Adam Tooze: How the 2020 Crash Was Almost Worse Than 2008
On Thursday, March 12, 2020, the news from the financial markets was grim. America’s stock markets suffered losses worse than anything in 2008. Only Black Monday, in October 1987, and the darkest days of 1929 were worse. That was bad, but for insiders, the stock market was not the real worry. A “correction” was in order. The world was heading into shutdown. It was to be expected that share prices would fall. The function of shares as risk‑bearing capital is to act as a shock absorber in hard times. Far more worrying than equity markets was what was happening in the market for bonds, and above all, U.S. Treasuries—the safe assets that promise a counterbalance to volatile equities.
In times of uncertainty and recession, as investors lose confidence, they tend to shift from shares, whose prices fluctuate with business fortunes, to government debt that can be sold at a steady price or can be used as collateral for borrowing on good terms. At the top of the pyramid of safe assets are dollar‑denominated U.S. Treasuries. Their status as the ultimate safe asset is not due to the strength of the dollar, which has progressively depreciated for half a century. Nor does it stem from the fact that U.S. fiscal policy has the highest reputation for probity. U.S. Treasuries are the ultimate safe asset because the market is gigantic.
At the start of 2020, almost $17 trillion in U.S. government IOUs were in public circulation. These are backed by the most powerful nation with the biggest tax base, and they trade in the deepest and most sophisticated debt market. You buy U.S. Treasury securities because the market is so big that, in an emergency, you can sell them without your sale affecting the price. There will always be someone who wants to buy your Treasuries. And there will always be important bills you can settle in dollars. When we say that the U.S. dollar is the reserve currency of the world, what we are talking about are not America’s nondescript green banknotes. What we are talking about is the wealth stored in interest‑bearing U.S. Treasuries.
A common chain of events in a recession is, therefore, for the price of equities to fall and the price of Treasuries to rise. When the price you pay for a Treasury rises, its yield—the annual interest coupon payment divided by the price you paid to own the bond—falls. And in response to the detection of the coronavirus in the U.S., in February 2020, that is what happened. Share prices fell. Bond prices rose and yields came down. Falling yields lower interest rates, make it easier for firms to borrow, and should in due course stimulate new investment. The financial markets were helping the economy to adjust. But then, gathering force from Monday, March 9, something more alarming began to happen. The run for safety turned into a panic‑stricken dash for cash. Investors sold everything—not just shares, but Treasuries too. That was very bad news for the economy, because it sent interest rates up—the opposite of what business needed. Even more disturbing than the perverse movement of bond prices and yields was the fact that the biggest financial market in the world was, in the words of one market participant, “just not functioning.” The trillion‑dollar Treasury market, which is the foundation of all other financial trades, was lurching up and down in stomach‑churning spasms. On the terminal screens, prices danced erratically. Or, even worse, there were no prices at all. In the one market where you could always be sure to find a buyer, there were suddenly none. On March 13, JP Morgan reported that rather than a normal market depth of hundreds of millions of dollars in U.S. Treasuries, it was possible to trade no more than $12 million without noticeably moving the price. That was less than one‑tenth of normal market liquidity. This was a state of financial panic, which, if it had been allowed to develop, would have been more destabilizing even than the failure of Lehman Brothers in September 2008.
The prospect of escalating dysfunction in the Treasury market collapse was horrifying. A “safe” asset that could no longer be easily sold, or could be sold only at a fluctuating discount, was no longer a safe asset. It ought to have been unthinkable to even ask whether U.S. Treasuries were safe. And if the implosion of the financial system was not bad enough, the Bank of America strategist Mark Cabana spelled out the wider implications. As he warned in mid‑March of last year, a nonfunctioning Treasury market was “a national security issue.” It would “limit the ability of the US government to respond to the coronavirus.” That was ominous, but for Cabana too the biggest risk was in the financial markets. “If the US Treasury market experiences large‑scale illiquidity it will be difficult for other markets to price effectively and could lead to large‑scale position liquidations elsewhere.” If you could not be sure of being able to convert your piggy bank of safe Treasuries into cash, it was not safe to hold the rest of your portfolio either, and if that was true for the United States, it was also true for the rest of the world. Beginning on March 12, the European Central Bank (ECB) registered outflows from all kinds of euro-area funds on a scale not seen since September 2008. Funds that had slimmed down their liquidity buffers to a bare minimum found themselves caught short and resorting to desperate measures like gating outflows. The fear of not being able to exit helped spread the panic.
