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No banks without states, no states without banks The political economy context of the banking crises in Austria and Hungary in 1931 The current presentation is on the third paper of my thesis PhD thesis plan Paper #1 The causes of the Hungarian crisis of 1931 Paper #2 The causes of the Austrian crisis of 1931 Paper #3 The political origins of the Hungarian and Austrian crises in 1931 In the 2007-8 US subprime crisis even those could get a mortgage loan who had no income, no job and assets The US subprime crisis The Austrian and Hungarian crises of 1931 can also be placed in a political economy context, like the subprime crisis Parallel • How was this possible? – How could so many lenders make so many risky loans without having to put up sufficient capital to protect them against insolvency? • Yes, the banks did a lot of bad things • But they were incentivized to do that by the regulator • Goal here: show that this time has been no different • Austria, Hungary 1931: same thing happened Goal: place the Austrian and Hungarian crises in a political economy framework Motivation • „In addition, for several years the government had pressured the Credit‐Anstalt to aid domestic firms suffering the effects of the Depression, which only added to the bank's difficulties; its absorption of the Bodenkreditanstalt in 1929 had been imposed on the reluctant chairman of the Credit‐Anstalt to protect the National Bank from losses on the rediscounts it had extended the Bodenkreditanstalt.” (Eichengreen 1992, p265) • Ausch (1968), Weber (1991), Eigner (1997) – politicians’ involvement in the various banking crises during the 1920s • The literature on Austria does address the political economy context • The one on Hungary does not • Goal here: place the matter in a framework and discuss relevance for 1931 crises Austria and Hungary also had universal banks – just like Germany – which emerged in the 19th century Background 19th century banking • Universal banks (lender and owner) – 5-10 in Austria, 3-5 in Hungary • Close relationships with industry, drivers of the late industrialization of these countries (Gerschenkron 1962) • In addition, they also have close relations with their respective states – key financiers of state debt (Kövér 2005) WWI • Universal banks strengthen their industrial connections: banks directly help finance war industries (Eichengreen 1992) • Austria: universal banks are majority owners in all industrial entities (Teichova and Cottrell 1983) • Universal banks have a role in financing the war effort through lending to the state (Pogány 2002) Post-WWI shock • Pressure to spend leads to hyperinflation • Hyperinflation weakens industry and wipes out banks’ capital • Banks strengthen their ownership in industrial enterprises: turn loans into equity holdings to preserve value • Nostrification, confiscation of assets in successor states Stabilization • League of Nations reconstruction scheme • Orthodox, liberal economic tenets built • Close surveillance WWI strengthened universal banks’ connections to industry as well as towards the state Background 19th century banking • Universal banks (lender and owner) – 5-10 in Austria, 3-5 in Hungary • Close relationships with industry, drivers of the late industrialization of these countries (Gerschenkron 1962) • In addition, they also have close relations with their respective states – key financiers of state debt (Kövér 2005) WWI • Universal banks strengthen their industrial connections: banks directly help finance war industries (Eichengreen 1992) • Austria: universal banks are majority owners in all industrial entities (Teichova and Cottrell 1983) • Universal banks have a role in financing the war effort through lending to the state (Pogány 2002) Post-WWI shock • Pressure to spend leads to hyperinflation • Hyperinflation weakens industry and wipes out banks’ capital • Banks strengthen their ownership in industrial enterprises: turn loans into equity holdings to preserve value • Nostrification, confiscation of assets in successor states Stabilization • League of Nations reconstruction scheme • Orthodox, liberal economic tenets built • Close surveillance The post- WWI shock weakened the universal banks economically but strengthened their stake in industry Background 19th century banking • Universal banks (lender and owner) – 5-10 in Austria, 3-5 in Hungary • Close relationships with industry, drivers of the late industrialization of these countries (Gerschenkron 1962) • In addition, they also have close relations with their respective states – key financiers of state debt (Kövér 