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The writer is the author of ‘Seven shocks’
The operation to bail out Credit Suisse into the arms of UBS was flawed and recklessly fabricated. It did not follow the cumbersomely negotiated model for the resolution of large systemically important financial institutions. It gave a strange echo of one of the reddest red flags in international financial history, the story of the interwar failure of the Vienna Creditanstalt.
In 1929, at the start of the Great Depression, the Austrian government pressured the Creditanstalt, by far the largest bank in the country, to take over the second failing bank, the Bodencreditanstalt. Less than two years later, the Creditanstalt itself failed, and the rippling contagion brought down the German banking system. The resulting panic then spread to the major financial centers, London and New York, and ensured that the Great Depression would be an economic memory that would leave permanent scars. At Lehman’s weekend September 2008then-Fed Chairman Ben Bernanke immediately thought of the grim warning provided by the Creditanstalt failure.
The Creditanstalt teaches two lessons. First, it is dangerous for any financial institution to take over a troubled bank. No one can say for sure what worms are in the rotten apple. It’s easy for nervous depositors, creditors and shareholders to think that the rot could spread even further. That is why, in the German crisis of July 1931, after the collapse of the Creditanstalt, Deutsche Bank refused the government’s request to take over or give a guarantee to the bankrupt Darmstädter Bank. A merged megabank would have been highly vulnerable to a bank run.
The second lesson is that very large banks become an impossible threat if they are located in small host countries. The Creditanstalt bailout of 1931 required large-scale government funding in the bailout, and the ensuing fiscal hole spawned a currency crisis. In 2008, small and even medium-sized countries were seriously challenged by the cost of bank support. Crises in oversized banks blew up Ireland and Iceland and required painful IMF involvement. Even in a larger economy, the HBOS saga cost the British taxpayer dearly.
The perception that any bailout today in a small country would be cumbersome, costly and above all uncertain creates further nervousness in a world where investors and depositors are used to diverting large sums quickly.
Small economies should also reflect on what their appeal is. They can be agile, enterprising, with skills that flourish in a loosely regulated environment. That describes Switzerland, and a considerable number of other small countries, accurately when it comes to the application of smart technologies. However, for finance, intelligence creates vulnerability, not strength, and a mega financial institution is especially fragile.
The vulnerability of small countries to the dangers of big banking poses an obvious asymmetry. Isn’t it unfair that the United States can get away with this kind of impromptu bailout of struggling banks? In 2008, when JPMorgan bought Bear Stearns, it seemed plausible that a strong bank could manage the integration of a failing institution. But that action was based on the backing of a big federal budget and a central bank with a big balance sheet. The painful fact for the rest of the world is that the US, and perhaps China as well, can get away with operations that are too dangerous for small countries. Big finance works only for big players.
There may be a case for a single large bank in any country, but then it would have to be extremely secure, with a transparent balance sheet and boring. However, he could not be expected to make bold and innovative financial decisions. Risk taking is best left to smaller players, who are free to play the capitalist game and take risks without expecting bailouts that undermine the basic legitimacy of a market order.
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