Versus Then
Source: Barry Eichengreen and Kevin O’Rourke, “A Tale of Two Depressions Redux,” http://voxeu.org/article/tale-two-depressions-redux.
As far as America was concerned, this was clearly an exaggeration. Bernanke was trying to scare Congress into action. But if one looks at data on international investment flows, the picture is truly astonishing. Across the world before the crisis hit, inflows and outflows of capital came to just under 33 percent of world GDP. The vast majority of this was accounted for not by transactions between the advanced world and emerging markets but by flows between advanced economies. At the height of the crisis, between the last quarter of 2008 and the first quarter of 2009, those flows collapsed by 90 percent to less than 3 percent of global GDP.77 In the second half of 2008 capital flows between rich countries plunged from $17 trillion to barely more than $1.5 trillion. No other aggregate in the global economy was affected on anything like this scale or with this suddenness. It was as though a gigantic stabilizing flywheel suddenly came crashing to a halt, sending a shuddering jolt through the entire financial system.
Gross Capital Flows as a Percentage of World GDP
Source: Claudio Borio and Piti Disyatat, “Global Imbalances and the Financial Crisis: Link or No Link?,” BIS Working Paper 346 (2011), graph 5.
In public, Ben Bernanke knew it was essential for him to keep a straight face: “Financial panics have a substantial psychological component. Projecting calm, rationality, and reassurance is half the battle,” he would later opine.78 But as an economist and an economic historian, Bernanke understood the scale of what he was up against. What threatened in 2008 wasn’t 1929. What threatened was something even bigger and quite possibly even worse. As he was to affirm on several occasions afterward, for Bernanke, “September and October of 2008” was clearly the “worst financial crisis in global history, including the Great Depression.”79 In the 1930s there was no moment of such massive synchronization, no moment in which so many of the world’s largest banks threatened to fail simultaneously. The speed and force of the avalanche was unprecedented. As Bernanke later admitted to the readers of his memoirs, “[I]t was overwhelming, even paralyzing, to think too much about the high stakes involved, so I focused as much as I could on the specific task at hand. . . . [A]s events unfolded I repressed my fears and focused on solving problems.”80 Only as he neared the end of his second term was he ready to unwind. Looking back, it was like being in a car wreck. “You’re mostly involved in trying to avoid going off the bridge; and then later on you say, ‘oh my god!’”81
Tim Geithner, from his vantage point at the New York Fed, gave a typically hard-boiled insight into his perspective on the struggle to save the financial system: “I didn’t have a way to explain the terror of those days until later, when I saw The Hurt Locker, the Oscar-winning film about a bomb disposal unit in Iraq. What we went through on interminable conference calls in fancy office buildings obviously did not compare with the horrors of war, but ten minutes into the movie I knew I had finally found something that captured what the crisis felt like: the overwhelming burden of responsibility combined with the paralyzing risk of catastrophic failure; the frustration about the stuff out of your control; the uncertainty about what would help; the knowledge that even good decisions might turn out badly; the pain and guilt of neglecting your family; the loneliness and the numbness.”82
There is no reason to doubt the sincerity of these professions. It was a fearful situation. But the metaphors—terrorist attack, car wrecks and unexploded improvised explosive devices—are telling. They position the crisis-fighting team as first responders facing a compelling emergency. And they place us, their audience, by their side. Who would not root for the fatherly Ben Bernanke trying to keep the family car on the bridge, or Geithner’s heroic bomb disposal team? Politics is set aside as we anxiously watch our heroes struggle to rescue us from disaster. There is no time to ask why this is happening. We are “all in this together.” But it is precisely with that assertion that a political economy of the crisis begins.83 Which system was it that needed to be saved in the autumn of 2008? Who was being hurt? Who was included in the circle of those who needed to be protected? And who was not?
As the crisis spiraled toward September 2008 the first responders performed a substitution. It had all started with the predictable but devastating bursting of the housing bubble. That crisis was affecting millions of households on both sides of the Atlantic. But starting with the rash of bank failures and fund failures in the late summer of 2007, the real estate crisis was gradually displaced from the center of attention. What now mattered was the possible failure of an investment bank. By September 2008 it was no longer individual
banks but the entire financial system that had to be saved at all costs. It was entire markets and sectors—the repo market, ABCP, the mutual funds—that needed life support. It was the implosion of the financial system, imagined as something akin to a massive electrical power failure that threatened the entire economy.
It was crucial to fix Wall Street, so the slogan went, to help Main Street. The mantra was repeated in local idiom all over the world. And for the purposes of ongoing business activity, it clearly was crucial to maintain business credit. In September even blue-chip businesses could not get short-term funding. McDonald’s could no longer get an overdraft from Bank of America.84 Engineering giant GE and Harvard University were rumored to be having liquidity issues.85 But beyond such immediate rescue measures, did the all-out focus on the financial system really serve the interests of the real economy?86 Was the inability to borrow causing a failure of investment and thus the ongoing depression? Or were the collapsed housing market and cash-strapped households curtailing economic activity such that there was no incentive to invest and thus no demand for loans?
These might seem like academic questions. The bomb was ticking. The car was hurtling off the bridge. Amid a global catastrophe, did it really matter which way the arrow of causation was pointing? Amid the intensity of the financial crisis, why should anyone care? Because 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 mobilization of all of the resources of the state to save society’s financial infrastructure from a threat of systemic implosion, a threat they likened to a military emergency.