2005) WWI • Universal banks strengthen their industrial connections: banks directly help finance war industries (Eichengreen 1992) • Austria: universal banks are majority owners in all industrial entities (Teichova and Cottrell 1983) • Universal banks have a role in financing the war effort through lending to the state (Pogány 2002) Post-WWI shock • Pressure to spend leads to hyperinflation • Hyperinflation weakens industry and wipes out banks’ capital • Banks strengthen their ownership in industrial enterprises: turn loans into equity holdings to preserve value • Nostrification, confiscation of assets in successor states Stabilization • League of Nations reconstruction scheme • Orthodox, liberal economic tenets built • Close surveillance The post-stabilization period is the focus of this paper: universal banks and the state colluded; both had the motivation to reestablish its old clout Background 19th century banking • Universal banks (lender and owner) – 5-10 in Austria, 3-5 in Hungary • Close relationships with industry, drivers of the late industrialization of these countries (Gerschenkron 1962) • In addition, they also have close relations with their respective states – key financiers of state debt (Kövér 2005) WWI • Universal banks strengthen their industrial connections: banks directly help finance war industries (Eichengreen 1992) • Austria: universal banks are majority owners in all industrial entities (Teichova and Cottrell 1983) • Universal banks have a role in financing the war effort through lending to the state (Pogány 2002) Post-WWI shock • Pressure to spend leads to hyperinflation • Hyperinflation weakens industry and wipes out banks’ capital • Banks strengthen their ownership in industrial enterprises: turn loans into equity holdings to preserve value • Nostrification, confiscation of assets in successor states Stabilization • League of Nations reconstruction scheme • Orthodox, liberal economic tenets built • Close surveillance Authorities consciously relied on the banking system to service their political objectives Argument Economic conditions Political and social conditions • Post-stabilization Austria and Hungary • Political pressure in the straitjacket of the economic – Austrian and Hungarian states cease trilemma to properly function after WWI • These conflicting conditions were resolved – Free capital flows – Losers through the help of the banking system in of WWI, elites and old – Fixed exchange rate system (gold institutions lose their legitimacy both countries standard) – Lost much of their territory, • The state, which could not spend and – Independent monetary policy-making population at the Peace Treaty and borrow, incentivized banks to lend inreceived a way reparations obligations that addressed the social issues and kept – Economic and political turmoil • Closely monitored by the League of the old elite in power follows, in Hungary communist Nations and the Bank of England who takeover in 1919, in Austria constant • This resulted in risky banking impose the first two conditions on social unrest these countries • This contributed to the banking collapse of • Social pressure 1931 – Returning, retiring soldiers, widows • Outcome: – Unemployment – No independent monetary policymaking – Balanced government budgets or in surplus) The Calomiris-Haber framework best explains the case Framework Gerschenkron, making up for the missing pre-requisites Eichengreen, social contract Calomiris and Haber, the Game of Bank Bargains • Explains the role of universal banks as drivers of industrialization in late industrializing countries (Germany, Austria, Hungary) • Does not explain close bank-state connections and how this may lead to weak fundamentals in the banking system • Explains the institution driving growth after a great turmoil • Explain the deal between employers, employees and the state • Does not explain close bank-state connections and how this may lead to weak fundamentals in the banking system • Explains that banking system is shaped by political institutions • Explains close bank-state connections and how this may lead to weak fundamentals in the banking system The Calomiris-Haber framework explains why banks’ behavior is not independent of the behavior and objectives of the state Calomiris-Haber framework Assets Equity and liab. Loans Deposits Cash Equity • Maturity mismatch • Threat of expropriation NO BANKS WITHOUT STATES AND NO STATES State steps in WITHOUT BANKS Gives • privileges State is necessary for (charters) and to banking system sets properly function obligations • But state has its own and regulates incentives that can