In the years since the dot‑com bust of 2000–01, central bankers had moved from being ringmasters to ever more frantic jugglers of liquidity. In 2012, Mario Draghi, then the ECB president, gave the era its mantra: “Whatever it takes.” Central banks dropped interest rates to zero. They engineered the rescue of ailing banks. They provided cheap credit to satisfy liquidity needs on an enormous scale. They purchased assets to stabilize financial markets. Nevertheless, for all the radicalism of these interventions, there was a sense that they could not go on forever. There must come a point where balance sheets were unwound and interest rates returned to something more like normal. When Jay Powell was chosen to head the Federal Reserve, Andrew Bailey the Bank of England, and Christine Lagarde the ECB, there was a sense that they belonged to a post-heroic generation. After the radical interventions of the period from 2008 to 2015, their primary task was to restore order. Their goal was normalization.
But in a general run like the one that had set in in March 2020, only one thing will restore confidence: limitless cash. And in the world’s dollar‑centered financial system, only one actor can provide that: the U.S. Federal Reserve. Normalization was out of the question.
The Fed’s first reaction to the coronavirus crisis, on March 3, 2020, had been to cut rates, the conventional way to support markets. But by the second week of March, it had become clear that this was not a conventional crisis. Stock markets were suffering historic losses. The Treasury market was in chaos. The only thing that anyone wanted was cash, and what they wanted above all was the U.S. currency. As the dollar surged, it transmitted financial pressure to the entire world. Anyone who had debts outstanding in dollars—and that was virtually every major corporation in the world along with many governments—was under pressure.
President Donald Trump was not one for the finer points of hedge-fund strategy or the details of the Treasury market, but he followed the S&P 500 obsessively, and that week he was incandescent. Why had the “boneheads” at the Fed not reacted to the collapse in the market? Trump summoned Treasury Secretary Steve Mnuchin, whom he blamed for his choice of Powell as Fed chair, and demanded that Mnuchin push the Fed into action. On Tuesday, March 10, unable to contain his rage, he had tweeted: “Our pathetic, slow moving Federal Reserve, headed by Jay Powell, who raised rates too fast and lowered too late, should get our Fed Rate down to the levels of our competitor nations. They now have as much as a two point advantage, with even bigger currency help. Also, stimulate!” So alarming was Trump’s tone that his staff were afraid that he might try to sack Powell mid-crisis. Nothing would be worse for market confidence.
On the evening of March 11, the president had abruptly announced the closure of America’s borders to European travelers. As Philipp Hildebrand, a former governor of the Swiss National Bank and now a vice chairman at the giant fund manager BlackRock, remarked rather primly: “This is one of the concerns that sort of sits in an overarching way over the whole system right now: Where is the leadership? Where is the U.S. leadership, which was one of the defining features of the crisis in 2008?” The answer would come not from the White House, but from the Fed.
Jay Powell was an unlikely hero. It is not that he did not look the part. According to legend, Powell was picked by Trump to replace Janet Yellen because Trump thought that Yellen, at 5 foot 3, was too short to be America’s central banker and that Powell cut a more imposing figure. He was also wealthy, which Trump liked. What Powell lacked were the impressive academic credentials of either Yellen or Ben Bernanke. In this sense he was a Fed chair for an era no longer in love with expertise. What Powell did have was plenty of experience in business, as a corporate lawyer. He also knew the importance of politics. Powell was nominated to the Fed board in 2011 as a bipartisan candidate after he helped convince Tea Party diehards in Congress that refusing to authorize new borrowing and forcing the federal government to live hand to mouth from tax revenue would be disastrous. Powell was not just a smooth operator. He was also a man with a philanthropic conscience. He favored a tight labor market as the best way to address inequality and inherited a Fed organization that under both Bernanke and Yellen had recognized it could not ignore America’s stark social disparities. Powell was supported in key operational positions by a Fed team staffed with veterans of 2008. At the policy-making level, Powell was supported by an activist generation, of which Lael Brainard, formerly of the Obama Treasury, was the leading exponent. As Fed chair, Powell would attract fewer dissenting votes than any of his recent predecessors.
