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How the Financial Crisis Did Not Change the World

How a Decade of Financial Crises Changed the World
by Adam Tooze
Viking, 2018, 720 pages

The tenth anniversary of the 2008 financial crisis came and went with surprisingly little reflection. Adam Tooze’s Crashed: How a Decade of Financial Crises Changed the World was perhaps the most celebrated attempt to analyze the crisis with the benefit of hindsight. Unfortunately, much of the book offers little more than a chronology of newspaper headlines, displaying superficial analysis and an incomplete understanding of finance and history.

Tooze spends too much time quoting speeches delivered at irrelevant institutions like the UN and devotes too little attention to events and conditions on the ground—events which often escaped the notice of the political leaders and high-profile economists he repeatedly flatters. He raises dire warnings about the rise of “nationalism,” but often overlooks the greater problems arising from mismismanagement and corruption in unaccountable institutions.

Tooze has a tendency to make sweeping claims which he never really substantiates. In the last few pages, out of the blue, he asserts that there are striking similarities between the events precipitating World War I and those of 2008. After raising this possibility, he poses a series of leading questions: “How does a great moderation end? . . . Is there any route to international and domestic order? Can we achieve perpetual stability and peace? . . . Or must we rely on the balance of terror and the judgment of technicians and generals?” Yet the book does not include any serious discussion of these issues. What is this “perpetual stability and peace” utopia? What does “balance of terror” mean, and what is the role of politicians, technicians, and generals in inciting or calming popular passions?

Tooze is far too credulous about what economists have called the “great moderation,” referring to the lower macroeconomic volatility during the 1980s and ’90s—which, on closer inspection, may just have been a case of confusing bull markets for brains. After all, we know that the macro models which supposedly led us through the great moderation offered zero guidance to prevent the crisis and its aftermath.

As for World War I, Tooze never establishes any clear parallels, or provides any real insights into where such parallels might be found. Perhaps one might view the popular dissatisfaction with centralized EU institutions and their recent policy miscalculations as rhyming with the rise of national movements in the nineteenth and twentieth centuries—movements which arose in part because incompetent monarchies failed to address urgent systemic problems.1 But there’s little indication that Tooze is especially concerned about the Austro-Hungarian levels of sclerosis introduced by the EU or the unaccountability of, say, the ECB.

Even when Tooze is correct—for example, in making the rather trivial observation that financial and political matters cannot be separated—his language is so vague that it tells us little about the origins of the crisis, much less suggests any path forward:

By dint of their massive weight, complex social systems such as financial markets, and apparatuses like the modern state and the interstate system that it inhabits, create a sense of solidity. They make us doubt whether they could possibly be amenable to political agency, decision or debate. We suspect technocratic preemption and usurpation around every corner and often with good reason. There are ways of describing the operations of these systems that void the presence of politics. But if a history such as this has any purpose, it is to reveal the poverty of such accounts. Political choice, ideology and agency are everywhere across this narrative with highly consequential results, not merely as disturbing factors but as vital reactions to the huge volatility and contingency generated by the malfunctioning of the giant “systems” and “machines” and apparatuses of financial engineering. . . .

Back to the 1500s and the conjoined birth of capitalism and the modern state system, such moments of decision, contingency, choice and attendant drama have been constitutive of our sense of modern history. Though that sense of history might temporarily have been in abeyance after 1989, it has returned with a bang. Such moments are the coordinates of memory and commemoration.

In his 2018 book Keeping at It: The Quest for Sound Money and Good Government, Paul Volcker relates an anecdote that illustrates far more succinctly the causes and consequences of separating economics from politics. He quotes a conversation with Princeton economists in which he remarked that “this university doesn’t pay attention to public administration.” An economist there responded, “Why should it? Public administration is not a real discipline like economics.” Volcker says that he politely refrained “from reminding him of the abject failure of economists to make reliable forecasts, the essence of ‘real’ science, or to foresee and understand the financial crisis we were undergoing.”2

Tooze summarizes the panic-driven, ad hoc reactions of governments and central banks to the events of the unfolding crisis. But he omits the many blunt acknowledgments from decision-makers like Ben Bernanke, Janet Yellen, and Tim Geithner confirming Volcker’s jaundiced views of contemporary economics and the faddish models that dominate the discipline. Geithner, in a 2015 panel on the financial crisis with Robert Rubin and Hank Paulson, moderated by Sheryl Sandberg, said this: “We certainly don’t know anything about how economies perform in the short term and even over the long run.” This honest assessment left both Sandberg and the audience audibly gasping, as can be seen on the YouTube clip. Nonetheless, in much of the book, Tooze summarizes their views uncritically.

