The Banking Panic Isn't Over

On October 6, 1929, it was reported that BodenKreditAnstalt would be merged into CreditAnstalt in a deal valued at $17,000,000 or $211,000,000 in 2008 dollars. The merger of the number two bank into the number one bank was due to the low capital position of BodenKreditAnstalt after WWI and the excessively loose credit standards that essentially put the bank on the ropes.

At the time, the deal was pushed through by the Austrian government and had to be backed by F.M. Rothschild and several London banks. In an effort to boost confidence, the Austrian government guaranteed all bank deposits.

After the initial stock market decline from September 3, 1929 to November 13, 1929, the stock market rallied 48% to the peak on April 17, 1930. For many, the rise in the market seemed to provide some reassurance that the financial system had been restored.

Unfortunately, because a bank's financial strength is closely tied to the value of the stock price, the subsequent worldwide financial meltdown from April 18, 1930 ensured that any, and all, bad loans from the BodenKreditAnstalt/CreditAnstalt merger would be next to impossible to resolve.

CreditAnstalt, ladened with the bad debts of BodenKreditAnstalt, soon suffered from it's own problem lending and falling stock price. CreditAnstalt, founded by S.M. von Rothschild and banker to the Hapsburg empire, was now in need of a lifeline. London banks, the Bank of England, Germany's Reichsbank, Bank for International Settlement and the Bank of Austria all threw money at CreditAnstalt starting in May of 1930 in a failed attempt to shore up the problem. The ultimate failure of the CreditAnstalt in 1931 led to the worldwide banking crisis and bank holidays in the U.S. that same year.

According to the New York Times ("Vienna's Market Calm in Bank Crisis." New York Times, May 18, 1931. p. 31.), the failure of CreditAnstalt, Austria's largest bank, lay squarely on the shoulders of the government effort to merge BodenKreditAnstalt. The newspaper aptly stated:

The troubles of the CreditAnstalt are quite unanimously ascribed here to the unsound policy pursued in 1929, when the crippled BodenKreditAnstalt was attached to the larger concern.

Similar tactics have been displayed with the government imposed mergers of Bear Stearns with J.P. Morgan (JPM), Bank of America (BAC) with Merrill Lynch, and Wachovia with Wells Fargo (WFC). How do I know that these mergers were forced on the acquiring institutions by the government?

• On the Bob Brinker radio show in an interview, available until 5/15/2009 (Saturday, 3pm-4pm hour), with the fawning Patricia Crisafulli, author of House of Dimon, it was stated emphatically that Jamie Dimon, CEO of J.P. Morgan, said that "we were asked (by the government) to do this. Bear Stearns was never something we would have gone out to buy..."
• The Bank of America and Merrill Lynch deal has been recently exposed by BofA CEO Ken Lay Lewis as a sort of "strong-armed" tactic by Treasury Secretary Hank Paulson and Federal Reserve Chairman Ben Bernanke.
• I cannot say for sure that the deal between Wells and Wachovia was government forced. However, it is my observation that the Wells deal with Wachovia was simply a PR ploy to get the public to believe that Wells was healthier than Citigroup (C) and therefore better positioned to take on new responsibilities. This strategy was crafty and similar to forcing $225 billion on nine "select" banks as a way to mask who is really the weakest. Citi was already known by the public to be a zombie bank so Wells was the target of a spin campaign by the government.

The passing off of one troubled institution to the next, in the hopes that the headache would go away, did not resolve the problems associated with the bad lending practices or malinvestment from prior periods. The fact that this approach to solving the problem has been repeated throughout the G8 nations and beyond leaves little room for error.

The blowback from such policies could set off a financial storm of unimaginable length and depth. All it would take is one slip up, in a far flung region, that could set the dominoes in motion.

Comments

[Roger Knights:]

"The blowback from such policies could set off a financial storm of unimaginable length and depth. All it would take is one slip up, in a far flung region, that could set the dominoes in motion."

This is what Taleb was implying the other day. And yet few appreciated what he was saying. A house of cards has risks that are hidden and enormously greater than we're used to thinking about, because they're systemic.

"The passing off of one troubled institution to the next, in the hopes that the headache would go away, did not resolve the problems ...."

Isn't it terrifying to think that the problems are so big and complex they are unresolvable at this point in time--and that the authorities couldn't do any better, in the circumstances? Maybe we had our last chance to save ourselves back in 2002.

May 12 03:33 AM

[punditobserver:]

And you are hoping every day that some catastrophe happens because its the only way you can escape from your trapped short position.

Good Luck.

May 12 06:44 AM

[Kirk Lindstrom:]

Good story but I believe some of the facts are missing or have been ignored.

You wrote:

"I cannot say for sure that the deal between Wells and Wachovia was government forced. However, it is my observation that the Wells deal with Wachovia was simply a PR ploy to get the public to believe that Wells was healthier than Citigroup (C) and therefore better positioned to take on new responsibilities. "

At the time there was a run on Wachovia, didn't the government go to Citigroup and ask it to put itself on the line to take over Wachovia? After the Citigroup deal stopped the run on Wachovia, along with increasing the FDIC limits to $250,000, Wachovia found it could get a better deal with Wells Fargo. At the time, it felt like Citi got screwed and the assets went to Wells Fargo.

May 12 09:18 AM

[Hal.P.:]

Good article. I think we are yet to see the worse to come too. Like then, what is taking place is an attempt to not face the bad decisions head on and accept the consequences and let banks and investments fail. The hope is that by merging good with bad that the good will somehow heal or spread the failure across the system so that it won't hurt as much.

But that's not how it's going to work. Gangrene has set in and must be cut off. Merging is only going to spread the sickness and increase it bringing everyone down hard, just like it did back in the 1930's. It's one of the reasons that China is doing it's best to shore up their gold holdings and get rid of as much US debt holdings as they can. They see the dollar as a dead man walking.

May 12 10:45 AM