BIS Compares & Contrasts the 2008 and 1931 Crises

July 18, 2011

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The Bank of International Settlements compared the 2008 crises with that of 1931, finding the shock of Lehman’s failing sparked a mistrust between debtors and lenders and a fight for liquidity.  The finding is similar to a study here of the 1997 Asian financial crises, and provides a road map for a potential Chinese hard landing.  The solvency of the banking sector is called into question.  Investors assume governments will take on the banking sectors bad debts, creating concern about the solvency of governments, leading to sovereign debt defaults and currency crashes.   This is consistent with the research by Rogoff and Reinhart.

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  • The difference between the two crises was that Gold was considered liquid and safe collateral in 1931, while central banks were willing to take in virtually any “asset” on to their balance sheets to reliquify .

2008

  • Following the Lehman crises, capital flowed out of international banks to the US and Japan (as the carry trade reversed and there was a demand for liquidity), causing domestic lending to contract.
  • There was a liquidity mismatch, with inventories of long term assets (mortgage securities) were financed by shorter term liabilities, such as commercial paper.
  • Liabilities at banks were large enough in Iceland and Ireland to call into the question the solvency of the government, which was presumed to back the banks.

1931

  • The banking crisis began in May 1931 with the disclosure of disastrous losses at
    Creditanstalt in Vienna
  • The ensuing crisis in Austria was followed immediately by a crisis in Hungary and shortly afterwards by one in Germany.
  • Pressures on sterling, which had been  chronic ever since the UK had returned to the gold standard in 1925, became acute during the summer of 1931 and the UK left the gold standard in September.
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