Every day brings new spotlight-grabbing headlines about the clashes, bashes and triumphs of President Donald Trump. On the bright side, America’s gross domestic product grew at a robust 4.1% rate in the second quarter. But all the hubbub — good and bad — distracts from a dangerous complacency that’s gripping the country distinguished by the failure to look for serious risks that could be hidden away in the global financial system.
What’s needed is vigilance and a rigorous effort to watch for such risks, Adam Tooze, economic historian and Columbia University history professor, argues in an interview with ThinkAdvisor. Nonetheless, the multi-prize-winning author forecasts the U.S. recovery’s inevitable end in 18 months to two years, at which time an economic recession will take hold.
Big banks, the mortgage space, emerging markets, the yield curve inversion and more should be monitored closely, stresses Tooze, whose new book is “Crashed: How a Decade of Financial Crises Changed the World” (Viking). Its publication on Aug. 7 marks the 10th anniversary of the start of the global financial meltdown.
Tooze’s cautionary stance stems from meticulously analyzing that crisis, which upended the status quo and opened the door to what he calls Trump’s rise as “an irresistible political force.” This after the Republican Party in the 2008-2009 crisis “failed as the bracket between its mass base and the imperatives of systemic stabilization.”
The big shift accompanying Trump’s election as president has triggered two deeply disturbing conflicts, the professor points out: Most of Europe and Asia, as well as Canada, have written America off as a reliable ally. Indeed, Trump has “an allergic response to globalization,” Tooze insists. And in the U.S., Republicans are torn between the belief that Trump’s strategies are prudent and the “goodies” — the financial benefits, delivered or promised — for Americans that are generated by his policies.
Trump’s, er, hypersensitivity to globalization hardly jibes with the reality of the world’s interconnectedness and the fact that the U.S. is indispensable when it comes to the global financial system, as Tooze emphasizes in the interview. Indeed, during the meltdown, “the Fed acted across borders to provide liquidity to banks in other countries,” he writes.
Born in London, bred in England and Germany, Tooze, 51, is a prize-winning author of “The Deluge,” about remaking the global order after World War I, and “The Wages of Destruction,” on the Nazi economy. Before Columbia, he taught at Yale and the University of Cambridge.
ThinkAdvisor recently interviewed the professor, on the phone from his New York City office. The conversation kicked off with why he wrote “Crashed” “with urgency,” as he noted in the book’s acknowledgements, ahead of Page 1. “There was an important story about how the financial crisis worked on the global level that needed telling. As the Trump phenomenon came into view,” he said, “that dominated the theme.”
Here are excerpts from the interview:
THINKADVISOR: Why do you say that the U.S. is in “a moment of renewed complacency”?
ADAM TOOZE: To the extent that one could say there’s a dangerous complacency, there’s reason to wonder where the hidden risks in global finance are. The balance sheets of the big American banks look relatively healthy. The question is whether various evasion mechanisms — perhaps the swap market and others — are [in play]. There are real issues in the emerging markets. Right now, we should be looking at all sorts of places to shake us out of our complacency.
Is the U.S. not paying enough attention to such issues?
Trump is definitely not paying enough attention. The recovery has got to come to an end. There’s every reason to think that a recession is coming America’s way in the next 18 months to two years. Will it be a regular recession, or are there more serious risks hidden away somewhere in the system?
What does this forecast mean to investors?
The question is: How long will the run-up continue? And can you afford to sit on the sidelines while the markets are still heading upwards? But at some point, that’s going to turn, and the turn might be quite nasty.
What’s the current state of the U.S. economy and securities markets?
We’re clearly on an incredible sugar high since the tax cuts. The yield curve is inverting, but the Fed is telling us not to worry as long as it’s pushed down artificially by a variety of factors, including a huge portfolio of stocks. That’s exactly what they said in 2006.
How significant is the yield curve inversion? Some say it typically augurs a recession.
It’s not the yield curve that kills you — it’s what people do in reaction to it. If investors have to search for yield, they go into more risky assets and start taking risks that may become unmanageable.
Should there be another financial crisis, how do you think President Trump would handle it? In 2008-2009, Republicans and Democrats cooperated to resolve the dire situation.
That’s an unanswerable question. But I don’t think Trump is going to be confronted with the kind of crisis we had in 2008. That won’t repeat.
What shape is the U.S. mortgage market in right now?
It’s striking that the housing finance system isn’t fixed. In fact, it’s increasingly true that mortgages are being financed by nonbanks — small specialist mortgage lenders who don’t qualify for bank charges; they avoid them. This is scarily reminiscent of the funding model for American mortgages before 2008. So, even if the big commercial banks are considerably safer than before 2008, it’s not obvious that the mortgage system is on a stable long-term foundation.
You write that in around 2007, President Trump had plans to launch a mortgage brokerage. Why didn’t he?
