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History Teaches Us that We Learn Nothing from History, Part 2: It’s 1931 all over again

Fol­low­ing last week­end’s epic fail announced $125 bil­lion bank bailout in Spain, the ever present ques­tion of “what’s next” has been loom­ing larg­er than usu­al this past week. Espe­cial­ly since the details of the bailout are yet to be deter­mined. After all, if an amount of mon­ey that could cut Spain’s unem­ploy­ment rate in half for a year [1] could end up fiz­zling in under 5 hours [2], some­thing does­n’t add up. Dra­mat­ic pol­i­cy fail­ures like this often lead to some sort of soul search­ing and grasp­ing for his­tor­i­cal lessons that might apply to the cur­rent conun­drum. Let’s watch [3]:

Bloomberg
Ghost of Nazi Past Haunts Aus­ter­i­ty-Gripped Europe: Euro Cred­it
By John Glover — Jun 22, 2012 2:21 AM CT

The specter of the 1930s finan­cial cri­sis that cul­mi­nat­ed in the rise of Adolf Hitler’s Nazi par­ty and the Sec­ond World War is stalk­ing Europe.

In May 1931, Cred­i­tanstalt, found­ed in Vien­na by the Roth­schild bank­ing dynasty and the biggest lender in what remained of the Hab­s­burg Empire, suf­fered a run. Its col­lapse after a merg­er with an insol­vent rival sparked a cri­sis that left Ger­many and cen­tral Europe strewn with failed banks, caused defaults in Europe and Latin Amer­i­ca, knocked the pound off the gold stan­dard, and forced the New York Fed­er­al Reserve by Octo­ber to raise its dis­count rate by 2 per­cent­age points.

“The biggest eco­nom­ic cat­a­stro­phe of the last cen­tu­ry has been, of course, the big cri­sis after 1929,” Ewald Nowot­ny, gov­er­nor of the Aus­tri­an cen­tral bank, said at a con­fer­ence this week in Vien­na. “I tru­ly can say that when we had the big cri­sis of 2007 and 2008, it was in the back of the mind of every­body, all of us, every cen­tral banker, that we must avoid the mis­takes of the 1930s.”

What Harold James, pro­fes­sor of his­to­ry and inter­na­tion­al affairs at Prince­ton Uni­ver­si­ty, calls the “vicious cycle” of con­ta­gion between banks and sov­er­eigns is spin­ning today, just as it was 80 years ago. Spain’s 10-year bor­row­ing cost has aver­aged 6.6 per­cent this month, more than a per­cent­age point high­er than a year ago, after it sought 100 bil­lion euros ($127 bil­lion) to bol­ster its banks.

Local Tax­pay­ers

The Euro­pean Union’s accord with Spain, trig­gered by the col­lapse of Bankia SA, the country’s third-biggest lender, will leave the nation with debt about equiv­a­lent to its annu­al gross domes­tic prod­uct. Ireland’s 63 bil­lion-euro bailout of its banks pushed sov­er­eign debt to 108 per­cent of GDP last year from 44 per­cent in 2008.

The crit­i­cal thing now and in the 1930s is that you can’t dis­tin­guish between bank and sov­er­eign debt,” said Bri­an Read­ing, an econ­o­mist at Lom­bard Street Research in Lon­don. “As long as bank­ing sys­tems remain nation­al, it doesn’t much mat­ter how inter­na­tion­al the bank is, local tax­pay­ers are on the hook for it if it col­laps­es.

Under Germany’s aus­ter­i­ty poli­cies in the 1930s, tax­es rose, ben­e­fits and wages were reduced and unem­ploy­ment soared, stok­ing the pop­u­lar ire that Hitler har­nessed. Extrem­ists are gain­ing ground now as unem­ploy­ment in Greece pass­es the 20 per­cent mark after five years of reces­sion. The far-right Gold­en Dawn won 6.9 per­cent of the vote and 18 seats in the country’s most recent elec­tions. France’s anti-immi­grant, anti-euro Nation­al Front won two seats in par­lia­men­tary elec­tions June 17.