Geithner’s 2015 statement merely confirmed what one could have inferred from earlier comments of these same officials, which revealed extraordinary cluelessness: “The Federal Reserve is not currently forecasting a recession” (Ben Bernanke, January 10, 2008). “The risk that the economy has entered a substantial downturn appears to have diminished over the past month or so” (Ben Bernanke, June 2008). “To sum up the story on the outlook for real GDP growth, my own view is that, under appropriate monetary policy, the economy is still likely to achieve a relatively smooth adjustment path, with real GDP growth gradually returning to its roughly 2½ percent trend over the next year or so, and the unemployment rate rising only very gradually to just above its 4¾ percent sustainable level” (Janet Yellen, December 3, 2007). “For my own part, I did not see and did not appreciate what the risks were with securitization, the credit ratings agencies, the shadow banking system, the S.I.V.’s. I didn’t see any of that coming until it happened” (Janet Yellen, 2010).

Criticism is easy. But unless one provides an alternative view, the criticism is merely academic. So let me offer a different explanation of the bad government and central bank policies, corruption, and lack of accountability that produced an undercapitalized, poorly regulated international banking system.

The U.S. Mortgage Bubble

Promoting home ownership has been a bipartisan goal of U.S. policymakers for many decades. In a 2007 speech, Ben Bernanke summarized the rationale behind one of the now well-known pieces of such legislation, the Community Reinvestment Act (CRA), which was enacted in 1977 and later amended in 1989, 1995, and 2005: “the obligation of financial institutions to serve their communities was seen as a quid pro quo for privileges such as the protection afforded by federal deposit insurance and access to the Federal Reserve’s discount window.” The academic argument for increasing home mortgage lending to lower-income people was that expanding ownership stabilizes communities while building up equity that could eventually serve as future collateral. President George W. Bush, a vocal proponent of increased mortgage lending, explicitly called for an “ownership society.”

Had the CRA been designed correctly, it might have been a positive step toward the “democratization of capital,” as I would call it.3 As it happened, it was a good idea, badly executed. Instead of providing equity and down payment assistance, Congress crafted measures that increased maximum allowable mortgage debt and reduced minimum thresholds of creditworthiness. At the same time, regulators failed to rein in specialty mortgage companies which made some of the worst loans precisely because they were not subject to bank regulations.

Politicians, economists, and banking executives also failed to appreciate the significant changes to incentives that arose from the massive expansion of mortgage securitization (as well as derivatives like credit default swaps). The business model of financial institutions went from “originate with due diligence and hold” to “originate, securitize, and distribute”—let others worry about due diligence. Of course, originators still had to make representations about the quality of the mortgages, but as long as the loans were not expected to stay on their books, default risk was not really their problem. This led to much undetected, or unacknowledged, fraud that only came to light after the crisis. There are many reasons to aggregate and securitize mortgage loans, especially when real estate prices are assumed to be uncorrelated across states. Still, someone has to be responsible for doing the proper due diligence. This was not done. Risk was simply being spread more widely throughout the system, often in ways that were not fully understood until the music stopped.

Moreover, because of incompetence or corruption, the credit rating agencies failed to recognize this risk. The rating agencies did not adjust to the new loan origination business model and disregarded warning signs such as the increasing default rates on mortgages relative to historic levels. Domestic and foreign institutions—without doing due diligence either, believing in the implied security of high ratings—bought more and more mortgage-backed securities (MBS).

Meanwhile, Congress permitted Fannie Mae and Freddie Mac to expand their portfolios without taking steps to ensure accountability. Given their ambiguous status as government-sponsored enterprises (GSEs), and the low borrowing costs and capital requirements associated with this status, buying up bundles of questionable loans was immensely profitable for the GSEs’ executives and shareholders—and convenient for politicians running on economic growth and home ownership—yet dramatically increased systemic risks.

