Nick Dewhirst looks back at the collapse of the Austrian banking system in the 1920s to see what lessons can be applied to today's banking crisis
Once upon a time there was a little bank in Austria, called Creditanstalt. Like many a fable, this one has an important message for present-day readers. Unlike many fables, this one happens to be true.
By 1914 Austria may no longer have been the Holy Roman Empire that dominated the known world, but it was still a major power, the assassination of whose archduke could ignite the first world war.
Unfortunately the price for being on the losing side was to be stripped of many of its territories, including Hungary, Czechoslovakia, and parts of Poland, Romania and Yugoslavia and Russia that it had also overrun.
Without the breadbaskets of these rich agricultural colonies and conquests, it was a world-class financial centre with a row of barren mountains and little else.
Peace therefore brought Austrians little prosperity. Without regular income from servicing successful farmers, its highly paid bankers had to seek other outlets for their financial skills. Fortunately hyperinflation created a stockmarket boom at the beginning of the 1920s, so they switched from customer business to own-account trading.
The long-established Allgemeinen Depositen Bank (United Deposit Bank) fell under the control of Castiglioni, the most famous stockmarket operator of the time, before being passed on to another group of unscrupulous financiers who misappropriated the depositors' funds to support their speculations. As a result of disastrous gambles against the French franc in 1924, the bank failed. The forced liquidation of its investments proved to be the pin that pricked that great bull market.
Prague's Centralbank der Deutschen Sparkassen (Central German Savings Bank) had been founded in 1901 to handle the savings of Bohemian farmers. During the war the headquarters were moved to Vienna, so it also found itself on the losing side and stripped of its high-quality Bohemian banking business. Dr Wutte, another dodgy dealer with great plans, gained control in 1922 as the bull market collapsed, and made a series of misjudged takeovers of several failing banks. These left it undercapitalised, so it folded in 1926.
Boden-Credit-Anstalt (Mortgage Institute), banker to the Kaiser, was a blue-chip bank that similarly fell under the spell of a whiz-kid, Dr Rudolf Sieghard. He overstretched himself, so the bank had insufficient resources to survive a run on the Austrian schilling caused by fascist riots in 1929.
In turn, it was taken over by der Oesterreichischen Creditanstalt fuer Handel und Gewerbe (Austrian Institute for Trade and Industry). This was the bluest of blue-chips, founded by the Rothschilds in 1856, and a core holding for international investors.
The problem was that as the Viennese banking house of cards collapsed, so Creditanstalt acquired more and more of other banks' assets, with the encouragement of the central bank, but without a commensurate increase in capital to support the expanded business. The regulator connived in keeping the banks afloat, not to enrich shareholders, but to maintain confidence in the banking system.
By May 1931 the Creditanstalt accounted for an estimated 60% of Austria's banking business, so when it too collapsed, this set off a currency crisis. That in turn caused a chain reaction among foreign banks. It was that which transformed the Wall Street Crash into the Depression.
The modern translation for these stories of speculation, leverage, fraud and collapse is that interest margins have been squeezed by retail money market funds on one side and commercial certificates of deposit on the other side; single-capacity firms have been replaced by universal banks; and today's whiz-kids can make more money in proprietary trading than on boring old lending, at least until the asset bubble collapses. Then it was the stockmarket. Now it is real estate.
The lesson is that this is a process that takes years. Regulators typically connive in delaying recognition of the true extent of past bad debts in the hope that banks can earn their way out of trouble through extra-wide margins in future, aided by cautious lenders and abetted by generous central banks.
Other examples are plentiful. Japan's bubble burst in 1990, but its banks are only now sanitised. The earlier Savings & Loans in the US similarly took a decade to resolve after the Texan oil boom collapsed in 1980. In the 1970s the UK was saddled with nationalising secondary banks and Johnson Matthey for years.
It would be churlish to translate 'Creditanstalt' but here is a hint - it will also be big and blue-chip. The crisis will only end when we all know who it is, and that may still take years.
- Nick Dewhirst is CEO of www.investors-routemap.co.uk.
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