The Fed was a competent, high‑functioning piece of the U.S. state apparatus. As such, it had unsurprisingly attracted Trump’s ire in the years prior to 2020. What was surprising was that in 2020 it became once again the driver of an expansive interventionist program of stabilization. It will be years before we have an inside view based on documentary evidence. For now, the simplest interpretation is that a team of veterans, conditioned by the experience of 2008, under undogmatic but broad‑minded leadership, equipped with an acute political antenna, saw a crisis of confidence that was threatening to become existential and responded in the way that such a crisis demands: with maximum force. The fact that it was not accompanied by more drama was part of the confidence‑building exercise. This should not lead us to underestimate the scale of what was done.
The first direct intervention in the market was led by the New York Fed, which is closest to the action on Wall Street. Its immediate aim was to restore depth to the Treasury market by enabling dealers to fund their portfolios as cheaply as possible. The main hub of market‑based finance is the so‑called repo market (repo is short for “repurchase”), where bonds can be traded temporarily for cash with a commitment to repurchase the bonds within a short period of time. Every day, trillions of dollars in long‑term bonds are refinanced in the repo market on a daily and monthly basis, making it possible to hold large portfolios on the basis of small amounts of capital. On March 9, the New York Fed made available $150 billion in overnight repo funding. On March 11, it announced an increase to $175 billion, as well as a further $95 billion in two‑week and one‑month repo. On March 12, the Fed began to offer one‑month and three‑month repo in $500 billion batches. The fact that the Fed was responding on a daily basis to the market’s mounting liquidity needs helped to calm nerves. As a repo lender, the Fed was propping up the Treasury market by helping others buy. The question was when it would step in itself.
By the end of the week, uncertainty was spreading around the world. Euro-area bond markets were unsettled by mixed messages from the European Central Bank. Big emerging markets—including G20 members Brazil, Mexico, and Indonesia—were under pressure from the soaring dollar. On Sunday, March 15, Powell made his next dramatic move. He called an unscheduled press conference and announced that the Fed was immediately cutting interest rates to zero—something that it had done just once before, at the height of the crisis in 2008. To stabilize the market, it would be buying at least $500 billion in Treasuries and $200 billion in mortgage‑backed securities, and it would start big. By Tuesday, $80 billion would be off the hands of the broker‑dealers, more in 48 hours than Ben Bernanke’s Fed had bought in a typical month of the 2008–09 crisis. And to satisfy the global craving for dollars, the Fed would be easing the terms on the so‑called liquidity swap lines—deals under which the Fed swaps dollars for sterling, euros, Swiss francs, and yen in potentially unlimited amounts. In effect, the Fed was assuming the role of a central bank to the world, dispensing dollars to every part of the credit system that was tight. In 2008 the swap lines had thrown a lifeline to Europe’s ailing banks. Now it was above all the Asian financial institutions that needed support. If they could get dollar funding from the Bank of Japan or the South Korean central bank, that would reduce the need to sell Treasuries.
Activating these elements of the global financial safety net does not require a dramatic stage‑managed meeting of heads of government. It can be done through relatively informal conference calls between a group of central bankers and their senior staff. It is a community as cosmopolitan as that in a scientific discipline, but smaller and even more close‑knit. It has outliers in national treasuries, at the International Monetary Fund and the Bank for International Settlements, and in many of the largest banks and asset managers. The ecosystem is completed by academic commentators and influential journalists who translate and amplify the common sense of this functional elite group. Within this community, there was no doubt by March 2020 that it was essential for the Fed to step in as a global lender of last resort, as it had done in 2008. This was in the interest of financial stability both in the United States and in the world at large. It was also a moment of truth as far as the Trump presidency was concerned. When he took office in 2017, many in the international finance community had feared that his administration would undercut the Fed’s role as the de facto central bank to the world. It seemed too enlightened to be compatible with his agenda of “America First.” If not Trump himself, then the flat‑Earth brigade in the congressional ranks of the GOP would shackle the Fed. A culture clash seemed predestined. But no such thing happened. After Powell’s performance on March 15, the president was full of praise for the Fed. Trump was all in favor of Fed intervention, no questions asked. The problem, it turned out, was not Trump. The problem was the markets.
On the night of March 15, as Powell finished his press conference, the futures market that anticipates the opening of the equity market on Wall Street on Monday morning sold off to the point that the circuit breakers, which are supposed to prevent the market from going into free fall, kicked in and further trading was automatically halted. When trading started on Monday morning, the fall was vertiginous. Once again, the circuit breakers were activated. The VIX, a measure of market volatility also known as the “fear index,” surged to levels last seen in the dark days of November 2008.