In 2003, Congress ignored warnings from both John Snow, the secretary of the Treasury, and Alan Greenspan, the Fed chairman. The former proposed legislation to tighten oversight of Fannie and Freddie but was rebuked for inventing frightful scenarios about the GSEs. In 2005, Alan Greenspan warned that Freddie and Fannie could put the “total financial system of the future at risk,” but Senator Chuck Schumer insisted that “Fannie and Freddie have done an incredible job.”

By the 2000s, these mistakes in housing policy were compounding the effects of an earlier change in the tax code. In 1997, capital gains amounting to $500,000 from the sale of a house were made exempt from taxes, whereas similar gains realized from the sale of other assets like stocks and bonds were taxed. It is not difficult to predict how all of the above policies combined would change incentives and encourage more resources to flow into the housing sector.4 The tax change ensured that new demand came not only from lower-income people, but from other buyers expecting to flip houses and realize untaxed capital gains.

The net effect of all this ended up being the exact opposite of the original intentions of the CRA and the stated goals of U.S. housing policy. After all, more buyers might become “owners” on paper, but when they have no equity stake in their houses, when they expect to flip properties quickly to benefit from a tax advantage, and when default risk is always being transferred to someone else, it is highly unlikely that any communities will be “stabilized” through this sort of home ownership. And, during the crash, many lost what little equity they might have managed to build up.

The reason for going through these policy changes in detail (and I am not even going into the misguided insistence on using mark-to-market accounting in 2008, when markets froze, or the impact of arbitrary decisions, based perhaps on personal or political sympathies, to bail out one investment bank and not another) is to show that the crisis can be understood without relying on abstract economic theories or complex statistics. In fact, an obsession with fashionable theories and aggregate data often obfuscates what is happening on the ground, which is exactly what occurred at the time.

Some investors, investment banks, and even economists started to see in 2006 and 2007 that something was likely to go wrong. Goldman Sachs, for example, started buying credit insurance on various tranches of MBS in December 2006. In February 2007, the cost of insuring $10 million of a AAA-rated portion of a mortgage-backed security was still only $68,000 plus a $9,000 annual premium. By summer 2007, with housing prices dropping, the cost of insurance went to over $900,000 upfront plus the annual premium. Once the cost of insuring mortgage-backed securities skyrocketed, MBS issuance fell drastically. Mortgage financing from MBS declined rapidly, too. Subprime originations went from $160 billion in the third quarter of 2006 to $28 billion in the third quarter of 2007. With the severe drop in home prices (combined with the misguided mark-to-market requirements for pricing these suddenly illiquid securities), the value of the assets that financial institutions had on their books became uncertain, and banks were only willing to make loans to one another at much higher rates. The spread between short-term U.S. Treasuries and libor rose from 0.44 percent to 2.40 percent in two weeks in August 2007.

This raises the question of why Bernanke, Yellen, Geithner, and so many others failed to comprehend the unfolding crisis until much later. Tooze never asks this question, but the topic is worth exploring. My answer, echoing the criticisms that Volcker and others have leveled against the present state of the economics discipline, is that the fashionable jargons and models passing for “science” have shaped the parameters of discussion and action in disastrous ways. As a consequence, the Fed failed to understand the meaning of its own statistics and the implications of its own actions.

The combined impacts of regulatory, legal, and monetary policy changes not only affected incentives but distorted the meaning of macroeconomic statistics, price indices in particular. Besides channeling resources into the housing industry, the 1997 change in capital gains taxes also had the impact of turning homes from “consumption,” with a roughly 25 percent weight in the consumer price index (CPI), to “investments,” which are not supposed to have any weight in the CPI. This change contributed, at least in part, to what Greenspan called at the time his great “conundrum”: in spite of the large increase in home prices and the expansion of credit, the CPI hardly moved.

In fact, people were buying houses expecting capital gains, and renting them at low prices, planning to flip them quickly, depressing the “equivalent rent” statistic that goes into CPI. Between 1983 and 1996, the price-to-rent ratio was stable at around 20, but between 1999 and 2006, the price-to-rent ratio jumped to 32. Nevertheless, an army of economists, at the Fed in particular, were buried in their models and jargon, pursuing a 2 percent yearly inflation target, a number that may as well have been picked out of a hat.

