In 1931, Austrian bank Creditanstalt, owned by Europe’s famous Rothschild banking family, went under, sparking a run on other Austrian financial institutions that soon spread disastrously across the globe.
The ensuing panic decimated bank after bank and is considered the trigger of the Great Depression.
Could history repeat itself, with Austria again triggering a global financial meltdown?
Some financial experts believe that Austria today is indeed again the “sick man” of Europe, the weakest link whose collapse could spur an abrupt deepening of today’s global financial crisis.
In the 1930s, the turmoil caused by Creditanstalt’s collapse was so intense that it lengthened the Great Depression in the United States by at least two years. The very name Creditanstalt became shorthand among economists for what we now call “systemic risk,” like the pain that followed the unwieldy collapse of Lehman Brothers in September 2008.
Today, Austria’s banks are in trouble again, and experts worry that their woes could turn into a contagion that spreads through Europe and perhaps the entire world.
“Austria could be a trigger,” says Desmond Lachman, resident fellow for the American Enterprise Institute, in an interview with Moneynews.com.
“If Austria is in serious trouble, then the market looks for the next country (to fall) — Sweden, the Netherlands, Ireland, Greece.”
Just like in the early ’30s, Austrian banks suffer now from excessive lending in Eastern Europe. Their loans to that region are estimated at $289 billion — 70 percent of Austria’s total economy, measured in gross domestic product (GDP).
That lending includes $44 billion in Romania, $37 billion in Hungary, $22.4 billion in Russia, and $14.3 billion in Ukraine.
The global financial crisis, of course, has sent these developing economies screeching to a halt.
The outstanding loans are, like the billions in bad home loans drowning U.S. banks, virtually worthless for the moment.
Exacerbating the situation, the Austrian banks made many of their loans in foreign currencies, such as the U.S. dollar and Swiss franc, to allow borrowers to take advantage of lower interest rates in those currencies.
Even households in Eastern and Central Europe were allowed to borrow in foreign currencies. Seventy percent of Ukraine’s loans and more than 40 percent of Russia’s are denominated in foreign currencies.
Now the currencies of Eastern Europe are plunging, making it more expensive for borrowers there to pay back their loans. Like investors across England who bought into Iceland’s “miracle” economy or Norwegian cities stuck with bad U.S. home-loan bonds — small-timers who just wanted a nice return on a “safe” CD — it was bound to end in tears.
“That bet turned out very badly,” Mitchell Orenstein, professor of European studies at Johns Hopkins University, tells Moneynews.com.
A bad bet, but not an unsurprising relationship: “Austrian banks saw Central and Eastern Europe as their old back yard. These areas were part of the Austro-Hungarian Empire,” Orenstein points out. “Creditanstalt was an old empire bank and fell for the same reasons. The problem was a lot of loans to the same exact areas as now: Czechoslovakia, Hungary, Ukraine. That’s why people are making the comparison. It’s certainly valid.”
A Shared Fate
Austria clearly has attached its fate closely to its eastern neighbors.
Overall, Austrian banks account for about 19 percent of the $1.5 trillion in loans outstanding in Eastern Europe, making them by far the biggest player in the region. In addition to Bank Austria Creditanstalt, Austria’s two other biggest banks also have substantial sums committed to Eastern Europe: Erste Bank and Raiffeisen Bank.
The banks’ troubled assets now amount to a whopping 12 percent to 14 percent of Austria’s GDP, Standard & Poor’s estimates. Analysts predict losses ultimately will total $42 billion.
On April 1, Moody’s downgraded its credit ratings for Raiffeisen’s owner RZB and for Erste.
“The persistent turmoil in international capital markets is likely to have an increasingly adverse effect on RZB’s core markets in Central and Eastern Europe and will exert pressure on asset quality, capital ratios, revenues, and earnings,” Moody’s said.
