Although few people realize it, the Great Depression hit Europe when the Creditanstalt bank of Vienna collapsed in May 1931 and began a domino effect that spread to the rest of Europe. The collapse of the Creditanstalt is seen as the trigger to the great deflationary spiral in Europe between 1931 and 1933. The reason for the impact of the Creditanstalt on Germany and the rest of Europe was that it not only was the largest bank in Austria, but it was larger than all the rest of the banks in Austria put together. The bank had ties to the rest of Europe and the collapse of the Creditanstalt led to a Europe-wide crisis.


The Growth of the Creditanstalt

The Creditanstalt bank was founded in 1855 as the Österreichische Credit-Anstalt für Handel und Gewerbe and was associated with the Rothschilds from its beginning.  When the Austro-Hungarian Empire collapsed at the end of World War I, the Creditanstalt continued to offer commercial, investment and savings to customers in the Successor States to the Empire as well as Amsterdam, Berlin, Bucharest, Paris and Sofia.  Its shares were traded on eleven exchanges, including New York.

The Creditanstalt became the largest bank in Austria through a series of forced mergers.  The Bodencreditanstalt took over the bankrupt Union Bank and the Verkehrbank in 1927, and the Creditanstalt took over the Bodencreditanstalt in 1927 with 90 million schillings of capital, but 140 million schillings of accumulated losses. The Bodencreditanstalt had already absorbed a multitude of small- and medium-sized banks and in 1927 was on the brink of failure.  The Bodencreditanstalt relied upon the discount window of the Austrian National Bank to survive, but when the Austrian National Bank closed its discount window, an acquisition by the Creditanstalt was arranged by the government creating a bank that was larger than the rest of the Austrian banks put together.  Unfortunately, this only delayed the inevitable collapse, concentrating the accumulated losses of Austrian industry in a single superbank.

After the hyperinflation of 1923-1924, Austrian banks failed to restore adequate capital endowments so that any ventures of its banks were increasingly debt financed.  In 1925, Creditanstalt’s equity was only 15% of what it had been in 1914 and its debt/equity ratio rose from 3.64 in 1913 to 5.68 at the end of 1924 and to 9.44 at the end of 1930. Part of the increase in the size of the bank came from loans which the Creditanstalt made to businesses in the successor states. The Creditanstalt did not want to restrict its operations to Austria and ignore the rest of the former Austro-Hungarian Empire. The Creditanstalt borrowed money, primarily from Great Britain and the United States, but this was only on a short-term basis and any failure to renew these loans would lead to the demise of the bank.  Acquisition of the Bodencreditanstalt added to the bank’s problems, and when the bank’s performance began to falter in 1930, the Creditanstalt bought up its own shares to keep the price of its stock from falling.

On May 11, 1931, the Creditanstalt announced that it had lost more than half of its capital, a criterion under Austrian law by which a bank was declared failed.  The bank’s losses amounted to 140 million schillings, equal to 85% of its equity. Not only was the Creditanstalt the biggest bank in Austria, but it was bigger than all the other Austrian banks put together. The Creditanstalt’s balance sheet was the size of the government’s expenditures and 70% of Austria’s corporations did business with the Creditanstalt. It had business interests in eleven banks and forty industrial enterprises of the Successor States and counted 130 domestic and foreign banks among its creditors. Over 50% of its stock was foreign held.  Talk about too big to fail!

The next day, the Austrian government announced a program to rescue the bank with 160 million schillings, 100 million from the Austrian government, 30 million from the National Bank and 30 million from the Rothschilds in Amsterdam.  The announcement of the bank’s failure led to a concern that other Austrian banks might be in danger of failure.  If the largest bank in Austria were on the verge of failure, could other Austrian banks be far behind?

This led to a run on Austrian banks and a massive increase in the money in circulation, which rose from 305 million schillings on May 7, 1931 to 1,141 million on May 31 as Austrians pulled their money out of their banks. Austria’s bailout failed to stop the bleeding and on May 29, the BIS arranged an additional credit of 100 million schillings.  The loan had been delayed by the French who objected to Austrian participation in the Zollunion with Germany. The 100 million schilling credit was exhausted in five days and the Austrian National Bank sought a private 150 million schilling loan from abroad.