Starting in March 2001, the Federal Reserve lowered interest rates from 5.5 percent to 1 percent, reached in June 2003, and held there for a year. It then made seventeen increases of 0.25 percent, reaching 5.25 percent in June 2006, and kept rates steady until 2007, when housing prices started going down. Not only did Greenspan fail to understand the cause of his “conundrum,” but the Fed failed to anticipate the effects of its own rate policies, which simultaneously fueled and disguised the inflating mortgage bubble.

Following prime interest rates, the typical initial rate on adjustable rate mortgages (ARMs) declined from 7.25 percent in 2001 to below 3.5 percent in 2004,5 then rose to 8 percent by 2006. Borrowers from 2001 to 2004, with initial ARM interest rates of 4–5 percent, started paying double that between 2005 and 2007, around 8.75–9.75 percent. As long as rates stayed low, incomes stable, and prices were rising, the large increases in mortgage debts were not perceived as a burden. Taking on a larger mortgage or flipping houses seemed like a great idea—until rates doubled. Thus the Fed, through its monetary policy, at first encouraged this activity and then ensured that a system dependent on ever-rising home prices would collapse—without even knowing it.

Lessons from Europe

With this brief survey of domestic events (I’ll discuss currency matters later), let us turn to a few items in Europe that are missing from Tooze’s account.

Consider Greece, whose main business sectors are hotels, restaurants, and agriculture; many of these are family-owned companies notorious for tax evasion. Add to this the estimated 43 to 45 percent of self-employment income (that of physicians, lawyers, etc.) that goes unreported, and foregone tax revenues amounted to over 30 percent of the country’s deficit during some years.

In addition to the national sport of tax evasion—shared with the Italians and Spanish—Greece also faces major demographic challenges. The country’s rapidly aging population, exacerbated by the emigration of ambitious young people, makes it virtually impossible for the government to meet its pension and other benefit obligations promised in better times. In light of these issues, it is hardly surprising that Greek bonds must effectively be backed by Germany. And it is these problems, in Greece and other European nations—problems which go well beyond financial sector mismanagement—that make European economic and political challenges so intractable.

Another illustrative case is Iceland, which Tooze mentions in passing. Behind the façade of an idealized Nordic-model welfare state was a society with a corrupt banking and political system.6 Iceland’s three main financial institutions, accounting for 85 percent of its banking system, crashed within a single week in October 2008. The management of all three (and the Icelandic government, as well) blamed the failure on Wall Street.

But there have to be at least two parties to any financial transaction. It turns out that when Iceland’s banks were privatized before 2008, they were sold at very low prices to politicians’ cronies with no banking experience whatsoever. One was a politician whose private-sector experience consisted of running two small knitwear factories for a few months in the 1970s. Another needed special legislative treatment to qualify for the position because he had been in serious legal trouble in Russia and previously received a conditional prison sentence in Iceland for fraud.

What are the lessons from Iceland’s crash and its bailout in 2008? Although Tooze is not overly sympathetic to simplistic European “blame Wall Street” rhetoric, he too often overlooks the need to hold government officials accountable, as already indicated in the previous section.

Who is going to do that? It is not (and was not) going to be an institution like the IMF. The IMF was created, justifiably, as part of the Bretton Woods agreement after World War II to ensure stable exchange rates. Once the world moved toward a floating currency regime, however, the IMF transformed itself into an international consulting institution with no clear purpose. It has been guided by the same economics groupthink that led U.S. policymakers astray; it was incapable of preventing the crisis; and it barely has the credibility to administer bailouts in the aftermath.

One of the key lessons of the financial crisis, then, is the need to restore institutional accountability across financial and political systems. The goal of economic policy should not simply be, say, increasing home ownership or minimizing the fallout from a crash, but rather to disperse capital through more accountable institutions that are independent from each other. More broadly dispersed capital would reduce the chances of mistakes being transmitted nationally or internationally and make it more likely that capital would be matched with talents—the necessary condition of prosperity. This is what I call the “democratization of capital.” What Tooze means by “capitalist democracy,” I have no idea.