operations misguide banking operations • Towards banks (managers/equity holders) – Government is a regulator – But it also relies on banks to finance the state and ensure the money supply • Towards debtors – Government acts as a law enforcer (enforce credit contracts) – But government also relies on debtors for political support • Towards depositors – Government allocates losses among depositors when there is a bank failure – But government also relies on their political support Contents Austria Hungary Wrap-up There were 8 universal banks in 1925; 4 failed by 1931: the Unionbank, the Verkehrsbank, the BCA and the CA The structure of the Austrian financial system based on total assets Verkehrsbank and Unionbank fail Merged into Boden-CreditAnstalt Sparkassen 25% Boden-Credit-Anstalt fails Merged into Credit-Anstalt 28% 29% 32% 36% Credit-Anstalt fails 37% 38% 50% 46% Other banks 46% 47% 33% 32% 1932 1933 Mortgage banks Universal 62% banks* 1925 61% 1926 59% 1927 56% 1928 53% 1929 1930 1931 * CA, BCA, WBV, NEG, Landerbank, Mercurbank, Unionbank, Verkehrsbank Source: Compass Finanzielles Jahrbuch, various years Austrian banks were not supervised; hence banks could apply fraudulent accounting to present themselves profitable Evidence on Austrian state and banks cooperating No bank supervision maintains the illusion of healthy banks • Banks were not monitored and Ministry of Finance was a guarantor of this state of affairs (Enderle-Burcel 1994) • Only annual reporting of financials to the central bank • Banks can maintain the illusion of financial stability – „silent reserves” – No write-off of nonperforming loans – Booking interest income when not received When banks still fail, state provides support • When banks fail, the survival of their industrial base is ensured with authorities’ support • Authorities are personally interested in maintaining banks • Authorities provide financial guarantees at the BCA-CA merger When banks become too weak, state intervenes to boost lending • When banks weaken, state boosts industrial lending by financial supporting stateowned financial institutions The 4 failed banks presented themselves profitable even months before their failure and led the public believe that they had substantial „silent reserves” Universal banks’ fraudulent accounting practices Reserves set aside for losses and write-downs Date when Date of the in the FY rumors merger/failu before about failure Name of bank re failure emerge* % of total assets Unionbank Mar-25-1927 0.09% Sep-20-1926 Verkehrsbank Mar-25-1927 0.02% Dec-3-1926 Boden-CreditAnstalt Dec-31-1929 0.00% Oct-12-1929 May-11May-11Credit-Anstalt 1931 0.00% 1931 No write-offs or reserve building prior to failure Change in actual Change in volume of Date of last last dividend last dividend dividend payment vs. Actual payment vs. payment Amount of previous volume of previous before last dividend dividend last dividend dividend failure** payment payment payment payment Jul-1-1926 Jul-1-1925 AS/share 2.5 0.3 % increase 257% -40% AS 2,000,000 1,312,400 % increase -29% -40% Jul-1-1929 7.5 0% 8,250,000 10% Jul-1-1930 3.4 -15% 7,225,000 -15% Pay dividends before before failure Source: Compass Finanzielles Jahrbuch, various years But these 4 banks did not really fail, they and their Konzern all survived somehow with the active help of the authorities Evidence on Austrian state and banks cooperating No bank supervision maintains the illusion of healthy banks • Banks were not supervised and Ministry of Finance was a guarantor of this state of affairs (Enderle-Burcel 1994) • Only annual reporting of financials to the central bank • Banks can maintain the illusion of financial stability – „silent reserves” – No write-off of nonperforming loans – Booking interest income when not received When banks still fail, state provides support • When banks fail, the survival of their industrial base is ensured with authorities’ support • Authorities are personally interested in maintaining banks • Authorities provide financial guarantees at the BCA-CA merger When banks become too weak, state intervenes to boost lending • When banks weaken, state boosts industrial lending by financial supporting stateowned financial institutions The mergers were complicit arrangements between the bankers with the state watching Transaction structure of the three mergers Credit-Anstalt (CA) - Boden- Boden-Credit-Anstalt (BCA) - Boden-Credit-Anstalt (BCA) Credit-Anstalt (BCA Unionbank Verkehrsbank Receiving bank CA BCA BCA Merged bank BCA Unionbank Verkehrsbank Successor entity CA BCA BCA Year 1930 1927 1927 - AS 8.75m was the - AS 55m was the BCA's - AS 28m