Saturday, April 24, 2010

Rhyming with Creditanstalt

I don't usually do this but this was so good I had to paste it verbatim. It is from creditwritedowns have been talking about the Austrian banks for months in investor debates and in disuctions. It is amazing how loudly we are rhyming with the 30s except the whole thing is much bigger. Creditanstalt got the whole thing headed back down again. After that what put the nail in the coffin was UK being forced to go off the gold standard in fall of 1931. Can we be rhyming any louder? What is happening seems so freaking obvious and hardly anyone sees it (at least judging by the U.S. equity markets).

Honestly, it is formatted better if you just go to creditwritedowns but the whole thing is pasted below.

The Greek Crisis Has Me Thinking About 1931

The news about Greece’s bailout has me thinking a lot about Creditanstalt, the Austrian bank which collapsed in 1931. This account bears remembering because we should see the 1929-1933 descent as a two-part episode, with the second part starting in the Spring of 1931 with Creditanstalt.

It should be noted that there were a lot of positive economic signs before the Creditanstalt ruined this. The key difference to today is the monetary liquidity and fiscal stimulus, which has buoyed both asset markets and the real economy. But, the situation in Greece makes me think a lot about Creditanstalt.
The similarities and the differences for the US economy were brought home for me by two data points I want to share.

News from 1931

First, there is the blog site News from 1930 which provides verbatim news from the Wall Street Journal exactly 79 years ago because the September 2008 Lehman bankruptcy roughly corresponds to the October 1929 crash. They have an entry from yesterday with a lot of good data points. The ones I want to highlight are bulleted below. By and large, they are very bullish. Everything is upbeat.

Thomas E. Dewey, Chief Asst. US Attorney, announces Amer. Bond & Mortgage is being investigated by Justice Dept. Company issued about $90M of mortgage bonds in past few years, most of which are now in default. Company owns and operates the Mayflower Hotel in Wash. and several NY hotels.

H. Bancroft, Wall St. Journal publisher, says unclear if business has definitely passed low point of depression, but “whether or not business has passed the extreme low point, it is very close to it.” Cites rapid US increase in savings and paying down of debt.

Pres. Hoover receives reports from editors of business papers covering seven major industries on "What Is Holding Back Industry." List by industry: Automotive – tariff and "hand-to-mouth buying." Construction – lack of standardization and banks’ hesitancy in making loans. Food – waste in distribution and failure of big baking cos. to lower bread prices. Chemical – lack of price stability, taxes, inadequate statistics, and bad trade practices. S. Dennis, chair. of nat’l conf. of business paper editors, proposes committee of outstanding business leaders headed by Owen Young to help business plan national economic policy and restore prosperity. Attacks "individualistic trend based upon the philosophy of ‘devil take the hindmost.’" Labor Sec. Doak warned editors it would be dangerous to reduce wages as percentage of nat’l income. Dr. J. Klein, Asst. Commerce Sec., pointed to some positive news including recent steadying in prices and European markets.

US seen likely to ease credit further if large export of gold from France threatens to follow recent $3.5M shipment; objective is to divert gold to where it’s needed.

A number of economists believe business is scraping bottom; they don’t expect quick improvement, since summer is usually dull for business, but believe a further sharp decline is unlikely.

W. Atterbury, Pennsylvania RR pres., notes business decline has lasted almost two years; precedent certainly indicates we’re scraping bottom and trend should turn upward before long. Wrong to single out rail difficulties in the depression; rails have been affected similarly to other industries, should recover similarly.

Last week’s bank statements contained some encouraging signs: loans and investments reversed downtrend, increasing $206M to $23.051M, though bulk of the increase went into buying securities; demand deposits increased, possibly due to veterans’ bonus money; purchases of non-govt. securities continued.

Harvard Economic Society says gains in seasonal spring recovery this year have been
far less widespread than a year ago, but, since they started from a much lower base, should be longer lasting. "We anticipate that they will continue and spread and that an upturn of general business is in early prospect."

