Principles, circumstances and constraints: the Nationalbank as lender of last resort from 1816 to 1931 Clemens Jobst, In this study, we provide a discussion of the role the Austrian central bank played as a lender Kilian Rieder1 of last resort (LLR) during selected episodes of financial distress from the Nationalbank’s foundation in 1816 until the Creditanstalt crisis of 1931. Based on our evidence, we argue that free lending as advocated by British economist Walter Bagehot was historically the exception rather than the rule in Austria, and that no clear evolution toward more “free lending” is observable over time. The panic of 1912, a particularly fascinating example of a “forgotten” crisis that has never been investigated in detail, serves as our benchmark because the Natio- nalbank’s crisis management during this specific episode comes very close to an effective case of free lending. Instances of credit rationing during other financial crises seem to have emerged as a consequence of public doubts about the value-storing capacity of banknotes and due to a lack of discountable or pledgeable assets resulting from the Nationalbank’s regulations and/ or risk management framework. Our study echoes earlier literature in the field, underlining the importance of the microeconomics of last resort lending, including the incentive structure of lending programs and the ex ante supervision of counterparties. JEL classification: E58, G01, N13, N14 Keywords: central bank, Austria, Oesterreichische Nationalbank, lender of last resort, financial crisis, banking crisis, credit rationing, liquidity crisis, bank run, moral hazard, Bagehot Why have central banks’ responses to academics, ever since Henry Thorn- financial crises differed so much over ton’s 1802 treatise on The Paper Credit of time? One explanation might simply Great Britain (Thornton, 1802). In its be endogenous learning: policymakers simplest specification, this theoretical draw lessons from mistakes committed and empirical discussion turns around in the past and adapt crisis manage the conditions and circumstances under ment accordingly. Undoubtedly, eco- which central banks should provide an nomic (history) research on the Great extra liquidity injection into the finan- Depression of the 1930s has informed cial system for the benefit of all banks monetary policy reactions to the recent under circumstances of a collective finan- financial turmoil of 2008 (Almunia et cial market liquidity crisis.2 al., 2010; Eichengreen, 2015). How- Walter Bagehot is famously taken to ever, a focus on lessons from history have answered this question in the fol- neglects the fact that the rationale and lowing way: Central banks should lend impact of central banks’ responses to freely, at high interest rates, and only in crises have always been deeply con- return for good collateral.3 The myriad tested, both by contemporaries and rationalizations of Bagehot’s principles 1 Oesterreichische Nationalbank, Economic Analysis Division, [email protected]; University of Oxford, Department of Economics and History Faculty, [email protected]. The views expressed in this paper are exclusively those of the authors and do not necessarily reflect those of the OeNB or the Eurosystem. The authors would like to thank Vincent Bignon (Banque de France) and Stefano Ugolini (Université de Toulouse) as well as the referee and the participants in a workshop among the authors of this volume for very helpful comments and valuable suggestions. Walter Antonowicz and Claudia Köpf from the OeNB’s Bank History Archives have greatly Refereed by: facilitated access to primary sources. Daniel Maier provided excellent research assistance. Charles Goodhart, 2 Rather than representing emergency liquidity assistance (ELA) to individual banks, the historical concept of last London School of resort lending was thought of as a form of support extended to the financial system as a whole. See Goodhart (1999). Economics 3 These principles are generally derived from various passages in Bagehot’s major work. See Bagehot (1873). 