Lords of Finance: 1929, the Great Depression, and the Bankers Who Broke the World (58 page)

In January 1931, he took his first tragic steps down the Faustian path. In December 1930, he had been introduced to Hermann Göring. Until then, despite his dealings with the Nationalist leader Hugenberg, he had had very little contact with the Nazis, whom he would later claim to have dismissed as a fringe group of rabble mongers. Nevertheless, Schacht’s wife was well known to hero-worship Hitler and was a devoted supporter of the party. In her diary, Bella Fromm, the diplomatic columnist of the
Vossische Zeitung,
recounts how she encountered the Schachts in February 1930 at the silver wedding reception of a prominent Berlin banker. Frau Schacht wore an expensive swastika of rubies and diamonds on her ample bosom and Fromm recorded the rumor that Schacht himself was “not above using the swastika
⁶⁵⁰
as his insignia whenever he thinks it will suit his purpose.” That night he even told her, “Why not give the National Socialists a break? They seem pretty smart to me.”

The conversation during his evening with Göring focused on the “economic situation
⁶⁵¹
, the rise in unemployment figures, the timidity of German foreign policy,” and Schacht took to this “pleasant, urbane
⁶⁵²
" man. On January 5, Göring invited Schacht, along with Fritz Thyssen, chairman of the giant United Steel Works, to meet Hitler at his modest apartment in a middle-class neighborhood of Berlin—Göring did not yet have access to the government money that would allow him to become the corrupt voluptuary of later years. The Nazi leader arrived after dinner dressed in the yellow and brown uniform of his paramilitary forces; Joseph Goebbels also showed up. Schacht admitted to being impressed. Hitler was surprisingly modest and unpretentious, especially for the leader of the second largest party in the country. During the next two hours, Hitler, “in spite of a hoarse, somewhat broken and not infrequently croaking voice,” dominated the discussion, doing 95 percent of the talking—about the restoration of Germany’s position in the world, about the need to get the six and a half million unemployed back to work, and how this could only be done by state intervention. Hitler was articulate, speaking without any “propagandist pathos,” but obviously “a born agitator.” It was a fateful encounter for the fascinated banker.

ARNOLD TOYNBEE
,
IN
his magisterial review of the year’s events on behalf of the Royal Institute of International Affairs, would later compare the events of the summer of 1931 to the summer of 1914. Both began with relatively minor events far from the hub of the world that nevertheless set in train a cascade that plunged out of all control and brought down an entire world order. In 1914, it was the assassination of the Austrian heir presumptive, the archduke Franz Ferdinand, at Sarajevo. In 1931, it was the failure of the Credit Anstalt, the oldest and largest bank in Austria.

On Friday, May 8, the Credit Anstalt, based in Vienna and founded in 1855 by the Rothschilds, with total assets of $250 million and 50 percent of the Austrian bank deposits, informed the government that it had been forced to book a loss of $20 million in its 1930 accounts, wiping out most of its equity. Not only was it Austria’s biggest bank, it was the most reputable—its board, presided over by Baron Louis de Rothschild of the Vienna branch of the family, included representatives of the Bank of England, the Guaranty Trust Company of New York, and M. M. Warburg and Co. of Hamburg. After a frantic weekend of secret meetings, the government made the problem public on Monday, May 11, at the same time announcing a rescue package of $15 million, which it would borrow through the BIS.

Austria was a small country, about a tenth the size of Germany, with a population of fewer than seven million and a GDP of $1.5 billion. Nevertheless, the news burst like a bombshell upon the City of London and the Bank of England. By an odd coincidence, Schacht was staying with Norman at Thorpe Lodge when the story broke. Harry Siepmann, one of the governor’s principal senior advisers, knowing something of the scope of the tangled mess that lay behind the headlines, announced, “This, I think, is it, and it may well bring down the whole house of cards in which we have been living.”

Like many German banks, the Credit Anstalt made direct investments in industry, similar to those of a modern private equity firm. It was,
however, especially vulnerable not only because it borrowed short-term money to finance what were long-term, highly illiquid, investments but also because it had an unusually large amount of foreign borrowing on its books—some $75 million out of a total deposit base of $250 million.

It had grown over the last decade
⁶⁵³
by absorbing a series of failing small banks and, in 1929, had been further “persuaded” by the Austrian National Bank to take over the Bodencreditanstalt, its next largest rival, whose losses turned out to be gigantic. In order to compensate Credit Anstalt
⁶⁵⁴
for saving the Austrian banking system by taking on the burden of a such a large bankrupt institution, the Austrian central bank had been funneling money secretly to it through London banks, a fact of which the Bank of England was well aware.

