From left: IMAGNO/Austrian Archives/CORBIS; AP PHOTO; Hulton Archive/GETTY IMAGES; Bettmann/CORBIS
In May 1931, a Viennese bank named Credit-Anstalt failed. Founded by the famous Rothschild banking family in 1855, Credit-Anstalt was one of the most important financial institutions of the Austro-Hungarian Empire, and its failure came as a shock because it was considered impregnable. The bank not only made loans; it acquired ownership stakes in all kinds of companies throughout the sprawling empire, from sugar producers to the new automobile makers. Its headquarters city, Vienna, was a place of wealth and splendor, famous for its opera, balls, chocolate, psychoanalysis, and the extravagant architecture of the Ringstrasse. The fall of Credit-Anstalt—and the dominoes it helped topple across Continental Europe and the confidence it shredded as far away as the U.S.—wasn't just the failure of a bank: It was a failure of civilization.
Once again, Europe's banking system, and by extension its social fabric, is threatened by bad loans. What had been slow-moving fiscal disasters in Greece, Ireland, and Portugal have gathered speed in recent weeks despite rescue packages designed to calm markets and prevent spreading the contagion to Spain, Belgium, and beyond. Portugal's 10-year borrowing costs hit a record 9.3 percent on Apr. 20, up from 7.4 percent just a month before, even as authorities met in Lisbon on an €80 billion ($116 billion) financing package. The higher that creditors drive up interest rates, the more unaffordable the debt becomes—creating the conditions for the very failure they fear. "All of the rescue packages don't really ensure that we can escape this adverse feedback loop that these countries are being trapped in," Christoph Rieger, head of fixed-income strategy at Frankfurt-based Commerzbank (CRZBY), told Bloomberg Television on Apr. 19.
With weak banking systems still resisting aggressive treatment, it's worth revisiting Credit-Anstalt to plumb for any applicable lessons. Long before 1931, Credit-Anstalt had begun to develop cracks that were invisible to the public. When the Austro-Hungarian Empire broke up after World War I, the bank continued to do business throughout the old empire without recognizing that the world had changed. Suddenly, more knowledgeable local lenders were getting the best deals, leaving Credit-Anstalt with the loans no one else would touch, says Aurel Schubert, an Austrian economist who wrote a 1991 book on the episode called The Credit-Anstalt Crisis of 1931. (There's a modern analogy in Greek banks' unwise loans in Bulgaria, Romania, and Serbia.)
The hyperinflation of 1921-23 that made the price of a beer rise to 4 billion marks badly damaged the finances of Credit-Anstalt as well as Austria itself. The nation was propped up by a 1923 loan from the League of Nations, the predecessor of the U.N. A Dutch citizen was appointed by the League to supervise the Austrian budget. He devised plans to raise taxes while cutting government jobs, pay, and pensions, the same prescription being urged on the weak members of the euro zone today. But Austria continued to stumble.
Bank regulation, meanwhile, was thin and getting thinner: Regulators began to demand a balance sheet just once a year, instead of every six months, says Schubert. As weaker banks failed, Credit-Anstalt took them over at regulators' insistence, becoming more bloated and less profitable with every merger. And the weakening of the economy was damaging lenders' ability to repay.
The tipping point came early in 1931 when a bank director named Zoltan Hajdu refused to sign off on Credit-Anstalt's books without a comprehensive reevaluation of the bank's assets. The bank revealed losses that it kept revising upward as the weeks passed. Depositors withdrew funds. The Austrian government stepped in to guarantee all the bank's deposits and other liabilities—but that only brought the government's own creditworthiness into question. "In today's language," says Schubert, "Credit-Anstalt was too big to fail, but too big to save."
Post a comment about this story in Reader Discussion…
RSS Feed: Most Read Stories
RSS Feed: Most E-mailed Stories
RSS Feed: Most Discussed Stories
Buy a link now!
About Advertising Custom Publishing EDGE Programs Reprints Terms of Use Disclaimer Privacy Notice Ethics Code Contact Us Site Map
©2011 Bloomberg L.P. All Rights Reserved.
Read Full Article »