Weak Merg­ers

Cred­i­tanstalt in 1931, like Spain’s Bankia now, was cre­at­ed by merg­ers with lenders weak­ened by tox­ic loans and cap­i­tal short­falls. After Cred­i­tanstalt failed, the gov­ern­ment stepped in to prop it up, fatal­ly hurt­ing its own cred­it. A run on Austria’s bonds and the schilling ensued, accord­ing to Michael Bor­do, nation­al fel­low of the Hoover Insti­tu­tion on cam­pus of Stan­ford Uni­ver­si­ty in Palo Alto, Cal­i­for­nia.

...

Yes, the many lessons civ­i­liza­tion learned from the eco­nom­ic cat­a­stro­phes of the 1930’s that led to the rise of fas­cism — the same ones aggres­sive­ly unlearned over the past half a cen­tu­ry [4] — are appar­ent­ly get­ting relearned. For instance, if you’re going to con­duct a major bailout of a sys­tem­i­cal­ly impor­tant bank, make sure it’s actu­al­ly big enough to get the job done. And if you’re going to do an inter­na­tion­al big bank bailout for a coun­try, don’t do it in such a man­ner that the bailout saves the bank but kills coun­try’s cred­it. Learn­ing from his­to­ry nev­er gets old [5]

Spain’s bor­row­ing costs hit 12-year high
Rates on 12 to 18-month bonds top 5% as PM fails to per­suade euro­zone lead­ers at G20 that bailout is not nation­al debt

Giles Trem­lett in Madrid
guardian.co.uk, Tues­day 19 June 2012 10.55 EDT

Spain’s econ­o­my con­tin­ued to ride the bailout roller­coast­er on Tues­day as bor­row­ing costs remained at unsus­tain­ably high lev­els and the gov­ern­ment paid its high­est rate in a dozen years to raise mon­ey.

A €3bn (£2.4bn)bond issue proved, how­ev­er, that Spain could still bor­row on the mar­kets — even if inter­est rates on 12 to 18-month bonds have now risen to more than 5%.

Prime min­is­ter Mar­i­ano Rajoy, mean­while, report­ed­ly failed to per­suade euro­zone col­leagues that a bailout of up to €100bn for Span­ish banks should not be count­ed as nation­al debt — a move that would have eased grow­ing pres­sure for a full bailout of Spain.

“Con­nect­ing bank­ing risk and sov­er­eign risk has become very dam­ag­ing,” Rajoy told fel­low world lead­ers at the G20 meet­ing in Mex­i­co, accord­ing to Span­ish reporters who accom­pa­nied him.

Although oth­ers in Europe would also like to reduce the link between bank­ing risk and coun­try risk, the euro­zone finance min­is­ters who decide on bailouts were report­ed­ly against the idea. “The rules do not per­mit it,” one senior offi­cial told El País news­pa­per.

The €100bn, which is expect­ed to be chan­nelled through Spain’s bank restruc­tur­ing fund, will increase Spain’s nation­al debt by up to 15%.

Spain is expect­ed on Thurs­day to state the glob­al fig­ure of how much it will take from the €100bn cred­it line offered to its banks by the Euro­pean Union’s bailout fund. That deci­sion would be made after a first — and rapid — round of inde­pen­dent audits of Spain’s bank­ing sys­tem.

A deci­sion by the Bank of Spain to post­pone a sec­ond round of audits from late July until Sep­tem­ber did noth­ing to set­tle mar­ket nerves. Yields on Spain’s bench­mark 10-year bonds dropped slight­ly, but still stayed over the cru­cial 7% rate that many econ­o­mists con­sid­er unsus­tain­able.

Finance min­is­ter Luis de Guin­dos insist­ed that Spain did not deserve to be pay­ing such a high penal­ty, claim­ing that reforms would soon reduce the bud­get deficit and set growth going again. “The way mar­kets are penal­is­ing Spain today does not reflect the efforts we have made or the growth poten­tial of the econ­o­my,” he said. “Spain is a sol­vent coun­try and a coun­try which has a capac­i­ty to grow.”