was the Verkehrsbank's equity in equity in 1928 Unionbank's equity in 1926 1926 - Of this 90%, i.e. AS 49.5m - Of this 90%, i.e. AS 25.2m - Of this 90%, i.e. AS 7.875m Acknowledged losses was recognized as a loss was recognized as a loss was recognized as a loss - This was only 14.1% of the - This was only 5.7% of the - This was only 5.8% of the Unionbank's total assets in Verkehrsbank's total assets in BCA's total assets in 1928 1926 1926 Bail-in of shareholders: Bail-in of shareholders: Bail-in of shareholders: - 90% loss ratio - 90% loss ratio - 90% loss ratio Bail-in of depositors and Bail-in of depositors and Bail-in of depositors and Who suffers losses and how creditors: creditors: creditors: much? - None: depositors and - None: depositors and - Guaranteed by the creditors did not incur any creditors did not incur any authorities losses losses Source: Compass Finanzielles Jahrbuch, various years The state provided implicit and explicit guarantees to the universal banks when they were in trouble State support to universal banks • Close relationships between bankers and politicians • Large banks do not fail: they are absorbed by other large banks and government is involved in these arrangements where no past losses are written off – Unionbank and Verkehrsbank into the Boden-Credit-Anstalt in 1927 – Boden-Credit-Anstalt into the Credit-Anstalt in 1929 Richard Reisch, President of the Austrian National Bank • Boden-Credit-Anstalt collapse: Reisch ignores years of egregious lending and insolvency – Reisch was the governor of the ANB, former Minister of Finance, former board member of the Boden-Credit-Anstalt, likely eligible for the pension plan of the bank (Eigner 1997) – Absorbing bank, Credit-Anstalt receives guarantees from government for all its deposits – Credit-Anstalt also receives loans from ANB through the cross-credit-scheme Source: Bank of England Archives, Ausch (1968, Weber (1991, Eigner (1997) By 1930, when the universal banks had become too weak, the state used its own resources to step up industrial lending Evidence on Austrian state and banks cooperating No bank supervision maintains the illusion of healthy banks • Banks were not supervised and Ministry of Finance was a guarantor of this state of affairs (Enderle-Burcel 1994) • Only annual reporting of financials to the central bank • Banks can maintain the illusion of financial stability – „silent reserves” – No write-off of nonperforming loans – Booking interest income when not received When banks still fail, state provides support • When banks fail, the survival of their industrial base is ensured with authorities’ support • Authorities are personally interested in maintaining banks • Authorities provide financial guarantees at the BCA-CA merger When banks become too weak, state intervenes to boost lending • When banks weaken, state boosts industrial lending by financial supporting stateowned financial institutions The importance of Other Banks and Mortgage Banks – several of them state-owned – started increasing from 1930 The structure of the Austrian financial system based on total assets Sparkassen 25% 28% 29% 32% 36% 37% 38% Other banks 46% 47% Some of them state -owned Mortgage banks Universal 62% banks* 1925 61% 1926 59% 1927 56% 1928 53% 1929 50% 1930 46% 1931 33% 32% 1932 1933 * CA, BCA, WBV, NEG, Landerbank, Mercurbank, Unionbank, Verkehrsbank Source: Compass Finanzielles Jahrbuch, various years The state also provided guarantees to Mortgage and Other Banks so that they can increase their lending to industry Government support to increase industrial lending Mortgage Banks’ and Other Banks’ equity and liabilities, annual change Mortgage Banks’ and Other Banks’ assets, annual change 400 300 200 116 100 160 272 200 0 -100 -200 1926 1927 1928 1929 1930 1931 1932 1933 Darlehen Equity and reserves 1926 1927 1928 1929 1930 1931 1932 1933 Domestic currency depositors Domestic currency creditors Darlehen Short-term lending Cash Inter-bank lending Other liabilities Investments Other assets Source: Compass Finanzielles Jahrbuch, various years Contents Austria Hungary Wrap-up Issue banks had over 60% of the total assets of the Hungarian banking system and Sparkassen were the second largest player The structure of the Hungarian banking system by total assets Non-Budapest savings banks (Sparkassen) Non-Budapest banks Budapest other banks Budapest issue banks 1926 1927 1928 1929 1930 1931 1932 1933 Source: Nagy Magyar Compass, various years The state focused issue banks’ attention fully on agricultural lending through the CMI and state-guarantees State intervention into banking in Hungary 1925-1929 