140 OESTERREICHISCHE NATIONALBANK Principles, circumstances and constraints: the Nationalbank as lender of last resort from 1816 to 1931 gave rise to many myths and misunder- ture to advance our take on Bagehot’s standings about the lender of last resort principles. Section 2 provides a brief (LLR) by diverting attention from the sketch of the monetary policy frame- historical context in which these func- work of the Nationalbank during the tions first emerged.4 In this study, we period under study. Section 3 then aim at retracing these roots in a parti- describes the “forgotten” panic of 1912, cular national setting, thereby adding which we argue to be a benchmark case Austria to the existing international of Bagehot-style free lending. Section 4 literature on LLRs, which is almost ex- looks at why free lending, which worked clusively dominated by studies on the so successfully in 1912, was not adopted U.S.A. and the U.K.5 We analyze the during most other financial crises. Sec- Nationalbank’s behavior in the context tion 5 concludes. of six crises – 1820, 1848–49, 1873, 1912, 1923–24, and 1931. Our selec- 1 The central bank as lender of tion encompasses both well-known and last resort less well-known episodes of financial Financial crises have generated an ex- distress, but does not represent a com- tensive literature in both economics and prehensive list; rather, it reflects our economic history (Allen et al., 2009). attempt to capture the manifold faces While the proximate and ultimate and aspects of LLR activities through- causes of the fragility leading to a finan- out history. While the crisis of 1820 cial crisis may differ and continue to be constitutes the first financial panic debated, all financial crises share some following the foundation of the privilegirte commonalities that are most relevant oesterreichische National-Bank in 1816, for the question of last resort lending the crash of 1931 in turn stands out as a (Gorton, 2012). These shall be briefly natural endpoint: it represents the last outlined here. crisis before financial repression in the aftermath of World War II (WW II) 1.1 The logic of financial crises led to the complete disappearance of Market economies depend on the use as banking crises in all industrial coun- transaction media of short-term debt tries until the 1970s. obligations issued by financial inter- Based on our evidence, we argue mediaries. These obligations can take that in Austria, free lending was histori- many forms. Normally, we think of cally the exception rather than the rule. deposits here but historically, banks The reason was not that the Nationalbank have also issued private notes or, more did not care for financial stability; recently, shares in money market funds rather, its policy was constrained by a or repos. These instruments have in range of factors, including regulation, common that their exchange requires limits to information and confidence in little or no information on the issuer or the Nationalbank itself. The remainder the underlying collateral; in normal of this study is structured as follows: times, they are information insensi- We first briefly review the LLR litera- tive.6 Banking crises are characterized 4 See Goodhart (1999) and Bignon et al. (2012) for a more in-depth discussion of these fault lines. 5 Some international perspectives are provided in Kindleberger and Aliber (2011). For in-depth studies of individual countries, see e.g. Buyst and Maes (2008) on 19th-century Belgium, and Bignon et al. (2012) on France. 6 Information-insensitive assets are safe assets in the sense that they are accepted as collateral without fear of adverse selection and can store value over time. See Gorton and Ordoñez (2014) and Gorton (2016). MONETARY POLICY & THE ECONOMY Q3– Q4/16 141 Principles, circumstances and constraints: the Nationalbank as lender of last resort from 1816 to 1931 by a flight out of these debt obligations to withdraw cash. However, panics may and into cash. They are systemic events also affect wholesale funding, as during in the sense that they involve many or the recent financial crisis of 2008 most financial intermediaries (Gorton, (Gorton and Metrick, 2012). Ultimately, 2012). panics might even target the liabilities Runs constitute a rational response issued by the central bank itself, nor- to shocks that cause creditors to doubt mally the most liquid and safe asset the ability of financial institutions to available, when people start to doubt honor their debt contracts. These shocks the future value of banknotes and strive may be very small in nature and might to exchange banknotes into real or for- even be expected to happen only in the eign assets. Despite the different ap- future. Yet, it suffices that they are pearance of panics, the consequences strong enough to induce creditors to are similar. In a systemic run, the question the quality of their claims, affected intermediaries are by defini- thereby turning previously informa- tion unable to fully meet the large-scale tion-insensitive into information-sensi- scramble for cash they are facing. In tive assets. When uncertainty about this sense, all intermediaries become asset values increases, the debt capacity insolvent, as they cannot honor their of collateral – the amount of secured obligations without trying to sell assets borrowing that can be sustained by an (Gorton, 2012). If many credit institu- asset – can fall dramatically (Acharya et tions sell their assets