The writer is author of ‘Seven Crashes’
The operation to rescue Credit Suisse by pushing it into the arms of UBS was flawed and rashly concocted. It did not follow the cumbersomely negotiated model for the resolution of large systemically important financial institutions. It gave an uncanny echo of one of the reddest of red flags in international financial history, the story of the interwar failure of the Vienna Creditanstalt.
In 1929, at the outset of the Great Depression, the Austrian government pushed the Creditanstalt, by far the country’s largest bank, to take over the failing second-largest bank, the Bodencreditanstalt. Less than two years later, the Creditanstalt itself failed, and the rippling contagion brought down the German banking system. Ensuing panic then spread to major financial centres, London and New York, and ensured that the Great Depression would be a permanently scarring economic memory. In the Lehman weekend of September 2008, then Fed Chair Ben Bernanke thought immediately of the grim warning provided by the failure of the Creditanstalt.
The Creditanstalt teaches two lessons. First, it is dangerous for any financial institution to take over a problematic bank. Nobody can tell for sure what worms are in the rotten apple. It is easy for nervous depositors and creditors and shareholders to think that the rot may spread further. That is why, in the German crisis of July 1931, following the Creditanstalt collapse, Deutsche Bank refused the government’s plea to take over, or to give a guarantee to, the bankrupt Darmstädter Bank. A merged megabank would have been very vulnerable to a banking run.
The second lesson is that very big banks become an impossible threat if they are in small host countries. The 1931 Creditanstalt rescue required large-scale government funds in the bailout, and the consequent fiscal hole generated a currency crisis. In 2008, small and even medium-sized countries were severely challenged by the cost of banking support. Crises in over-sized banks effectively blew up Ireland and Iceland, and required painful IMF involvement. Even in a larger economy, the HBOS saga cost the British taxpayer dear.
The perception that any bailout today in a small country would be cumbersome, costly and above all uncertain makes for greater nervousness in a world in which investors and depositors are used to shunting large amounts quickly.
Small economies should also reflect on what their appeal is. They can be nimble, entrepreneurial, with skills blossoming in a loosely regulated framework. That describes Switzerland — and a substantial number of other small countries — accurately when it comes to the application of smart technologies. For finance however, smartness creates vulnerability not strength — and a mega financial institution is especially fragile.
The vulnerability of small countries to the perils of big banking raises an obvious asymmetry. Isn’t it unfair that the United States can get away with this sort of improvised rescue of struggling banks? In 2008, when JPMorgan bought Bear Stearns, it looked plausible that a solid bank might manage the integration of a fallen institution. But that action relied on the backstop of a big federal budget and a central bank with a large balance sheet. The painful fact for the rest of the world is that the US, and perhaps China too, 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 exceedingly safe, with a transparent and boring balance sheet. However, it couldn’t be expected to make bold and innovative financial decisions. Risk taking is better left to smaller players, who are free to play the capitalist game, and to take risks without expecting rescues that undermine the basic legitimacy of a market order.
Source: Economy - ft.com