Bud­get min­is­ter Cristóbal Mon­toro con­tin­ued to call for the Euro­pean Cen­tral Bank (ECB) to resume buy­ing Span­ish bonds in order to keep bor­row­ing costs down — and some ana­lysts saw ECB action as inevitable as fears over con­ta­gion in Italy grew.

But oth­ers thought it was too late to see off a full bailout of Spain’s entire econ­o­my. “It is inevitable,” said Harvin­der Sian, of RBS. “The mar­ket has made its state­ment. There has to be a change in the way the Euro­peans are attack­ing the cri­sis.”

Many ana­lysts now con­sid­er that the deci­sions which will shape the future of Spain are no longer in the hands of its own politi­cians. “The Span­ish gov­ern­ment is close to exhaust­ing its domes­tic pol­i­cy options, with the mar­kets increas­ing­ly demand­ing a game-chang­ing response from the EU/ECB to the lat­est phase of the cri­sis,” said Raj Badi­ani of IHS Glob­al Insight.

...

Ok, well, not ALL [6] the lessons have been learned. But at least it appears that Banki­a’s bailout will be big enough. Per­haps that will help calm the mar­kets [7]:

Spain: Audi­tors deter­mine bank bailout could cost as much as $78B in worst case sce­nario

By Asso­ci­at­ed Press, Pub­lished: June 21

MADRID — Spain’s trou­bled banks could need as much as €62 bil­lion ($78.6 bil­lion) in new cap­i­tal to pro­tect them­selves from eco­nom­ic shocks, accord­ing to inde­pen­dent audi­tors hired by the gov­ern­ment to assess the country’s strug­gling finan­cial sec­tor, offi­cials said Thurs­day.

The Span­ish gov­ern­ment will use the audi­tors’ report as the basis for their appli­ca­tion for a bank bailout loan from the 17 coun­tries that use the euro. With ten­sions ris­ing over the future of the euro­zone, Spain is expect­ed to sub­mit its spe­cif­ic request for out­side assis­tance no lat­er than Mon­day, said Jean-Claude Junck­er, who chairs meet­ings of zone’s finance min­is­ters.

“We invit­ed Spain to pur­sue this clear and ambi­tious strat­e­gy, which needs to be imple­ment­ed swift­ly and com­mu­ni­cat­ed ear­ly,” Junck­er said after Span­ish Econ­o­my Min­is­ter Luis de Guin­dos pre­sent­ed the audit results to the min­is­ters who are mem­bers of the so-called Eurogroup.

Deputy Bank of Spain Gov­er­nor Fer­nan­do Restoy not­ed that this worst-case sce­nario cit­ed by the audi­tors was far below the €100 bil­lion ($126.7 bil­lion) loan offered by the eurozone’s finance min­is­ters two weeks ago.

Spain’s bank­ing sec­tor is strug­gling under tox­ic loans and assets from the col­lapse of the country’s prop­er­ty mar­ket in 2008. Con­cerns that Spain’s econ­o­my is so weak that it could not afford the cost of prop­ping up its banks has sent its bor­row­ing costs soar­ing to lev­els not seen since it joined the Euro­pean sin­gle cur­ren­cy in 1999.

...

In the audi­tors’ stress test for the worst-case eco­nom­ic sce­nario — a fall in gross domes­tic prod­uct of 6.5 per­cent over the peri­od 2012–2014 — most of the banks were deemed to be in a “com­fort­able” posi­tion, Restoy said.

“We’re not talk­ing about the imper­a­tive cap­i­tal neces­si­ties of the banks. We’re not talk­ing about some­one urgent­ly need­ing such and such an amount of cap­i­tal to deal with their oblig­a­tions,” said Restoy. “We’re talk­ing about the cap­i­tal that would be need­ed if we were to see a sit­u­a­tion of extreme ten­sion which is very unlike­ly to come about.”

