The Euro-Crisis: Learning a Lesson from the Past

An article in Bloomberg Businessweek, April 24.

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 April 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 April 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 re-evaluation 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.”

Harold James, a British historian at Princeton University, described what happened next in his 2001 book, The End of Globalization: Lessons from the Great Depression. “The Viennese panic brought down banks in Amsterdam and Warsaw. In June and July, the scare spread to Germany, and from there immediately to Latvia, Turkey, and Egypt (and within a few months to England and the U.S.).” Austria got an undersized loan from the Bank for International Settlements and some help from the British branch of the Rothschild family. But French politicians rejected an international rescue without political concessions from Germany that weren’t forthcoming.

Thus the failure of Credit-Anstalt accelerated the financial panic that turned a recession into a global depression. Economic distress in Austria contributed to the outbreak of violent conflict between socialists and fascists in 1934. Jews became scapegoats. In 1938, Nazi Germany occupied Austria, and Adolf Hitler was received by adoring crowds in Vienna. Albeit indirectly, the failure of Credit-Anstalt helped clear the path for some of the darkest events of the 20th century.

Today’s Europe is far from a series of events resembling this tragic cascade. But the experience of the 1930s and 1940s has made European policymakers and economists hyper-aware of historical precedents. The current debate is about how to avoid a repeat. To those who believe hyperinflation was the key policy mistake in Credit-Anstalt’s fall, keeping a lid on inflation is priority No. 1. Others stress the lack of international coordination, or the failure to regulate, or even the handcuffs on government policies from adherence to the gold standard – represented today by the euro zone’s reliance on a common currency. As in most car crashes, the witnesses have a hard time agreeing on just what they saw.

The scariest thing about the Credit-Anstalt default is that it occurred in a small, peripheral country, just as today’s worst problems are concentrated so far in Greece, Ireland, and Portugal, which combined make up just 5 percent of the 27-nation European Union’s gross domestic product. “Austria is a tiny, tiny little place, and you wouldn’t imagine it could set off a chain of domino reactions. But it did. I do see exactly that potential now,” says James.

For that reason, German economist Holger Schmieding says Europe should do everything in its power to prevent or at least delay defaults by national governments. Schmieding, chief economist of the German private bank Joh. Berenberg Gossler, says keeping Greece and others from defaulting for as long as possible – if not forever – will give banks in Germany, France, and other nations that have lent to them the time they need to rebuild their capital so they can withstand the hit from loan losses. The Bank for International Settlements says that as of last September, German banks had over €220 billion worth of exposure to Greece, Ireland, and Portugal, and French banks had over €150 billion worth.

For all of Europe’s bickering over aid to Greece, Ireland, and Portugal, the Continent is more united and financially stable now than in the interwar period. “Unlike Austria in 1931, the euro zone has the resources to bail out the threatened banks without really triggering a full-blown debt crisis,” says Michael D. Bordo, a Rutgers University economic historian. The more Europe takes the lessons of Credit-Anstalt to heart, the less likely it is to make the same mistakes again. The introduction of Schubert’s book begins with the famous line of George Santayana, the Spanish philosopher, who said, “Those who cannot remember the past are condemned to repeat it.” J. Bradford DeLong, an economist at the University of California at Berkeley, thinks Europe has absorbed Santayana’s message – to an extent. “Because we remember the Credit-Anstalt, we will not make that mistake,” DeLong says. “We will make different ones.”


2 responses to “The Euro-Crisis: Learning a Lesson from the Past

  1. Elisabeth Ecker

    There is more to the “adoring crowds in Vienna” including the murder of the chancellor Dollfuss by the Nazis. Severe Economic downturns can invite strong leaders and lead to dictatorships. Be warned!

  2. It is no coincidence that Austria invented the word angst!
    Neither is it a coincidence that Austrian banks (and supermarkets) today blanket the territory once Ruled by Franz-Josef. Wonder if local competing banks are doing to them now that they did in 1923-30?