Post-stabilization state support to boost agricultural lending 1930 State steps up support from 1930 to boost agricultural lending Issue banks State incentivized the establishment of a Central Mortgage Institute • State worked together with issue banks on the establishment of the CMI • CMI could issue debentures abroad which could finance agricultural lending • State provided money for the CMI and requested the cooperation of the largest issue banks State provided guarantees to issue banks • From 1930, when the opportunity for foreign issues evaporated, the state started providing guarantees to issue banks to boost their lending • Guaranteed financing could only be spent in agriculture Sparkassen HNB provided financing to sparkassen • Sparkassen’s largest financing resource was the rediscount provided by the HNB • Sparkassen have historically been agricultural lenders and maintaing them served the goal of financing agriculture The state was anxious to boost lending and from 1930 incentivized the financial sector to lend through state-guaranteed loans The annual change in the financing sources of issue banks (m pengős) Deposits ST creditors Other liab. Guarantees LT creditors Equity 800 600 400 200 0 -200 -400 -600 -800 1927 1928 1929 1930 1931 1932 1933 Source: Nagy Magyar Compass, various years State-guaranteed loans all had to be distributed in agriculture and since other sources for new lending largely disappeared, in 1930 all of the new lending went to agriculture The annual change in the financing sources of issue banks (m pengős) Agricultural lending 80% stateguaranteed Other lending Cash 800 600 400 200 0 -200 -400 -600 1927 1928 1929 1930 1931 1932 1933 Source: Nagy Magyar Compass, various years Sparkassen, traditional agricultural lenders, were supported by the Hungarian National Bank State intervention into banking in Hungary 1925-1929 Post-stabilization state support to boost agricultural lending 1930 State steps up support from 1930 to boost agricultural lending Issue banks State incentivized the establishment of a Central Mortgage Institute • State worked together with issue banks on the establishment of the CMI • CMI could issue debentures abroad which could finance agricultural lending • State provided money for the CMI and requested the cooperation of the largest issue banks State provided guarantees to issue banks • From 1930, when the opportunity for foreign issues evaporated, the state started providing guarantees to issue banks to boost their lending • Guaranteed financing could only be spent in agriculture Sparkassen HNB provided financing to sparkassen • Sparkassen’s largest financing resource was the rediscount provided by the HNB • Sparkassen have historically been agricultural lenders and maintaing them served the goal of financing agriculture Sparkassen were heavily financed by the central bank in pursuit of ensuring lending to agriculture Sparkassen’s financing Equity Rediscount from other sources 11% Rediscount from the central bank 32% 18% 31% 24% 26% 24% 21% 23% 45% Deposits 1927 1928 1929 1930 1931 Source: Nagy Magyar Compass, various years and HNA As a result, the Hungarian central bank’s rediscount was much higher than that of the Austrian Rediscount to total assets in Austria and Hungary Austria 14.0%14.0% 11.2% 10.7% Hungary Hungary without Sparkassen 10.7% 7.6% 6.1% 5.1% 2.6% 1926 4.7% 4.8% 3.4% 2.4% 1927 1928 6.2% 4.9% 3.3% 1929 2.6% 2.1% 1930 1931 Source: Nagy Magyar Compass, various years As a result of all these incentives set by the authorities, the banking system’s exposure to agriculture increased to high levels Agricultural lending to total lending at Budapest issue banks 30% through debentures 30% through guarantees 46% 68% 68% 69% 73% 1930 1931 1932 1933 56% 28% 16% 1926 1927 1928 1929 Source: Nagy Magyar Compass, various years Contents Austria Hungary Wrap-up The incentives set by the state increased the exposure of the banking system to a sector which crashed in 1930 Shared interest of the political class and bankers Austria • If industry is maintained, main constituencies are happy • No political instability • Politicians can hold on to power • If industry is maintained, bankers can keep their empire Hungary • If agriculture is supported, main constituencies are happy • No political instability • Politicians can hold on to power • Agricultural lending gave a new market to a lot of issue banks and sustained Sparkassen 1926 1927 1928 1929 1930 1931 1932 1933 Source: For Hungary: Eckstein 1956, Statisztikai Szemle; for Austria: Österreichs Volkseinkommen 1913 bis 1963, WIFO, 1965; Monatsberichte, WIFO, 1927-1931 THANK YOU