“We should keep in mind we are not talk­ing about how much cap­i­tal an enti­ty needs to sur­vive. We’re talk­ing about how much cap­i­tal an enti­ty will need to con­front a sit­u­a­tion of extreme stress,” he added.

Euro­zone finance min­is­ters offered Spain a bailout loan of up to €100 bil­lion on June 9. The terms of the loan — for which Spain, rather than banks, will ulti­mate­ly be respon­si­ble for — still have to be nego­ti­at­ed.

...

The release of the audits prob­a­bly won’t erase mar­ket ner­vous­ness about Spain, said Mark Miller, an ana­lyst with Cap­i­tal Eco­nom­ics in Lon­don.

“At face val­ue it looks as if there is a rea­son­able safe­ty mar­gin giv­en that up to €100 bil­lion is poten­tial­ly avail­able,” he said. “Hav­ing said that, the extent of the eco­nom­ic sit­u­a­tion in Spain could even dete­ri­o­rate beyond what is being described as an adverse sce­nario.”

...

Well there’s some good news for a change. Sure, the $125 bil­lion ‘bailout’ of Spain’s banks will be added to Spain’s nation­al debt, poten­tial­ly dri­ving the coun­try into insol­ven­cy. But at least that entire $125 bil­lion prob­a­bly won’t be nec­es­sary. After all, the audi­tors con­clud­ed that only $78 bil­lion would be need­ed under a ‘worst case sce­nario’ of a 6.5% fall in GDP from 2012–2014. Spain’s econ­o­my shrank at an measly annu­al­ized rate of 1.2% in the fourth quar­ter of last year [8], so it will take some real­ly bad poli­cies or shocks if we’re going to see that ‘worst case sce­nario’ come to fruition. For instance, the imme­di­ate prob­lem fac­ing Spain is the record high inter­est rates it’s pay­ing in the debt mar­kets and the threat that it sim­ply won’t be able to stay sol­vent. So any­thing that active­ly encour­ages ‘the mar­ket’ to expect Spain to default could poten­tial­ly trig­ger the cat­a­clysmic Span­ish default sce­nario might trig­ger a ‘worst case sce­nario’. You know, some­thing like Ger­many’s Chan­cel­lor send­ing sig­nals that the euro­zone’s ‘core’ (which is pret­ty much just Ger­many at this point) isn’t seri­ous about address­ing Spain’s imme­di­ate debt cri­sis and is ok with a default or even the unrav­el­ing of the euro­zone. And we all know [9] that [10] could [11] nev­er [12] hap­pen [13]:

Finan­cial Times
June 22, 2012 7:07 pm
Euro­zone rift deep­ens over debt cri­sis

By Guy Din­more in Rome and Peter Spiegel in Lux­em­bourg

Lead­ers of the eurozone’s four largest economies pledged on Fri­day to back a €130bn growth pack­age and defend the com­mon cur­ren­cy but remained divid­ed over the cred­it cri­sis as Ger­many con­tin­ued to resist pro­pos­als to issue com­mon debt and use bailout funds to sta­bilise finan­cial mar­kets.

The meet­ing in Rome was intend­ed to demon­strate a com­ing togeth­er ahead of next week’s EU sum­mit, but end­ed in dis­agree­ment over the need for short-term inter­ven­tion in the mar­kets and how to achieve greater polit­i­cal and finan­cial union.

At a joint press con­fer­ence Angela Merkel, Ger­man chan­cel­lor, declined to endorse affir­ma­tions by all three of her co-heads of gov­ern­ment — Italy’s Mario Mon­ti, François Hol­lande of France and Spain’s Mar­i­ano Rajoy — of the need to use the eurozone’s bailout funds to “sta­bilise finan­cial mar­kets”.