The Fed was tackling one crisis at a time. On March 17, it announced support for the markets that lend to businesses to cover payroll and other short‑term expenses. On March 18, it widened its support to include mutual funds, where better‑off Americans like to keep their savings. On March 19, the Fed widened the network of liquidity swap lines to cover 14 major economies, including Mexico, Brazil, and South Korea. The next day the provision of dollars to the European Central Bank and the Bank of Japan was sped up. Whether or not you were a recipient of a swap line, the Fed’s action set the tone. The Fed even opened a new facility that would allow foreign central banks to repo U.S. Treasuries. Anything to avoid their having to actually sell them.
With the Fed signaling that it would provide dollars in abundance, the appreciation of the dollar eased and the door was opened for other central banks to act. The Bank of Japan bought bonds. The Reserve Bank of Australia slashed rates. Emerging-market central banks that had previously to worry about the strength of the dollar relative to their local currencies were now free to act as well. By the end of the third week of March, 39 central banks from Mongolia to Trinidad had lowered interest rates, eased banking regulations, and set up special lending facilities.
Would it be enough? Powell had activated all the basic elements of the 2008 repertoire—interest-rate cuts, quantitative easing, support for money markets, swap lines. These familiar tools had worked to calm the acute stress in Treasury markets. As demand recovered, yields came down, but it was not enough to calm stock markets or the corporate debt market. So long as instability continued there, the ripples would reverberate throughout the entire system.
The basic problem was that central banks could shift credit supply and interest rates, but unlike in the banking crisis of 2008, they could not reach the source of the crisis itself, the coronavirus and the lockdown. The markets were waiting for news from Washington, but not from the Fed, from Congress. How much would America’s politicians mobilize in support of incomes, spending, and the medical response? The news on Sunday, March 22, was not good. Democrats and Republicans were at loggerheads. As trading began in Asia on the morning of Monday, March 23, the futures market crashed, and the plunge continued when Wall Street opened. At the low point of the trading day on Monday, March 23, the S&P 500 and the Dow Jones had lost about 30 percent of their value. Around the world, equity markets had inflicted losses of $26 trillion on the fortunate few who own large portfolios of shares and on the collective pools of savings held by pension and insurance funds. If it wanted to stop the slide, the Fed would have to make another move.
At 8 a.m. on March 23, 90 minutes before markets opened, Jerome Powell met his “Whatever it takes” moment. “Aggressive efforts must be taken across the public and private sectors to limit the losses to jobs and incomes and to promote a swift recovery once the disruptions abate,” he declared. By the middle of April, the Fed would go on to establish a total of nine separate facilities to backstop the private credit market. They went by a scrambled assortment of acronyms, but their purpose was to extend a huge overdraft facility to an economy whose revenues were shrinking, whose workers were furloughed, and whose markets were cracking “under a stampede of sellers.” The Fed’s money did not need to be drawn. The fact that it was there provided essential reassurance.
Powell’s approach to stabilization was three-pronged.
In its role as lender of last resort, on March 23 the Fed revived the Term Asset‑Backed Securities Loan Facility, or TALF—one of the stalwarts of the 2008 crisis—to backstop auto, credit-card, small‑business, and student loans. This was on top of the facilities it had already opened for issuers of commercial paper, money market mutual funds, and primary dealers in Treasury securities. These loans were largely internal to the financial system and involved the Fed in minimal lending risk. They fulfilled the classic function of central banks—to provide liquidity in emergencies against good collateral. But by March 23, it was clear that the Fed needed to do more.
In a second, more radical step, Powell announced the establishment of two facilities to support credit to large employers. The Fed was no longer just backstopping lending by others. It would offer to provide the credit itself. The Primary Market Corporate Credit Facility was intended to buy debt or loans directly from corporations. The Secondary Market Corporate Credit Facility would buy corporate debt off the books of other investors, including the sort of exchange‑traded funds that specialize in high‑risk, high‑yield debt. The volume proposed for the two facilities was $750 billion. By buying corporate bonds, the Fed would take a far larger risk of loss than it did in conventional lender‑of‑last‑resort operations. To cover the worst‑case contingency, it invoked an emergency under Section 13(3) of the Federal Reserve Act. This meant that losses, if they arose, could be met out of $30 billion in equity provided by the U.S. Treasury Exchange Stabilization Fund, a relic of the 1930s that served as a convenient source of capital for emergency interventions.
