Creditanstalt and the Global Depression

The start of the Great Depression in Europe is often dated to May 11, 1931, when a run on Austria’s largest bank, Creditanstalt, began. Bank failures had already been increasing the prior year so whether the near failure of Creditanstalt actually caused the slide into the Great Depression or was simply its largest casualty up to that point is open to debate. Nonetheless, the run on Creditanstalt leads fairly directly to two other major financial events of 1931, the agreed-upon suspension of reparations payments by Germany and the end of the interwar years’ experiment with a gold standard.

Creditanstalt

Österreichische Credit-Anstalt für Handel und Gewerbe, or simply Creditanstalt, was founded in 1855, during a period of robust bank formation in Austria, by a group of Vienna bankers led by Baron Anselm von Rothschild. Like all Austrian banks, it struggled through the 1920s, a period of severe fiscal fragility and economic disarray. During the ‘20s, struggling banks were amalgamated with larger ones. In 1929, Creditanstalt took over the bank Bodenkreditanstalt which had itself absorbed two other banks in 1927. Bodenkreditanstalt was a troubled bank; it had a negative equity value when it was fused with Creditanstalt, 140 million Austrian schillings ($20 million) of accumulated losses exceeding equity capital of 80 million schillings.

1930-31

In the early 1930s, the Great Depression was setting in. Prices declined through 1930; the price of wheat fell from $1.32 per bushel in December 1929 (already down from $1.50 in June 1929) to $0.77 in December 1930. Cotton fell from $0.17 per pound to $0.09 between December 1929 and December 1930 and copper from £68 per long ton to £47 over the same period. Falling prices hurt exporting countries but also inflicted pain on companies that had borrowed money and needed to service these debts with reduced revenue and profits.

Amidst the drop in prices, lending seized up and demand was weak. World trade was falling partly as a result of falling prices, partly from weak demand, and partly because of rising tariff barriers. High tariffs among Austria’s neighbors hurt the small country’s exports. To mitigate this, Austria entered into negotiations to form a customs union with Germany but these talks were done in secret; closer ties between the two countries after the First World War was likely to cause uproar, particularly in France.

In 1930, the Austrian government succeeded in raising a $60 million loan, though only barely as demand was tepid and bankers were stuck holding many unsold bonds. Nonetheless, the money replenished Austrian foreign exchange reserves. If the government had been a few months delayed, the loan likely never would have happened.

In retrospect, 1930 was a year when mounting strain was beginning to have concerning effect on the banking system. Numerous Italian banks were either liquidated, bailed out, or reorganized in 1930, largely in secret so to prevent panic. A wave of bank failures took place in America in November and December 1930 and a couple of French banks closed at the same time. The following year, the proposed customs union between Germany and Austria was announced. It was met with support in the financial community but condemnation from other governments, particularly from France, and led to some capital flight from Austria.

Austrian Crisis

On Friday May 8, 1931, Creditanstalt quietly informed the government that it was in trouble. The following Monday, May 11, the bank announced publicly that losses of 140 million schillings had impaired its equity capital, cutting these reserves that protected creditors by half. The losses were the result of loans that turned bad and drops in the market price of shares held by the bank; Creditanstalt owned stakes in industrial companies that were struggling. Some of these losses were actually incurred by Bodenkreditanstalt but were now Creditanstalt’s problem.

A bailout was arranged the next day and put through the Austrian Parliament on Wednesday. Under the plan, the government, the Rothschild family, and the central bank, Oesterreichische Nationalbank, provided a total of 160 million schillings. However, a bank run commenced anyway and 300 million schillings were withdrawn from the bank by the end of the week. A quarter of Creditanstalt’s deposits were gone within a few days.

Bailout

During the bank run, people were hoarding money in physical cash. The conversion of bank deposits to banknotes meant that the Austrian central bank’s banknote liabilities tripled to just over one billion schillings over the week from May 7 to May 15, 1931 and reached 1.14 billion by the end of May. Savers were also exchanging their schillings for foreign monies, imperiling the fixed exchange rate of the Austrian schilling to other currencies. It was estimated that three-quarters of the money withdrawn from Creditanstalt was converted into foreign currency.

Thus, the Oesterreichische Nationalbank was in a predicament worrisome to any central bank at the time. True, continuing to provide liquidity to Creditanstalt and other Vienna banks by advancing money against the banks’ assets saved them from bankruptcy. The central bank’s portfolio of discounted bills, largely financing provided to Creditanstalt, grew from 60 million schillings to 300 million in the span of a single week at the start of the crisis. However, because the liquidity was being used to meet withdrawals, this could only be done by putting more banknotes into circulation, many of which were promptly exchanged for other currencies.

