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07/18/2014

Prelude to the Great Depression

With last week’s market indigestion caused largely by some issues with Portugal’s second-largest bank, Banco Espirito Santo, I thought we’d look back at a far more serious banking crisis, the fall of Creditanstalt Bank of Vienna, which helped precipitate the Great Depression and the rise of Hitler.

You’ll recall that after the U.S. stock market collapsed in October 1929, the world was almost immediately thrown into a great funk, but it wasn’t until about two years later that real trouble started.

By mid-1930, in some ways most of the world economies had stabilized. The European countries, still trying to recover from the ravages of World War I, were seeing some forms of pick up in international lending and trade. But in September of that year, a dark event occurred in Germany, as the National Socialists (the Nazis) made tremendous gains in the election and suddenly were the 2nd-largest party in the Reichstag. The amazing result stunned the world and led to a large drop in confidence as well as capital withdrawals from Germany. By 1931, Hitler’s Stormtroopers, drawn largely from the burgeoning unemployed, numbered some 300,000.

During the early part of ‘31, German and Austrian banks attempted to improve their weakening capital positions by boosting their stock price and the way some went about this was to buy their own shares. As historian Charles Kindleberger points out, "A bank buying its own stock rapidly weakens its ratios of cash and capital to deposits, as cash and capital in the open market both shrink while deposits remain unchanged in the short run." The other problem was that deposits were shrinking at the same time. And, just as was the case in, say, Enron, many of the bank directors were simply trying to manipulate the share price for their own personal gain.

As for Creditanstalt (also labeled Kredit Anstalt) Bank of Vienna, the largest commercial institution in the country, it was the victim of both a rapidly deteriorating economy, particularly in Germany and Austria, massive speculation*, and poor management.

[*Back in the 1850s, Creditanstalt was a wildly popular IPO, with initial shares being oversubscribed by 43 times. --Kindleberger.]

By May 1931 most of Europe was in the midst of a rolling deflation, starting with the collapse of some small banks in France, which led to the fall of the government there because three officials were implicated in a scandal. The crisis grew and on May 11, Creditanstalt collapsed, declaring it had lost about $20 million, with only $7 million or so left in capital. The Austrian government sought a loan, part of which was arranged by the newly formed (1930) Bank for International Settlements, but it was not nearly enough.

Austria then sought help from the French, but the French were in no mood to lend a hand. You see, earlier in the year Germany and Austria had sought to form a Customs Union, in order to help trade between the two. But France - remember, World War I was still just a few years removed - correctly saw this as a violation of the Treaty of Versailles, which forbid a union between Austria and Germany, so the French, key to the loan package, refused to go along unless Austria renounced the customs idea. The Austrians, in turn, refused and their government fell. Soon there was a run on the banks, as foreign assets were immediately withdrawn, while the Gold bloc of France, Belgium, the Netherlands and Switzerland started converting dollars into gold, exacerbating an already weak banking system in the U.S.

For its part, Germany’s official government policy was to slash government spending, which only added tens of thousands to the unemployment lines, while Chancellor Bruning declared that
Germany could no longer pay its reparations. 

It was a very fluid situation, even for those days, so that by June 19, U.S. President Hoover proposed a moratorium on reparations for 12 months, as well as granting America’s allies relief from its war debts. Of course this only ticked off the French even more because Germany was gaining such a big concession. [British Prime Minister MacDonald at the time found France’s behavior to be "inconceivably atrocious."] As it developed, the moratorium, which Hoover formally extended to 18 months, didn’t help and the banks went under anyway.

Of course this whole doomsday scenario, which plunged the entire world into Depression by 1932, played right into the hands of Hitler. By mid-July 1931, the British ambassador to Germany, stationed in Berlin, couldn’t help but notice the "unnatural silence hanging over the city, and particularly (an) atmosphere of tension similar in many respects to that which I observed in the critical days immediately preceding the war." [Brendon] Germany was being swept up in "fatalism."

In the history of the era, the collapse of Creditanstalt stands out amongst the other banking disasters because it was Austria’s biggest and led directly to a run on institutions in Germany as well. Soon thereafter business worldwide ground to a halt. [In 1932, for example, both German and U.S. industrial production were just half the levels achieved in 1929.] Author Piers Brendon adds that it also "exacerbated an already poisonous anti-Semitism." And regarding what followed, historian Norman Davies concludes:

"The effects of the Depression were psychological and political as well as purely economic. Everyone from banker to bellboy was perplexed. The Great War had brought death and destruction; but it had also brought a purpose to life and full employment. Peace appeared to bring neither. There were men who said that life amidst the danger and comradeship of the trenches was preferable to life on the dole. The anxieties brimmed over into violence on the streets: left-wing battle squads pitched into right-wing gangs in many European cities. It was the season for charlatans, adventurers, and extremists."

Sources:

"The Dark Valley," Piers Brendon
"Europe: A History," Norman Davies
"The Power of Gold," Peter Bernstein
"America: A Narrative History," George Brown Tindall and David E. Shi
"20th Century," J.M. Roberts
"Manias, Panics, and Crashes," Charles Kindleberger

Wall Street History returns in two weeks.