B. Hutchinson, Chrysler VP: "Automobile production and sales are steadily progressing toward what we regard as normal volume and may reach that point this summer." Expects more sustained production for remainder of the year than in previous years; inventories in very satisfactory shape.

C. Mitchell, Bank of US chairman, admitted under defense cross-examination that he attended the directors’ meeting at which large loans to affiliates were approved; Mitchell previously contended he had little to do with those loans.

Refineries ran at 68.2% in week ended Apr. 18; stocks of gasoline declined 383,000 barrels to 46.384M. Crude oil production in week was 2.422M barrels/day, up 113,750 from prev. week but down 138,900 from a year ago.

There is a lot more from this entry. Notice the bullet on Mitchell; they had their scandals too. And they were just then surfacing, much as they are today.

But that last bullet is important. Refineries were operating at only 68% of capacity. That is much worse than today. Utilization rates are depressed but they are well above 80%. To me, this speaks to the robustness of the 2010 real economy as compared to the 1931 real economy.

Nevertheless, the bullets showing extreme levels of rebound confidence (in what we now realize was the middle of a terrific slide into Depression) are frightening to say the least.

The Greek disaster

Then you have Peter Boone and Simon Johnson writing on Greece, The IMF, And What Comes Next.

These two are pretty bearish on a positive outcome for Greece and the Eurozone. Earlier this month, I wrote a post "Greece And The Potential Upside In An IMF Rescue" as a sort of optimistic spin on their depressing "Greece And The Fatal Flaw In An IMF Rescue." But, I was just brainstorming potential exit strategies. The reality for Greece is very much as Boone and Johnson present it: dire.

Here’s what they say in their latest post. This is what had me thinking Creditanstalt:

The latest developments from Europe – including Greece appealing for an IMF program today – may well be a watershed, but if so, it is not a good one. The key event yesterday was that the yield on all the debt of weak eurozone governments widened while German yields fell. The spreads show all you need to know: a very clear and large contagion risk.

The five year Portuguese yields rose from 3.84% to 4.26%. The five year Spanish bonds rose from 2.89% to 3.03%, and the five year Irish bonds rose from 3.74% to 3.97%. These are not minor moves for investment grade sovereign bond funds. This kind of change means, for example (and roughly), you lose 0.5% on the value of a bond in one day. These are bonds that just pay 3% per year – and one such day may be enough to cause “investment grade investors” to decide not to stay involved and not to come back for a long while…

These higher government bond yields are also hitting banks. No doubt there is a bank run on in Greece to some extent at the wholesale level. This will spread to other banks in the region. Since their marginal funding costs are tied to the creditworthiness of the sovereign, and since the collateral for these banks’ portfolios is tied to local property values and assets, these changes in sovereign yields will have a negative impact on banks’ balance sheets.

Irrespective of the next move – which lies this weekend with the International Monetary Fund and the ministers of finance meeting in Washington for the Fund’s spring meetings – this looks like the moment when the Greek problems really start to generate contagion across the eurozone region. We’ll see rates on government debt trending higher, asset prices (such as real estate) falling even more, and renewed concern about banks on the European “periphery”.

It is that contagion and bank run part that I find worrying. I wrote about 1931 in March of last year, quoting from Charles Kindelberger (read it here). What essentially happened was that an innocuous notice from a Dutch bank that it was raising the lending rate for a fairly insignificant Austrian bank created a panic run on that bank, Creditanstalt. This bank was bailed out. But rather than calm things down, the bailout created a rout on the entire country. Eventually, Austria’s collapse reverberated around the world through bank interconnectedness and Depression ensued.

As Spring 1931 corresponds to right now, I see parallels to what is occurring in Greece and what occurred in 1931 Austria. This as a critical juncture in the Euro experiment, not just for Greece, but globally. Boone and Johnson suggest that a bailout of Greece is now perceived as a collective backstop of Portugal, Spain, Ireland and Italy too.