The Bailouts

When MBS and collateralized debt obligations (CDOs) began to default, the problems with mark-to-market accounting surfaced. Suddenly illiquid securities were being assigned wildly different values, leading to massive write-offs by investment banks, commercial banks, and other institutions, which soon stopped lending to each other. The opportunities for raising new equity were soon exhausted. Bear Stearns and Merrill were rescued by government-supported sales; Lehman and AIG were allowed to go bankrupt; and Goldman Sachs became a bank holding company to access lower-cost funds from the Fed. Citigroup received direct aid from the U.S. Treasury. The Fed also began buying MBS and other securities, an unprecedented move, both from U.S. and global banks. Between 2008 and 2010, 52 percent of the Fed’s purchases of MBS were from foreign banks, mainly European. The Fed also signed swap agreements that gave European banks access to dollars.

Indeed, when financial markets freeze (or do not exist), governments must become the sources of credit, regardless of whose fault it is. Nevertheless, the commonly repeated narrative that the Fed acted as a “lender of last resort” after the crisis is misleading. Acting as a lender of last resort implies charging high interest rates, which is not what happened. Instead Bernanke, whose PhD dissertation was about banking during the Great Depression, wanted to make sure the banks were solvent.7 But, fearing inflation, the Fed sterilized the inflows from printing money with higher rates on reserves. Banks responded by keeping their capital parked at the Fed rather than lending.

This amounted to fiscal policy, subsidizing both banks and government spending (government debt increased sharply, yet interest payments on the ballooning debt stayed at pre-2008 levels), while disincentivizing lending to businesses. Inadvertently, the policy punished shocked, less wealthy savers who got negligible returns on their depository and fixed-income savings while subsidizing those with significant stakes in stock markets.

A lender of last resort might also have imposed strict conditions on its loans to ensure accountability. Instead, the Fed permitted the failed management of financial institutions to stay in place and allowed them to keep their compensation from the boom years. As Nassim Nicholas Taleb points out in Skin in the Game: Hidden Asymmetries in Daily Life (2018), former Treasury secretary Robert Rubin collected over $120 million in compensation from Citigroup in the decade preceding 2008. When the bank became insolvent and was rescued by the government, none of that money was clawed back. If promoting “skin in the game” was the rationale for U.S. policies designed to increase home ownership prior to the crisis, then why was the same principle not enforced on bank management teams during the bailout?


Tooze is perhaps most interesting when discussing the increasing reliance of the global financial system on dollar swap lines from the Federal Reserve. But, as David P. Goldman notes, this reliance could lead to the next crisis. The cost of hedging currency flows related to trade and other imbalances may be starting to strain bank balance sheets. Derivative obligations related to financial exchange have ballooned from $60 trillion in 2010 to $90 trillion today, and the credit quality of European banks is again deteriorating, just as the Fed has tightened liquidity in the United States.8 If foreign banks become unable to roll their foreign exchange derivative obligations, another crisis could occur.

On the whole, Tooze seems to think that the response to the crisis would have been better if governments had simply spent more money. And, true, governments must provide credit when they are the only institutions capable of playing that role. But Tooze gives too little thought to the questions of how governments should allocate the money, or who is to be held accountable for this spending. Should governments simply spend money to “dig holes in the ground,” creating incomes but no assets that might bring returns in the future? Should they prop up another real estate bubble? A failure to properly think through these questions no doubt contributed to the crisis in the first place, as the previous sections should make clear.

Some economists have come to blame the financial crisis and other problems on a “savings glut”—a blinding misnomer. After all, how can there be a savings glut in a world of seven billion when many, even in rich countries, are desperately in need of capital and want to improve their lives? Why are savings not being channeled toward investing in those people and their projects? The answer is that the “savings glut” is itself a consequence of bad policies and a lack of accountable institutions, rationalized by the modeling and jargon of academics.

Tooze does not subscribe to the “savings glut” excuse, but his understanding of politics is often woefully naïve, even on matters such as strengthening financial regulations. European banks, for example, currently hold European government bonds on their books at historic cost, free from reserve requirements—implying no risk of default or rescheduling—a sort of fiscal policy in disguise. Strict financial regulations could not permit this practice, yet does anyone think that ending it is possible at this time?