Brian Trumbore

 



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Wall Street History

07/18/2014

Prelude to the Great Depression

With last week’s market indigestion caused largely by some issues with Portugal’s second-largest bank, Banco Espirito Santo, I thought we’d look back at a far more serious banking crisis, the fall of Creditanstalt Bank of Vienna, which helped precipitate the Great Depression and the rise of Hitler.

You’ll recall that after the U.S. stock market collapsed in October 1929, the world was almost immediately thrown into a great funk, but it wasn’t until about two years later that real trouble started.

By mid-1930, in some ways most of the world economies had stabilized. The European countries, still trying to recover from the ravages of World War I, were seeing some forms of pick up in international lending and trade. But in September of that year, a dark event occurred in Germany, as the National Socialists (the Nazis) made tremendous gains in the election and suddenly were the 2nd-largest party in the Reichstag. The amazing result stunned the world and led to a large drop in confidence as well as capital withdrawals from Germany. By 1931, Hitler’s Stormtroopers, drawn largely from the burgeoning unemployed, numbered some 300,000.

During the early part of ‘31, German and Austrian banks attempted to improve their weakening capital positions by boosting their stock price and the way some went about this was to buy their own shares. As historian Charles Kindleberger points out, "A bank buying its own stock rapidly weakens its ratios of cash and capital to deposits, as cash and capital in the open market both shrink while deposits remain unchanged in the short run." The other problem was that deposits were shrinking at the same time. And, just as was the case in, say, Enron, many of the bank directors were simply trying to manipulate the share price for their own personal gain.

As for Creditanstalt (also labeled Kredit Anstalt) Bank of Vienna, the largest commercial institution in the country, it was the victim of both a rapidly deteriorating economy, particularly in Germany and Austria, massive speculation*, and poor management.

[*Back in the 1850s, Creditanstalt was a wildly popular IPO, with initial shares being oversubscribed by 43 times. --Kindleberger.]

By May 1931 most of Europe was in the midst of a rolling deflation, starting with the collapse of some small banks in France, which led to the fall of the government there because three officials were implicated in a scandal. The crisis grew and on May 11, Creditanstalt collapsed, declaring it had lost about $20 million, with only $7 million or so left in capital. The Austrian government sought a loan, part of which was arranged by the newly formed (1930) Bank for International Settlements, but it was not nearly enough.

Austria then sought help from the French, but the French were in no mood to lend a hand. You see, earlier in the year Germany and Austria had sought to form a Customs Union, in order to help trade between the two. But France - remember, World War I was still just a few years removed - correctly saw this as a violation of the Treaty of Versailles, which forbid a union between Austria and Germany, so the French, key to the loan package, refused to go along unless Austria renounced the customs idea. The Austrians, in turn, refused and their government fell. Soon there was a run on the banks, as foreign assets were immediately withdrawn, while the Gold bloc of France, Belgium, the Netherlands and Switzerland started converting dollars into gold, exacerbating an already weak banking system in the U.S.

For its part, Germany’s official government policy was to slash government spending, which only added tens of thousands to the unemployment lines, while Chancellor Bruning declared that
Germany could no longer pay its reparations. 

It was a very fluid situation, even for those days, so that by June 19, U.S. President Hoover proposed a moratorium on reparations for 12 months, as well as granting America’s allies relief from its war debts. Of course this only ticked off the French even more because Germany was gaining such a big concession. [British Prime Minister MacDonald at the time found France’s behavior to be "inconceivably atrocious."] As it developed, the moratorium, which Hoover formally extended to 18 months, didn’t help and the banks went under anyway.

Of course this whole doomsday scenario, which plunged the entire world into Depression by 1932, played right into the hands of Hitler. By mid-July 1931, the British ambassador to Germany, stationed in Berlin, couldn’t help but notice the "unnatural silence hanging over the city, and particularly (an) atmosphere of tension similar in many respects to that which I observed in the critical days immediately preceding the war." [Brendon] Germany was being swept up in "fatalism."

In the history of the era, the collapse of Creditanstalt stands out amongst the other banking disasters because it was Austria’s biggest and led directly to a run on institutions in Germany as well. Soon thereafter business worldwide ground to a halt. [In 1932, for example, both German and U.S. industrial production were just half the levels achieved in 1929.] Author Piers Brendon adds that it also "exacerbated an already poisonous anti-Semitism." And regarding what followed, historian Norman Davies concludes:

"The effects of the Depression were psychological and political as well as purely economic. Everyone from banker to bellboy was perplexed. The Great War had brought death and destruction; but it had also brought a purpose to life and full employment. Peace appeared to bring neither. There were men who said that life amidst the danger and comradeship of the trenches was preferable to life on the dole. The anxieties brimmed over into violence on the streets: left-wing battle squads pitched into right-wing gangs in many European cities. It was the season for charlatans, adventurers, and extremists."

Sources:

"The Dark Valley," Piers Brendon
"Europe: A History," Norman Davies
"The Power of Gold," Peter Bernstein
"America: A Narrative History," George Brown Tindall and David E. Shi
"20th Century," J.M. Roberts
"Manias, Panics, and Crashes," Charles Kindleberger

Wall Street History returns in two weeks.

Brian Trumbore