The banks’ troubles have forced the government to provide a $130 billion bailout. Despite the banks’ continuing problems, the public spigot seems now to be closed.
“That’s the limit,” says Werner Königshofer, a member of parliament from the opposition Freedom Party. He tells The Washington Post that “you can’t do everything for everybody.”
In February, Austrian Chancellor Werner Faymann said banks may have to be nationalized, and the Austrian press has openly speculated in recent weeks that the country itself could go bankrupt.
Austrian government bond yields have risen to the level of Portugal, Italy, and Greece, nations notorious for economic mismanagement and underperformance. The OECD estimates that Austria’s public debt will surge to almost 70 percent of GDP next year, from 62.6 percent last year.
To avoid a meltdown, the Austrian government has urged the European Union to put together a $260 billion rescue package for members in the east.
Yet Germany and other countries have rejected that idea, and President Barack Obama had little luck changing sentiment at the recent G20 summit in London. Bigger economies there argue that it really amounts to an effort to put Europe on the hook for mistakes made by Austrian banks.
If Eastern European banks tumble, the fallout would hit Austria’s sovereign debt ratings quickly — very bad news, as many a Latin American leader could tell you. Austria could end up a zombie country, dependent on last-resort lending from institutions like the International Monetary Fund. At the G20, leaders did agree to put $1.1 trillion into IMF coffers for just this kind of need.
Roger Kubarych, chief U.S. economist for UniCredit Group, which owns Bank Austria Creditanstalt, argues that the bank’s position now is far different, thanks to a different world economy. “One of the strengths of the Austrian economy is that it’s open,” Kubarych says.
In addition to making loans, Austrian banks bought or established their own banks in countries to their east. Those moves came as these nations sought to establish market-based banking industries after the fall of communism.
UniCredit now has banks in 22 countries serving 40 million people, including Italy, Germany, Russia, and nearly all of the former Soviet bloc countries of Eastern Europe.
“It’s natural for banks to follow companies. Austrian companies are heavily involved in outsourcing in these countries,” Kubarych says. “They’ve had close ties for decades and decades.”
Minimizing the Problems
And there is a case for hope. In addition to Poland and the Czech Republic, the economies of the Slovak Republic and Slovenia also are in decent shape, Orenstein says. As a result, he and others don’t see the plight of Austrian banks as a dire development.
Another plus for Austrian banks is that they didn’t join some of their European brethren in loading up on U.S. subprime securities, and they are reasonably well capitalized.
Their capital and reserves ratio registered a healthy 7.1 percent of total assets as of December. But that figure is computed on a non-risk adjusted basis, Deutsche Bank economist Sebastian Becker points out in a recent report.
Debt securities nevertheless are rising as a percentage of total bank assets, while deposits are falling, Becker warns. “Austrian banks increased the share of debt securities refinancing over the past 10 years to 24.6 percent of total assets from 17.5 percent.”
Experts remain on edge. In the environment of a global financial crisis, Austrian banking blues are particularly worrisome, Lachman says.
“In Europe, the eastern countries are a problem,” Lachman explains. “Austria is just the most egregious case of being exposed. Switzerland, Sweden, the Netherlands, and Belgium also have big exposures.”
The woes of Eastern Europe’s basket cases are in some ways a lot worse than those of Asian countries during that continent’s crisis in 1997-1998, Lachman says. The currency-driven contagion then soon spread to Russia and affected global finance for years.
“The Baltics are running current account deficits that total 15 percent to 20 percent of GDP. There’s a huge amount of short-term debt that has to be rolled into foreign exchange.” In addition, political instability has emerged in the Czech Republic, Hungary, Latvia and Ukraine.
“I think people are minimizing the problems,” Lachman says.
Most people wouldn’t associate Mark Twain with Austria, but Lachman does. The American author once said, “history doesn’t repeat itself, but it does rhyme,” he notes.
In the case of Austria now, Lachman warns, “you just get different dominoes that fall.”
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