“We need to use all exist­ing mech­a­nisms to sta­bilise mar­kets, to give con­fi­dence, to fight spec­u­la­tion,” Mr Hol­lande said. “This would be an impor­tant step,” he added, endors­ing a pro­pos­al by Mr Mon­ti that the bailout fund should be used to buy the debt of “vir­tu­ous” coun­tries on the open mar­ket.

Instead, Ms Merkel said Europe need­ed to respect exist­ing rules and had to work towards com­mon struc­tures to reg­u­late the euro rather than have poli­cies ema­nat­ing from “17 par­lia­ments each with nation­al sov­er­eign­ty”.

“If I am giv­ing mon­ey to Span­ish banks ... I am the Ger­man chan­cel­lor but I can­not say what these banks can do,” she said.

...

Yes, there’s no way we’re going to see a repeat of the 1930’s glob­al finan­cial pan­ic. The his­tor­i­cal lessons are just too com­pelling for a repeat of those mis­takes [14]:

April 20, 2011, 11:01PM EST
Bloomberg Busi­ness­week
Lessons from the Cred­it-Anstalt Col­lapse
Europe is in far bet­ter shape than when the Aus­tri­an bank failed in 1931, but the risk of a domi­no effect remains

By Peter Coy

In May 1931, a Vien­nese bank named Cred­it-Anstalt failed. Found­ed by the famous Roth­schild bank­ing fam­i­ly in 1855, Cred­it-Anstalt was one of the most impor­tant finan­cial insti­tu­tions of the Aus­tro-Hun­gar­i­an Empire, and its fail­ure came as a shock because it was con­sid­ered impreg­nable. The bank not only made loans; it acquired own­er­ship stakes in all kinds of com­pa­nies through­out the sprawl­ing empire, from sug­ar pro­duc­ers to the new auto­mo­bile mak­ers. Its head­quar­ters city, Vien­na, was a place of wealth and splen­dor, famous for its opera, balls, choco­late, psy­cho­analy­sis, and the extrav­a­gant archi­tec­ture of the Ringstrasse. The fall of Cred­it-Anstalt-and the domi­noes it helped top­ple across Con­ti­nen­tal Europe and the con­fi­dence it shred­ded as far away as the U.S.-wasn’t just the fail­ure of a bank: It was a fail­ure of civ­i­liza­tion.

Once again, Europe’s bank­ing sys­tem, and by exten­sion its social fab­ric, is threat­ened by bad loans. What had been slow-mov­ing fis­cal dis­as­ters in Greece, Ire­land, and Por­tu­gal have gath­ered speed in recent weeks despite res­cue pack­ages designed to calm mar­kets and pre­vent spread­ing the con­ta­gion to Spain, Bel­gium, and beyond. Por­tu­gal’s 10-year bor­row­ing costs hit a record 9.3 per­cent on Apr. 20, up from 7.4 per­cent just a month before, even as author­i­ties met in Lis­bon on an €80 bil­lion ($116 bil­lion) financ­ing pack­age. The high­er that cred­i­tors dri­ve up inter­est rates, the more unaf­ford­able the debt becomes-cre­at­ing the con­di­tions for the very fail­ure they fear. “All of the res­cue pack­ages don’t real­ly ensure that we can escape this adverse feed­back loop that these coun­tries are being trapped in,” Christoph Rieger, head of fixed-income strat­e­gy at Frank­furt-based Com­merzbank (CRZBY), told Bloomberg Tele­vi­sion on Apr. 19.

...

The tip­ping point came ear­ly in 1931 when a bank direc­tor named Zoltan Haj­du refused to sign off on Cred­it-Anstalt’s books with­out a com­pre­hen­sive reeval­u­a­tion of the bank’s assets. The bank revealed loss­es that it kept revis­ing upward as the weeks passed. Depos­i­tors with­drew funds. The Aus­tri­an gov­ern­ment stepped in to guar­an­tee all the bank’s deposits and oth­er lia­bil­i­ties-but that only brought the gov­ern­men­t’s own cred­it­wor­thi­ness into ques­tion. “In today’s lan­guage,” says Schu­bert, “Cred­it-Anstalt was too big to fail, but too big to save.”