People in Austria were afraid that the inflation of 1924 would return and both the banks and the Austrian currency would collapse. They began converting their schillings into foreign currency to avoid the impact of a devaluation. Austria’s foreign reserves declined from 850 million schillings in May to 300 million schillings by the end of the year. The announcement of the losses of the bank raised questions about its solvency, but the run on the bank that followed created problems of illiquidity. The gradual decline in the price of Creditanstalt shares in Vienna and their collapse in May is seen below.





Total losses of the Creditanstalt came to 828 million schillings of which 600 million were losses on bad loans.  The Austrian government guaranteed all the losses of the Creditanstalt on June 27, 1931 but this meant guaranteeing 1,200 million schillings of bank liabilities when the federal budget was 1,800 million schillings. In August, the League of Nations arranged a 250 million schilling loan from seven governments which covered the losses of the Creditanstalt, but the Austrian schilling continued to hemorrhage foreign reserves.  On October 9, 1931 the Austrian government introduced exchange controls on the Austrian schilling.

The run on Austrian banks triggered runs on Hungarian, Czech, Romanian, Polish and German banks. On June 19, 1931, President Hoover declared that there should be a one-year moratorium on the payment of war debts and reparations.  The Danatbank failed in Germany on July 13 leading to a bank holiday on July 14 and 15 in Germany and the closure of the Berlin Stock Exchange until a brief reopening in September. The Reichsbank guaranteed the deposits of all of the banks except for the Danatbank and the banks reopened later in July. The Germans had learned from Austria’s failure to provide a lender of last resort to stem the tide.  The Berlin Stock Exchanged closed again in September and remained closed until April 1932 when the stock exchange reopened.

It took until January 1933 for the Creditanstalt crisis to be finally resolved when the Austrian government took over the bank and issued preferred stock to foreign creditors. The government provided annuities for claims against the bank.  The total losses of the bank amounted to 1,070 million schillings, 7 times the original losses, with the Austrian National Bank bearing the burden of 700 million schillings in losses. On May 5, 1934, the Austrian schilling was devalued by 28%. As the chart of the Austrian Stock Exchange shows below, the devaluation of the schilling stopped the decline in Austrian shares.





The Great Depression Begins in Europe

The crisis proceeded to Great Britain which went off the Gold Standard on September 21, 1931 after its gold reserves shrank from £200 million to £5 million.  Twenty-five countries soon followed in Britain’s footsteps, depreciating their currency against the U.S. Dollar or leaving the gold standard.  By the end of 1931, the Depression was global.  The United States stayed on the Gold Standard until April 1933 when President Roosevelt took the United States off the Gold Standard.  By 1933, the globalized financial system that had prevailed until 1914 was broken and national economies existed almost independently of each other.  It would take another 50 years for the world to recover and return to a globalized economy.

It wasn’t so much that the collapse of the Creditanstalt caused the collapse of the global financial economy, but it set in motion a chain of events that revealed the poor condition of European economies and the fragility of the financial system which quickly fell apart and led to the beginning of the Global Depression of 1931-1933.  The principal problem was that no lender of last resort, either domestic or international, stepped in when the collapse of the Creditanstalt first occurred to guarantee the bank’s liabilities and stop the rot from spreading.

The fear of another domino collapse of the global economy occurred in 2008 when Lehman Brothers went bankrupt and there was a fear that the larger banks would withdraw credits from General Electric, McDonalds and other global corporations leading to a second collapse in the global financial system.  Luckily, Bernanke, Paulson and Geithner remembered how the lack of a lender of last resort in the Creditanstalt collapse of 1931 had precipitated the failure of the global financial system in the 1930s.  They made sure the collapse of Lehman didn’t create similar problems and prevented a repeat of the Global Deflation of 1931-1933.