The Federal Reserve’s response to the financial crisis involved lending tens of trillions of dollars to borrowers based outside the U.S. This was not charity but an act of enlightened self-interest.
As Nathan Sheets, then the head of the Fed’s international finance division, explained in his presentation to the Fed’s policy-making committee on Oct. 28, 2008, “The structural interconnectedness of the global economy” meant that trouble abroad would create “unwelcome spillovers” for the U.S. Floridian mortgage borrowers and Midwestern manufacturers were entangled with Japanese farm cooperatives, Irish property developers, and German regional banks.
The Fed’s decision to deploy its power abroad is one of the pivotal moments in Crashed: How a Decade of Financial Crises Changed the World (Penguin), Columbia University historian Adam Tooze’s brilliant new account of the tumult of the past decade. I had a chance to talk with Tooze about the book in a recorded conversation.
As Tooze describes, both the size and the distribution of the lending was a demonstration of America’s indispensability to the global financial system. Borrowers all over the world needed help that only the Fed could provide. At the worst of the crisis, the Fed had nearly $1.7 trillion in emergency loans outstanding. Of that, roughly $600 billion was extended directly to foreign central banks.
The Fed also had about $450 billion in loans outstanding via the Term Auction Facility and more than $300 billion provided by the Commercial Paper Funding Facility. Foreigners received the majority of the funding from both of those facilities and were also avid users of the comparatively small primary credit facility.
The Fed lent abroad in such magnitudes because its officials appreciated America’s dependence on Europe’s banks. Collectively, those banks were too big and too important for U.S. financial intermediation to be allowed to fail. In the years before the crisis, European banks borrowed from American money-market funds and provided credit to Americans by buying asset-backed securities.
By the end of 2007, foreign banks had accumulated more than $6.5 trillion in claims on U.S. borrowers, of which $4 trillion could be attributed to banks in France, Germany, Switzerland, and the United Kingdom. Banks in other European countries, particularly Belgium, the Netherlands, and Spain, accounted for another $1 trillion. For perspective, U.S.-chartered commercial banks had extended only $7.5 trillion of credit on the eve of the crisis.
Tooze quotes a European official joking that Frankfurt, home of the European Central Bank, had effectively become another branch of the Federal Reserve system during the crisis. A global financial system based on the U.S. dollar demanded a global response led by the American government. While the Fed tried to downplay the significance of its interventions, the reality is that it had engaged in an act of international economic statecraft comparable to the Marshall Plan.
The Fed’s willingness to think expansively and act decisively was in contrast to Europe’s own policy makers, who, as Ben Bernanke, then the Fed’s chairman, tactfully put it, “have had some difficulty coming to the realization that Europe would be under a great deal of stress and was not going to be decoupled from the United States.”
In early October 2008, the Dutch had suggested pooling the collective resources of the European Union’s economies to bail out their banks and guarantee deposits. The French, British, and even the boss of Deutsche Bank all supported the idea of a joint effort. This made sense, since most European banks had significant operations in neighboring countries. Regardless of whether their headquarters were in Paris or Amsterdam or Frankfurt, their exposures were pan-European. National borders should have been irrelevant for deciding who would bear the burden of saving a tightly integrated financial system.
Then the German government and the ECB made one of the greatest policy mistakes since the 1930s. They insisted on national solutions led by national governments. French President Nicolas Sarkozy claimed German Chancellor Angela Merkel had told him, “Chacun sa merde”—she would not clean up others’ messes. This decision led directly to the European sovereign crises and to a lost decade for hundreds of millions of people.
Perhaps even more egregious was the ECB’s refusal to help people outside the euro area who needed euros. The Fed understood what would have happened to Mexico and to Korea if they were deprived of dollars, so they created swap lines and lent in size. Yet Trichet and his colleagues declined to make similar arrangements with Poland, Hungary, and the Baltics. The post-Communist states eager for equality with the West were instead fobbed off on the International Monetary Fund. Fed officials were shocked. Tooze convincingly argues that this was the beginning of the increasingly poisonous division between Europe’s West and East.
Tooze’s history never loses sight of the political implications of these financial developments. The crisis was caused by transnational banks. The rich world’s governments focused on returning those banks to profitability, but devoted far less attention to the people who lost their jobs, homes, and pensions. We are living with the consequences.
Write to Matthew C. Klein at firstname.lastname@example.org