The Fed has always steered clear of this kind of direct lending to businesses. If you bought the debt of individual firms, you were picking favorites. If you bought a cross section of corporate debt, you ended up holding many poor‑quality loans. The higher‑risk end of the corporate debt market, so‑called junk bonds, was where private-equity firms made winnings before which the bonuses of Wall Street bankers paled into insignificance. For political and legal reasons, if nothing else, the Fed preferred not to be in the business of backstopping the most speculative end of the financial system.
In refusing to buy corporate debt, the Fed was unusual among major central banks. Both the Bank of England and the European Central Bank bought corporate debt. In Europe in March 2020, large corporations such as VW were unabashed in their lobbying for support from the ECB. The Bank of Japan went even further. It bought shares, taking the risk of equity ownership. From 2010 to the end of 2020, it built a $434 billion holding in the Japanese equity market. That was impressive, but America is the world’s benchmark capital market. And none of the other central banks had ever done anything on the scale that Powell was now contemplating.
What the Fed really needed from Congress was political cover for its adventurous policy. The unspoken premise of the Fed’s announcement was that a new partnership would be forthcoming with Treasury and Congress. Ideally, the Fed would have made its grand announcement on the morning of Monday, March 23, in conjunction with a congressional stimulus package. That would have to wait until later in the week. In the meantime, anticipating the priorities of Congress, the Federal Reserve declared that it would flank its lending programs for big business with a Main Street Lending Program to support lending to small and medium‑size businesses.
Finally, as the third prong of its support operation, the Fed threw its full weight behind the markets for public debt. Municipalities were on the front line of the coronavirus fight, managing the pandemic response and paying for extra precautions, while facing plunging tax revenues. On March 23, the Fed announced changes to both the Money Market Mutual Fund Liquidity Facility and the Commercial Paper Funding Facility that promised to ease the flow of credit to municipalities. On April 9, this would develop into the Municipal Liquidity Facility, under which the Fed notionally earmarked $500 billion to support short‑term notes issued by large cities, counties, and states.
All of these facilities were confidence‑building measures for the financial system as a whole. Indirectly, they served to relieve pressure on the Treasury market. The Fed did not stop there. The most direct way to support the market for Treasuries was for the Fed to buy them. By the weekend of March 20–1, the Federal Open Market Committee had already announced purchases totaling $500 billion of Treasury securities and $200 billion of mortgage‑backed securities. Powell now lifted even that ceiling. On the morning of March 23, the committee declared simply that it would “purchase Treasury securities and agency mortgage‑backed securities in the amounts needed to support smooth market functioning and effective transmission of monetary policy to broader financial conditions and the economy.” Over the week that followed, the Fed bought an astonishing total of $375 billion in Treasury securities and $250 billion in mortgage securities. At the high point of the program, the Fed was buying bonds at the rate of a million dollars per second. In a matter of weeks, it bought 5 percent of the $20 trillion market.
The effect of these interventions on the market was extraordinary. March 23 was the turning point. Once investors knew that the lender and market maker of last resort was in place, confidence returned, credit flowed, and financial markets, particularly in the United States, began an astonishing recovery. By mid‑August the S&P 500 had fully recovered its losses since February and had begun an ascent into record territory. It restored wealth to that small minority who had a substantial direct stake in the financial markets. It helped to revive corporate fortunes more generally and thus to revive the economy. If the financial markets had suffered a heart attack in March 2020, most of the world would have suffered, but the benefits of the recovery were distributed unequally. Worldwide, the wealth of billionaires rose by $1.9 trillion in 2020; $560 billion of that benefited America’s wealthiest people. Among the surreal and jarring juxtapositions of 2020, the disconnect between high finance and the day‑to‑day struggles of billions of people around the world stood out.
The jitters in the world economy in 2019 had already put into question the prospect of normalization. The year 2020 overturned it completely. Not only did the central banks act on an unprecedented scale, but they did so with an alacrity that betrayed the increasing disinhibition of the preceding decades. In 2008 there had still been a note of hesitancy about central-bank interventions. In 2020, that was gone. The full implications of the opening of the monetary floodgates would become clear over the weeks that followed, as fiscal policy caught up. This was emergency action of the most radical kind. But what now was normality?
This article is adapted from Adam Tooze’s forthcoming book, Shutdown: How Covid Shook the World’s Economy.