I think he was too late for the game and was distracted. But he wanted in. That’s a very striking element in the story: How he himself was directly caught up in the crisis. The condo office building he had in Chicago was in deep trouble in the winter of 2009.
What was Trump’s view on the bank bailouts?
He said publicly that they were necessary to keep the show on the road. That’s not something he would want people to remember right now because it doesn’t play well with the [House] Freedom Caucus and other folks like that in the Republican Party.
What do you think will happen with the Dodd-Frank Act, which Trump promised to repeal?
The real risk is not that the administration will try to repeal Dodd-Frank directly. They’ll do the same thing that they did with Obamacare: They had no success in repealing it, so they used tax legislation to remove the mandate requiring people to pay for the insurance. Likewise, they’ll leave Dodd-Frank on the books and just loosen all the regulations the Treasury oversees, [thus] enabling the banks to do whatever they like.
Will stress tests for the banks still be required?
Sometimes by doing a stress test, you’re not really exerting any discipline in the financial sector. The latest round of stress tests was laughable. Morgan Stanley was told they were going to fail, and then they were offered a sweetheart deal to ensure they didn’t publicly fail.
What’s the overwhelming lesson of the financial crisis?
That there’s a big difference between investment bets turning bad and a full-on economic heart attack of the sort we had in 2008. The big difference comes from who’s holding the assets and how they’re funding them.
What was the case in ‘08?
The killer was that trillions of dollars of bad bets were held [by] the banks. That’s lethal because the banks are inherently fragile: short-term funded and leveraged like no other business in the economy.
What’s the cautionary lesson, then?
The thing we really need to monitor is leverage and liquidity. If the banks have huge imbalances in their liquidity, if their leverage is excessive and they’re holding the risks, that’s a really toxic combination.
During the financial meltdown, banks around the world were on the brink simultaneously. Global synchronization never before occurred on that scale, you write.
It was an unprecedented crisis happening in America, but it wasn’t an all-American crisis. It affected the entire European banking system; [countries] were all at risk simultaneously. All the markets were, and are, interconnected. We now know that you have to look across borders. You have to look where in the world economic risks are piling up and who’s exposed.
That seems at odds with President Trump’s position. He apparently wants to disconnect from other countries.
He absolutely does. The world is organized precisely opposite to the way he wants it: He has an allergic response to globalization. But the American industrial system is integrated, and those links are real and very expensive to disentangle.
How big a threat to the worldwide economy is Russia?
Russia doesn’t have the capacity to destabilize the global financial system. The Russian economy is barely growing. The Russian banking sector is big domestically with oligarchs [wealthy business leaders with political clout], but the Russian economy by itself isn’t a major factor. Russia shouldn’t be confused with China. China is the center of global growth right now.
When it comes to global finance, America is indispensable, you write. Please elaborate.
The whole rest of the world depends on the U.S. because the entire system is based on dollars. In the financial crisis, only the U.S. Treasury could save the life of the global banking system. And that’s still true. The only people that can provide limitless funds in an emergency are the American authorities. We live in a world structurally dependent on the United States.
Yet, allies including Germany and Canada now have the attitude that America can no longer be depended upon as the friend it once was.
Correct. The rest of the world is looking at the situation in the U.S. right now and saying that, for the foreseeable future, America has been written off. It’s no longer a reliable partner. Everyone is making plans on the assumption that America isn’t viable as a cooperative player because the U.S. can’t be trusted. Their thinking is: “How do we cope without America?”
But how can they get along without America?
That’s the dilemma: You can’t live with America; you can’t live without America. It’s both essential and impossible. So when people talk about trying to be independent of America, do not kid yourself about the scale of that challenge.
Do they feel that way solely because of President Trump?
The rest of the world thinks this guy is a vandal, an arsonist — he’s burning down the house. But when they say they can’t trust America, they mean not just Trump but the country that elected him, where 80% of Republicans think he’s doing a great job.
The financial crisis set the stage for Trump to become president when in 2008 the Republicans lost control of their own party, you write. Where do Republicans stand now vis-a-vis Trump?
The Republicans are in a trap: They know that in the long run, Trump is probably not in the best interest of the U.S. But in the short run, if you’re offered inducements, it’s very difficult to stand aside and say you don’t think Trump has the [safe and prudent] long-run strategy for the U.S.
What sorts of “inducements”?
For example, when Trump showed he was delivering on the tax cuts, there was almost a fiduciary obligation to support the administration because it was going to make [companies’] shareholders better off.
Wall Street didn’t like Trump before the election, but it was quite pleased afterward, you say. What about now?
The top tier of Wall Street — the really senior management — [gave] very little money to Trump. He’s not their kind of guy culturally. But there’s every evidence that lower down in the organizations — among the traders and working Joes of Wall Street, who don’t share the embarrassment and hang-ups of top management — people have huge support for him.
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