And this is simply not credible. So, the sovereign bond contagion is already with us. However, if a Greek bank run ensues, I am pretty sure Swiss, German or Austrian bank exposure to these banks would be a serious problem. the question is what can the Eurozone due about this? Is the US involved in any way? Yes it is.

Johnson and Boone say:

Yesterday was also a wake-up call for the United States. It is no longer reasonable or responsible to say: “US banks have no exposure to Greece”. US banks are heavily exposed to Europe, and this is turning into a serious Europe-wide problem. The US badly needs to make sure this does not spread beyond Greece and Portugal/Ireland.

To restore confidence in buying Spanish and other major European nation bonds, it would surely help to have clear signals that President Obama himself, and the Federal Reserve, are taking an active stance now on making sure this does not spread to become another threat to global financial stability. A broader wall of preventive financing must now be put in place – after all, this is exactly why (in principle) the IMF was recapitalized this time last year.

Such a push by the US would be awkward, to be sure, as the French and Germans (and British) are not keen to have more US involvement in their affairs. But the Europeans have handled matters so badly in the past few months, it is time for a much more scaled-up US role.

The following passages are excerpts from Charles Kindleberger’s book "The World in Depression."

The Creditanstalt

Just as in May 1873 and July 1914, with tension growing among Germany, France, and Britain, the crack, when it came, appeared in Austria. In the early spring of 1931, a Dutch bank wrote a polite letter to the Creditanstalt in Vienna saying that it was obliged to raise the charge on its acceptance credits from 0.25 percent a month to 0.375 percent. It was a timorous letter, says Beyen, not a prescient one, and the bank was somewhat surprised when the Creditanstalt chose to pay off the loan rather than renew at the higher rate. Three months later the Creditanstalt could have used the money.

The Austrian economy had been in disarray since the Treaty of St. Germain of 1920. Its finances had required League of Nations loan assistance, which entailed international supervision between 1922 and 1926…Industrial capital was consumed in the postwar inflation, and financial capital in the unsuccessful bear speculation against the French franc in 1924 that produced failures of the Allgemeine Industriebank, the Austro-Polnische Bank, and the Austro-Orientbank, as well as the private Union Bank owned by one Bosel, with grave difficulties for Kolmar& Co., Kettner, and the Brothers Nowak. Maerz calls this episode "the opening shot of a series of bank failures culminating in the breakdown of the Creditanstalt seven years later."…

In May 1931 losses were still at 140 million schillings, and capital at 125 million plus disclosed reserves of 40 million for a total of 165 million. Under Austrian law, if a bank lost half its capital it had to "turn in its balance sheet," or close down. In an effort to rescue the Creditanstalt, the government, the National Bank, and the House of Rothschild, the last with help of the Amsterdam branch, furnished 100 million, 30 million, and 22.5 million schillings, respectively. But the announcement of the support operation on May 11, 1931, started a run, partly foreign, partly Austrian…

By June 5 the credit [for the entire country] was exhausted and the Austrian National Bank requested another. Still under pressure, the bank raised its discount rate to 6 percent on June 8 and 7.5 percent on June 16. The new credit was arranged by the BIS, by June 14 this time, but subject to the condition that the Austrian government should obtain a two-to-three year loan abroad for 150 million schillings. At this point the French interposed the condition that the Austrian government should abandon the customs union with Germany. The Austrian government refused, and it fell…

The demise of the Creditanstalt and the Austrian government was followed by a run on Germany and an attack on Sterling, which was depreciated a massive 25 percent as a result. Afterwards, central banks began a run on the U.S. dollar, liquidating it for gold. The banks included the Bank of France, the National Bank of Belgium, the Netherlands Bank and the Swiss National Bank. The result was an immediate need to increase the interest rate in the U.S. from 1.5 to 3.5 percent.

These events triggered further panics and bank runs in the U.S.. Later, the U.S. dollar was depreciated and multiple bank holidays were called to contain the panic.

The U.S. economy bottomed only in April 1933.

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