The Austrian Banking Crisis Of 1931: One Bad Apple Spoils The Whole Bunch

The Austrian Banking Crisis of 1931 continues to be of great interest to economic history folks. After all, it is seen as one major reason for spreading of Great Depression from US to Europe shores. Once Credit Ansalt, the major Austrian Bank failed, others followed like a pack of cards.

An interesting paper by Flora Macher revisits the evidence so far and offers a new perspective:

The current literature is inconclusive on the relative importance of foreign and domestic factors in bringing about the Austrian financial crisis in 1931.

This paper has emphasized the importance of a domestic cause behind the Austrian banking crisis in 1931. The universal banking structure heavily exposed the largest banks to Austrian industry through their Konzerns. When Konzern corporations performed badly, as they did during the second half of the 1920s, so did the universal banks. The four banks that came under distress in 1925-31 were all insolvent from 1925 due to the weak performance of their Konzern. The paper has also shown that one bad apple, the UB’s Konzern, spoiled the performance of a whole bunch of other universal banks and caused a systemic crisis in 1931. This finding suggests that the crisis may have been avoidable had the UB’s troubles been adequately managed. Finally, while it remains unresolved whether the CA was illiquid before it decided to seek a bailout, it is certain that after 11 May 1931, the flight of both domestic and foreign creditors contributed to the banks’ illiquidity.

Could this have been avoided? One option would have been allowing the UB to fail. The CA’s, the BCA’s, and the VB’s Konzerns were performing much better in relative terms. Had these banks not been poisoned with the UB’s Konzern, they may have survived. Their absorption of the UB’s failing corporations and their avoidance to acknowledge and write off nonperforming assets were what caused them to fail. At the same time, since the universal banks were closely interconnected through their Konzerns, they were reluctant to let one member go under who might then have undermined the stability of the rest as well. Not choosing this, however, eventually buried them all.

Another option would have been a state bailout of the UB. Had this bank been provided sufficient state support to write off its non-performing assets, it would not have gone bankrupt and would not have had to be merged into other stronger banks whom it would gradually weaken and cause to fail. What made this impossible was that the state was bound by restrictions set by financial markets and the League of Nations, which considered bank bailouts anathema to the orthodox fiscal and monetary principals of the time.

Hmm..

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