Chapter 7
BAILOUTS
The ferocity of the financial crisis in 2008 was met with a mobilization of state action without precedent in the history of capitalism. Never before outside wartime had states intervened on such a scale and with such speed. It was a devastating blow to the complacent belief in the great moderation, a shocking overturning of prevailing laissez-faire ideology. To mobilize trillions of dollars on the credit of the taxpayer to save banks from the consequences of their own folly and greed violated maxims of fairness and good government. But given the risk of contagion, how could states not act? Having done so, however, how could they ever go back to the idea that markets were efficient, self-regulating and best left to their own devices? It was a profound challenge to the basic idea that had guided economic government since the 1970s. It was all the more significant for the fact that the challenge came not from the outside. It was not motivated by some radical ideological turn to the Left or the Right. There was precious little time for thought or wider consideration. Intervention was driven by the financial system’s own malfunctioning and the impossibility of separating individual business failure from its wider systemic repercussions. Martin Wolf, the Financial Times’s esteemed chief economic commentator, dubbed March 14, 2008, “the day the dream of global free-market capitalism died.”1 That was the day the Bear Stearns rescue was announced. It was only the beginning.
I
Bailout battles were fought all along the contours of the integrated Atlantic financial economy—in the United States, Iceland, Ireland, Britain, France, Germany, the Benelux, Switzerland. The financial firepower deployed was immense and accounting for it became a field of political argument in its own right. But whichever metrics we use, it is clear that there had never before been anything so extensive or massive in scale. Commitments were made in excess of $7 trillion.
The main mechanisms for intervention were fourfold: (1) loans to banks; (2) recapitalization; (3) asset purchases; and (4) state guarantees for bank deposits, bank debts or even for the entire balance sheet. Everywhere the crisis struck, states were forced to take some combination of these measures. The agencies involved were central banks, finance ministries and banking regulators. What summary statistics cast as cool enumerations were, in fact, frantic, improvised solutions that emerged from barely coordinated sessions of all-day, all-night problem solving. As the crisis intensified it put the financial and political resilience of states to the test. Broadly speaking, this produced four types of outcome, which reflect the degree of immersion in global finance, the resources of the states at risk, the shape of the governing elite and the balance of power within the financial sector itself.2
In the most extreme cases the crisis overwhelmed the state. Ireland and Iceland simply did not have the resources, the institutions or the political capacities to deal with the gigantic shock to their overgrown financial sectors. They would suffer a comprehensive crisis, as would the worst-hit emerging market economies of Eastern Europe. Others were better placed. Despite having a grossly overgrown financial sector, Switzerland survived intact. It did so through early, intense and unrelenting attention to its one failing megabank, UBS.3 Though it was never nationalized, it became in effect a ward of the state. The larger European states and those with less excessive banking systems—the UK, Germany, France, Belgium and the Netherlands—presented a more mixed bag. Despite the scale of the crises they faced, they had the resources to cope. They attempted comprehensive organizational and financial solutions, including abortive proposals to coordinate a common European response to the crisis. But efforts to achieve consistency and coordination were undermined by national political calculation and the uncooperative behavior of leading banks that fancied themselves large enough to survive without the humiliation of taking state aid. There was no spiraling disaster, but containing the crisis was hugely expensive and success was partial at best.
Government Support Measures to Financial Institutions Since October 2008, as of End of May 2010 (in billions of euros unless stated otherwise)
Source: Based on Stéphanie Stolz and Michael Wedow, “Extraordinary Measures in Extraordinary Times: Public Measures in Support of the Financial Sector in the EU and the United States,” Bundesbank Series 1 Discussion Paper 13, 2010.
Out of this trial of strength the United States emerged as the one nation-state with the capacity not only to backstop the biggest financial sector in the world but also to impose a comprehensive solution. Not for nothing, America’s crisis fighters liked to speak in military terms, about “big bazookas” and “shock and awe.” Geithner went furthest in this respect. For inspiration he invoked the war-fighting doctrine developed in the aftermath of the Vietnam debacle by America’s chairman of the Joint Chiefs, Colin Powell: Strike with massive force and plan a clear route out.4 It was an analogy that had first been invoked by Larry Summers at the time of the Mexico financial crisis in 1994. Now it became Geithner’s mantra. For him, the “Powell Doctrine applied to international finance” meant “the overwhelming use of force, with a clear strategy for resolution.” As Geithner insisted, “There is more risk and greater cost in gradualism than in aggressive action.” For Geithner and his cohorts it was clear that swift and decisive action paid dividends. Compared with the disastrous performance of the European economy, the United States was set back on track.5 The leadership of American finance renewed itself. Even when viewed narrowly in accounting terms, many of the Treasury and Fed support programs made a profit for the American taxpayer.6 The benefits of preventing a second Great Depression were vast.
By contrast with the European experience it is not hard to see how this self-congratulatory American narrative gained purchase. But its economic merits are not so obvious as its proponents presume. And it offered no comfort to the advocates of laissez-faire. Gone were the days when economic policy was about shrinking the state to set free the spontaneous order of market liberty. No longer did wisdom lie in devising predictable rules to curtail the arbitrary discretion of policy makers. Economic policy modeled on warfare was a matter
of will, vigilance, tactical nous and firepower. And despite the populist appeal of the military rhetoric, there was a political price to pay.7 The crisis fighting of 2008–2009 scrambled American politics. The Bush administration lost the backing of much of the congressional Republican Party. The crisis snapped the fragile bond between the GOP’s managerial, big-business elite and its right-wing mass base. As the popular wing of the party, backed by maverick oligarch donors, moved increasingly toward indignant antiestablishment opposition, mainline conservatives like Bernanke and Paulson were left to complain that it was not they who left the party, but the party that left them.8 The Bush administration’s crisis-fighting effort was carried by the Democratic Party’s majorities in Congress. That contradiction would be resolved by Barack Obama’s election victory on November 4, 2008, only weeks after the crisis reached its peak. But the fracture of the American Right would in due course have profound consequences both for America and for the wider world.