At one point, Tooze suggests that the United States might have done better by nationalizing “sick” banks. But he does not discuss Mitterand’s experience nationalizing the French banks, which makes the entire discussion unserious, especially coming from an historian.

Or take China: how does Tooze envision carrying out a drastic change in the financial sector of a one-party, centralized country such as China, where banks are directly under government control? Such a change would require the Chinese Communist Party to give up much of its power. Does anyone expect them to agree to that?

In one of the worst sections of Crashed, Tooze attempts to fit Ukraine into his financial crisis narrative. He writes the following about the episode: “In April 2014, in Ukraine, systemic risk was recast in geopolitical terms. The IMF’s main shareholders did not want to see the embattled pro-Western regime in Kiev declared bankrupt within weeks of an anti-Putin revolution.”

But what does Ukraine’s crisis have to do with the 2008 crash? Why lump together Ukraine’s 2014 bailout with the post-2008 bailouts? Readers should always beware when writers use indirect language: Who, in the above passage, is doing the “recasting”? What was the “risk” exactly, and what does “geopolitical terms” mean?

A more realistic account would acknowledge Europe’s diplomatic mistakes in upsetting the Ukraine-Russia-EU relationship. Henry Kissinger described the latter mistakes bluntly: “The European Union must recognize that its bureaucratic dilatoriness and subordination of the strategic element to domestic politics in negotiating Ukraine’s relationship to Europe contributed to turning a negotiation into a crisis.”9

And whom did the IMF bail out? It was not Ukraine, as Tooze naïvely states, but Europe’s political class, who failed to manage the situation effectively.

Indeed, that may be the only parallel to the earlier bailouts, which rescued the elites without solving the fundamental problems plaguing economic and political systems around the world. This statement may seem cliché, yet the issue remains unaddressed. Tooze is eager to criticize politicians for being too concerned about fiscal deficits rather than financial risk, and he clearly would have preferred more aggressive bailouts and tougher financial regulations. But ultimately he is an apologist for the precrisis status quo and the politicians and economists who created it. He longs for a return to some mythical great moderation, and appears to believe that some larger bailouts might achieve that. But the bad policies and lack of accountability that led to the misallocation of capital at the root of the crisis run deeper than that, and these problems remain.

This article originally appeared in American Affairs Volume III, Number 1 (Spring 2019): 45–58.


See my chapter on “Nationalism” in Reuven Brenner, The Force of Finance: Triumph of the Capital Markets (New York: Texere, 2008).

Paul A. Volcker, with Christine Harper, Keeping at It: The Quest for Sound Money and Good Government (New York: PublicAffairs, 2018), 162.

See Brenner, The Force of Finance, and “Dismiss Macroeconomic Myths and Restore Accountability,” American Affairs 1, no. 1 (Spring 2017): 62–81, about “democratization of capital” and accountability.

It is another question whether “real estate” should be favored for any special treatment. Perhaps if we used a variation on the French term for “real estate,” immobilier, there would be more public debate on this. After all, the term “immobile” captures the essence of this asset class better than the term “real”: it immobilizes people to some extent, and it is also easier to tax. The 1997 change in the tax law actually turned this asset into becoming more “mobile”—for a while.

The rates on these contracts were based on the following calculation: the sum of the one-year Constant Maturity Treasury Index (CMT) and an assumed 2.75 percent margin.

See Thorvaldur Gylfason, “Iceland after the Fall,” Milken Institute Review (First Quarter 2010): 40–51.

Bernanke exaggerated the role of banks, forgetting the success of high-yield markets since the 1970s—in many ways a superior alternative to loans handed out by banks (which is why banks were so much against this new market at the time; in a short period, it took away more than 30 percent of their business). The 1930s should never have been his frame of reference.

David P. Goldman, “Has the Derivatives Volcano Already Begun to Erupt?,” Asia Times, October 9, 2018.

Henry Kissinger, “Henry Kissinger: To Settle the Ukraine Crisis, Start at the End,” Washington Post, March 5, 2014.

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