Aurel Schubert

Calculus of a Crisis: Explaining the Credit-Anstalt Collapse
While the political economy of the Great Depression and the impact of the said contraction on the world stage have long been objects of study, there are but few attempts to examine in detail the events surrounding the Credit-Anstalt collapse, the conflagration that deepened the economic contraction of the 1930s and led to the demise of the interwar gold standard. The Credit-Anstalt’s placement at the center of Austro-Hungarian finances lent the bank its initial distinction; its alleged key role in deepening the Great Depression gave the Credit-Anstalt its unique standing in a world of globalized capital flows. How the Credit-Anstalt crisis unfolded and how the downfall of one the largest financial institutions in Europe became instrumental in the propagation of a financial crisis are examined in this edifying monograph. Based on Schubert’s doctoral dissertation at the University of South Carolina, this volume endeavors to examine the crisis through the lens of modern economic theory. In studying the market’s efficiency in incorporating existing information into equity prices, and in examining the possible channels of transmission of the turbulence generated by the financial crisis, Schubert provides a relatively comprehensive survey of the interwar economic oscillation that Austria underwent, and underscores the fact that the factors that led to the twilight of the Credit-Anstalt remain extant in the current financial environment.

In 1919, with the signing of the Treaty of Saint-Germain-en-Laye, the Austro-Hungarian empire ceased to exist, bringing to a close more than seven centuries of Habsburg dynastic rule. As Austria’s transition to democracy unfolded, severe economic dislocations followed. Some of these dislocations emanated from the division of the Austro-Hungarian Empire at the conclusion of the First World War. Others stemmed from the incapacity of the nascent Austrian state to manage its finances. As one of the largest of the so-called ‘Successor States’, Austria was in a unique position to become a new fulcrum of the central European economy, given its geographic proximity to Germany and its relatively formidable industrial base. But the dismality of the post-war economic environment proved to be too much for the Austrian state to handle. Indeed, at the very moment of its emergence as an independent nation-state, Austria was already under severe economic stress. Declining commodity prices took their toll on the country’s agricultural sector. The Vienna-centered civil service bureaucracy, mandated to administer the Austro-Hungarian empire’s 415,000 square miles of territory, remained disproportionately large even as its sphere of influence was reduced to 52,000 square miles of Austrian real estate. Public expenditures were kept high by welfare-redistributive programs, preventing the government from balancing its budget. And the state was resorting to inflationary finance in order to fund government expenditures. Amidst this turbulence, banks inevitably started to fail. The second largest bank in Vienna, the Boden-Credit-Anstalt, ran into liquidity problems in 1929. The Austrian government managed to persuade the Credit-Anstalt to acquire the ailing Boden-Credit-Anstalt; Schubert speculates that the Credit-Anstalt agreed to such a transaction in order to ensure access to government support in the future. In acting as a de facto lender of last resort, the Credit-Anstalt thus significantly increased its exposure to Austrian industry at a moment of maximum peril, when global trade was contracting, economic protectionism intensified balance-of-payments difficulties, and borrowers became increasingly unable to service their debts.

The problems confronting the Rothschild-backed Credit-Anstalt became publicly known only on May 1931, when it was revealed that cumulative losses of 140 million schillings had eroded nearly 85 percent of the bank’s capital and reserves. This led to a widespread loss of confidence in the Austrian banking system, with the public withdrawing one-third of the Credit-Anstalt’s deposit base within two weeks of the disclosure. The Austrian central bank, to its credit, moved to institute a liberal discounting policy, seemingly in cognizance of the so-called Bagehot rule on lending freely in times of crisis. With the weaknesses of the Austrian financial system finally laid bare, a palpable rush to exchange Austrian schillings for foreign currencies and gold followed. The need for an international lender of last resort soon emerged, as capital flight rapidly drained the reserves of the central bank. But foreign lenders were not quite forthcoming, and the financial assistance that was initially provided proved to be insubstantial. Before the year was over, the central bank would lose 700 million schillings in foreign reserves, and the government would introduce exchange controls. It would turn out that the extent of the Credit-Anstalt’s losses was far greater than the previously disclosed amount: instead of 140 million schillings, the actual deficit amounted to more than 1 billion schillings, 700 million of which was attributable to nonperforming loans.

To what extent was the Credit-Anstalt catastrophe responsible for the transmission of the 1930s contagion? The Credit-Anstalt’s liquidity crisis and the ensuing attack on the schilling led investors to worry about the state of the finances of Hungary, Germany, and Britain. What started as a loss of confidence in an Austrian bank soon became a full-fledged international crisis. Nations were forced to choose between domestic financial stability and staying on the gold standard. Many governments would cast the gold standard over the side to avail of new policy options.

With regard to the Credit-Anstalt collapse and the resulting attack on the Austrian currency, there are, writes Schubert, two interrelated sets of causes: proximate causes, which include managerial deficiencies and the deleterious impact of the business depression; and fundamental causes, which include the economic consequences of the dissolution of the Austro-Hungarian empire, the ensuing hyperinflation, and the maturity mismatch between the Credit-Anstalt’s assets and liabilities. Schubert notes that the Credit-Anstalt was ill-advised to carry on with its pan-Danubian scope of affairs after the dissolution of Austria-Hungary, instead of curtailing its financial undertakings to reflect the post-war economic reality. As Austrian banks at the time levied interest rates that were higher than the rates charged by non-Austrian financial institutions, low-risk debtors thus chose to obtain funds from local banks, squeezing the Credit-Anstalt and other Austrian banks out of the high-grade borrower market. They were subsequently induced to extend funding to ‘subprime’ debtors which ultimately proved unable to service their loans.

Schubert attempts to draw parallels between the conditions prevailing at the time of the Credit-Anstalt crisis and the circumstances at the time of the monograph’s publication. Unchecked tendencies toward protectionism in the developed world, such as the passage of the Smoot-Hawley Tariff Act in 1930 and the Omnibus Trade and Competitiveness Act of 1988, pose a major threat to global prosperity, as the capacity of borrowing nations to service their debts will be negated by their inability to conduct trade. Inflation, described by Schubert as a “poison” on the world economy, eroded the capital base of Austria’s banks in the 1930s and the deposit base of US savings and loan associations during the 1980s. Lack of fiscal discipline often leads to a loss of confidence in a nation’s fiscal solvency and a flight from domestic assets, resulting in economic dislocation. And institutions in a position to act as international lenders of last resort ought not to adopt a tentative, Shakespearean approach to deliberation regarding financial assistance in trying times, as they did during the Credit-Anstalt emergency; the IMF’s procedures, according to Schubert, preclude the Fund from acting decisively in time-critical crisis situations. All in all, Schubert reasonably addresses a substantial lacuna in our understanding of the interwar international contraction; given the need to attend to conundrums arising from the multipolar nature of the global economy, historians and economists would do well to study in detail economic turning-points, which undoubtedly includes the Credit-Anstalt episode.… (meer)