Harold James, a British his­to­ri­an at Prince­ton Uni­ver­si­ty, described what hap­pened next in his 2001 book The End of Glob­al­iza­tion: Lessons from the Great Depres­sion. “The Vien­nese pan­ic brought down banks in Ams­ter­dam and War­saw. In June and July the scare spread to Ger­many, and from there imme­di­ate­ly to Latvia, Turkey, and Egypt (and with­in a few months to Eng­land and the U.S.).” Aus­tria got an under­sized loan from the Bank for Inter­na­tion­al Set­tle­ments and some help from the British branch of the Roth­schild fam­i­ly. But French politi­cians reject­ed an inter­na­tion­al res­cue with­out polit­i­cal con­ces­sions from Ger­many that weren’t forth­com­ing.

Thus the fail­ure of Cred­it-Anstalt accel­er­at­ed the finan­cial pan­ic that turned a reces­sion into a glob­al depres­sion. Eco­nom­ic dis­tress in Aus­tria con­tributed to the out­break of vio­lent con­flict between social­ists and fas­cists in 1934. Jews became scape­goats. In 1938, Nazi Ger­many occu­pied Aus­tria, and Adolf Hitler was received by ador­ing crowds in Vien­na. Albeit indi­rect­ly, the fail­ure of Cred­it-Anstalt helped clear the path for some of the dark­est events of the 20th cen­tu­ry.

...

The scari­est thing about the Cred­it-Anstalt default is that it occurred in a small, periph­er­al coun­try, just as today’s worst prob­lems are con­cen­trat­ed so far in Greece, Ire­land, and Por­tu­gal, which com­bined make up just 5 per­cent of the 27-nation Euro­pean Union’s gross domes­tic prod­uct. “Aus­tria is a tiny, tiny lit­tle place, and you would­n’t imag­ine it could set off a chain of domi­no reac­tions. But it did. I do see exact­ly that poten­tial now,” says James.

For that rea­son, Ger­man econ­o­mist Hol­ger Schmied­ing says Europe should do every­thing in its pow­er to pre­vent or at least delay defaults by nation­al gov­ern­ments. Schmied­ing, chief econ­o­mist of the Ger­man pri­vate bank Joh. Beren­berg Gossler, says keep­ing Greece and oth­ers from default­ing for as long as pos­si­ble-if not for­ev­er-will give banks in Ger­many, France, and oth­er nations that have lent to them the time they need to rebuild their cap­i­tal so they can with­stand the hit from loan loss­es. The Bank for Inter­na­tion­al Set­tle­ments says that as of last Sep­tem­ber, Ger­man banks had over €220 bil­lion worth of expo­sure to Greece, Ire­land, and Por­tu­gal, and French banks had over €150 bil­lion worth.

For all of Europe’s bick­er­ing over aid to Greece, Ire­land, and Por­tu­gal, the Con­ti­nent is more unit­ed and finan­cial­ly sta­ble now than in the inter­war peri­od. “Unlike Aus­tria in 1931, the euro zone has the resources to bail out the threat­ened banks with­out real­ly trig­ger­ing a full-blown debt cri­sis,” says Michael D. Bor­do, a Rut­gers Uni­ver­si­ty eco­nom­ic his­to­ri­an. The more Europe takes the lessons of Cred­it-Anstalt to heart, the less like­ly it is to make the same mis­takes again. The intro­duc­tion of Schu­bert’s book begins with the famous line of George San­tayana, the Span­ish philoso­pher, who said, “Those who can­not remem­ber the past are con­demned to repeat it.” J. Brad­ford DeLong, an econ­o­mist at the Uni­ver­si­ty of Cal­i­for­nia at Berke­ley, thinks Europe has absorbed San­tayana’s mes­sage-to an extent. “Because we remem­ber the Cred­it-Anstalt, we will not make that mis­take,” DeLong says. “We will make dif­fer­ent ones.”

Lessons learned [15].