The central bank could print as many banknotes as it wanted but Austria had fixed exchange rates, allowed money to leave the country, and had only a limited amount of reserves in foreign currency or gold. So, there was a limit to how much could be done in practice if people wanted their money out of Austria altogether. For much of May, the central bank was losing about 30-40 million schillings per day in reserves; about a quarter of its pile was spent through in three weeks. Thus, the efforts to save Creditanstalt imperiled the central bank unless the latter’s reserves were replenished.

Within days of the crisis unfolding, a bailout for Austria was organized by the Bank for International Settlements; 100 million schillings ($14 million) was provided by ten participating countries and the BIS itself. The bailout money was not available to Austria’s central bank until May 31 and so brisk was the pace of withdrawals that the funds were exhausted within five days as the central bank disclosed the reduced state of its reserves, triggering more bank runs. The Oesterreichische Nationalbank raised interest rates from 5% to 6% on June 8 and to 7.5% on June 15 to try to encourage people to keep their money in Austria.

Unfortunately, the effort failed to stop the run and a second bailout was scuppered by French opposition to the German-Austrian customs union and Austrian refusal to abandon it. Making matters worse, though it was empowered by parliament to do so, the Austrian government was also hesitant to guarantee all of Creditanstalt’s deposits, a move which might have arrested the crisis. During this impasse, the Bank of England did step in to provide a loan by itself, likely at the last moment before the suspension of withdrawals from Austria would have been resorted to. This held the country over until a new 250 million schilling loan was arranged by the League of Nations in August. The situation in Austria was momentarily stabilized.

International Repercussions

While the Austrian episode was playing out, bank runs were fanning out across Germany and Central Europe starting from late May 1931. Germany itself quickly became the top concern. The gold reserves of the Reichsbank, Germany’s central bank, were reduced by 164 million reichsmarks ($39 million) in the first six days of June and by a further 400 million reichsmark ($95 million) between June 10 and June 15. The draining of reserves abated by June 17, a few days after the central bank raised interest rates from 5% to 7% to entice capital to Germany. By this point though, more than half of Germany’s gold reserves were gone.

On June 20, the American government approved a proposal to suspend German reparations payments for one year and a $100 million loan to Germany was arranged by the BIS and various central banks. As in the case of the Austrian bailout, the reparations relief in Germany took a while to come together. The French government, which had held out on account that reparations, it claimed, should not be treated any less favorably than commercial claims, only approved the reparations moratorium on July 6.

Despite the relief, Germany’s financial system was suffering; Darmstädter und Nationalbank, a large bank, had failed. A bank holiday was promptly instituted from July 13 to July 16 at the end of which the central bank lifted interest rates to 10%. Capital controls were also implemented to bar the withdrawal of foreign credit from Germany and the gold standard abolished.

The ban on withdrawals from Germany forced banks in neighboring countries, which had money tied up in Germany, to liquidate assets in other countries, notably Britain, in order to replenish their reserves. No such moratorium was imposed in Austria, allowing bank runs there to recommence as foreign creditors realized the global financial system was closing up and now was the time to get money out. The Bank of England’s gold reserves were also depleting for this and other reasons, including fiscal budget problems and a ‘mutiny’ over pay (somewhat exaggerated in the press) among Royal Navy personnel in Invergordon, Scotland.

So, Britain abandoned the gold standard on September 21, 1931 and was immediately accompanied by twenty-five other countries – the dominions of the British Empire, their close trading partners, and the Scandinavian countries. Austria implemented capital controls on October 9 and, by the end of the year, Japan too had abandoned the international gold standard. The holdouts would follow over the remainder of the 1930s.

Lesson

Creditanstalt, as Austria’s largest bank, was too big to fail. However, the efforts to save it also brought the world financial system to the brink, and indeed over the edge. For Austria, the bank was also too big to rescue without extraordinary help.

The history here illustrates how addressing a problematic bank can deplete available resources for doing such things and create more instability and more bank runs. This is not to say that letting the bank fail would be any better. That too would have created damage. Rather, what had to give was firstly, an international bailout, and secondly, the abolition of the framework within which central banks and governments operated. Austria had fixed change rates, capital mobility, and a gold standard and this imposed restraints that, in 1931, could no longer be maintained.

More from the Tontine Coffee-House

Read about the waves of bank failures in early 1930s America and the end of the brief international gold standard between the two world wars. Consider subscribing to this blog’s newsletter or checking out book recommendations, which include many of the sources often referenced in my posts.