Ten years ago this week, I was in Madrid on a Monday afternoon, watching as some of the 26,000 employees of Lehman Brothers spilled onto a Manhattan sidewalk, their mighty investment bank suddenly non-existent. As I could plainly see, this was no mere American crisis: the streets around me were already filling with Spanish and Central American workers forced to walk away from construction projects where work had halted, permanently, their U.S. and European bank financing having suddenly vanished.
Over the next couple of days, the world economy ground to a halt, some of the mightiest financial institutions of the United States and Europe went bankrupt, markets crashed like never before and economic output and employment fell into a decline that wouldn’t recover for half a decade; its after-effects are still shaping our lives today.
The terrifying aftermath of 2008 should have taught us some lasting lessons. Yet, as Columbia University economic historian Adam Tooze writes in his monumental history of 2008 and its after-effects, Crashed: How a Decade of Financial Crises Changed the World, most of those lessons are being ignored.
It’s all real estate. By 2008, everyone had expected some sort of financial crisis to emerge from government debt, trade imbalances or dependency on imports. None of these things ended up causing a crisis – it was, he writes, a “financial crisis triggered by the humdrum market for American real estate.” Government debt, in fact, ended up being the solution to, not the cause of, both the financial and the euro crises.
By the 1990s, Western real estate had taken the place once occupied by gold as the chief source of collateral backing loans and interbank finance. American mortgages represented an outlandish share of the entire world’s financial system. Many, as we now know, were unsustainable.
And not just in America. Those high-risk mortgage-backed securities and collateralized debt obligations whose collapse crashed Wall Street? A third of them were issued by European banks. And even bigger real estate booms across the European periphery led banks in France, the Netherlands, Ireland and especially Britain to package their own countries’ mortgages into collateralized securities – by 2008, they had sold US$750-billion in asset-backed securities, much of it subprime and overvalued.
Real estate remains the key foundation of the world economy. In Canada alone, property (most of it residential) last year created a fifth of all economic activity, a far larger share than any other industry or activity.
Europe is the United States. “The central axis of world finance was not Asian-American but Euro-American,” Dr. Tooze writes. European and American banks were so tightly integrated that the 2010 euro debt crisis was an almost inevitable effect of the subprime crisis unfolding on both shores – and, Dr. Tooze argues, would never have occurred if European leaders had followed the U.S. lead, in 2008 and 2010, in pouring funding into the financial system to bail out the economy.
Instead, Jean-Claude Juncker, then-president of the Eurogroup, declared in 2010: “I see no reason why we should mount a U.S.-style program in Europe.” He, and German leaders, failed to see that the continental emergency (which obliterated tens of millions of jobs) was not a problem of sovereign governments, but of a border-crossing private-debt system starved of underlying demand, dependent on about 30 banks that are as American as they are European.
This remains a reality, as French President Emmanuel Macron was forced to acknowledge this summer. Europe is attempting to save the Iran nuclear-peace deal by ignoring the Trump administration’s ill-considered withdrawal, but this has proven near-impossible because the bank-payment and finance systems remain U.S.-controlled and all pass through New York; he's now calling for a separate European payments network. Because there is a single Atlantic finance system, any future crises will strike the whole Western world.
Free markets are a product of big government. What prevented an all-out worldwide depression, and triggered the return to full employment and growth the world is experiencing today, was the Barack Obama administration's difficult decision to launch the largest government-spending act in history. Europe eventually followed, too late to prevent the worst. By Dr. Tooze's estimate, governments ended up committing more than US$7-trillion to save banks. Most of these state investments would eventually turn a profit for taxpayers.
That said, Dr. Tooze leaves a key question hanging in the air: “Did the all-out focus on the financial system really save the interests of the real economy? Was the inability to borrow causing a failure of investment? Or were the collapsed housing market and cash-strapped households curtailing economic activity?” The United States, and eventually Europe, chose the first explanation. Yet, the second represented the real underlying problem – one that still simmers and could fuel the next crisis.