The announcement of the rescue package failed to stabilize the situation, perhaps because more people knew how deep the problems went than the government realized—when Credit Anstalt was finally wound up two years later, the accumulated losses amounted to $150 million. Over the next four days a run developed, not only on the Credit Anstalt but on all Austrian banks, which lost some $50 million in deposits, about 10 percent of the total. In an attempt to shore up its banking system, the Austrian National Bank followed Bagehot’s principle and lent freely, injecting an extra $50 million, which caused an overnight jump of 20 percent in the national money supply.

Norman had a soft spot for Austria. After the war, he had provided it with the first loan to stabilize its currency—for his services to the country he had been awarded the Grosse Goldene Ehrenzeichen (Grand Decoration of Honor in Gold) from the Austrian ambassador to the Court of Saint James, Baron Georg von und zu Franckenstein. For the next several days, having now discovered the remarkable advantages of international telephone calls, he was constantly on the line to Harrison in New York and Luther in Berlin. Fearing that a monetary breakdown in Austria would spread to neighboring countries, he was determined to mount an international rescue effort.

None of the central bankers had faced an international financial crisis
before; they therefore had to make things up as they went along. In so doing they made two mistakes. Given the scale of the problem, they came up with far too little money; and believing that it was necessary to put together as international a consortium as possible, they did not act quickly enough. For all the frantic telephone calls, it took them three weeks to drum up the money, and then only came up with $15 million.

By the time the loans had been agreed to, the promised money had already been used up and the run on Austrian banks had become a run on the Austrian currency. The National Bank lost $40 million of its $110 million of gold reserves. Faced now with both a banking system under threat and a currency under siege, it now pleaded for another $20 million.

The crisis was made immeasurably more complicated by the politics of the situation. In March 1930, Germany and Austria had announced that they would form a customs union. Germany’s neighbors, in particular the French and the Czechs, remembering that the nineteenth-century Zollverein, the historic customs union among the states of the German Confederation, had been a prelude to German unification, and fearing that this might be the first step to
Anschluss
, union between Austria and Germany, had been agitating to block the move.

The French government
⁶⁵⁵
now saw its opportunity. Indeed it helped to create it by secretly encouraging French banks to pull money out of Austria. By June 16, the situation was becoming more desperate by the hour. The cabinet, fearing the breakdown of law and order in Vienna, was on the verge of imposing a bank holiday. Austria was still waiting anxiously for the second loan when it received word that France had offered to provide it—but only if Austria would abandon the customs union. As if in an ultimatum, the Austrian government was given three hours to respond.

With its back to the wall, Austria might have accepted. In London, however, Norman was outraged at this blatant abuse of French monetary power in such a delicate financial situation and cabled that the Bank of England would provide the loan on its own. But if he thought he had succeeded in pricking the panic in its bud, he was mistaken.

ON JUNE
5, at 2.30 in the afternoon, Thomas Lamont put a call through to President Hoover. As soon as the Austrian crisis had broken, Germany had also begun to lose gold reserves. The contagion was not so much because Germany had a large amount of capital tied up in Austria, rather it was largely a matter of psychology. The world, which had never drawn much of a distinction between the banking situation in Berlin and that in Vienna, jumped to the conclusion that if the main Austrian bank was in such serious trouble, it was very possible that a German bank might soon follow. As money started escaping Germany, rumors circulated that Berlin might soon request a suspension of reparations. Lamont feared that to cope with the political turmoil and flight of capital that would ensue, Germany might impose exchange controls. With American institutions holding about a billion dollars in short-term credits to Germany, such a move could threaten the solvency of more than one U.S. bank.

Saying that he was about to make a suggestion that the president would “more than likely throw out of the window
⁶⁵⁶
,” Lamont proposed that Hoover unilaterally declare a holiday on all payments on war debt and reparations. No European country could advance the idea, for it would immediately call into question its own credit, signaling to its creditors as he put it that “the jig is up.” Only the United States was in a position to take the lead. Hoover was initially unconvinced. “I will think about the matter” he told Lamont, “but politically it is quite impossible. Sitting in New York as you do, you have no idea what the sentiment of the country at large is on these intergovernmental debts. . . . Congress sees France piling up lots of gold, increasing armaments. . . .”

Lamont tried to convince Hoover that it would actually help him politically. There were “a lot of people whispering about the 1932 convention,” he warned, and such a dramatic move would quiet doubts about the beleaguered president’s leadership. He signed off with the casual authority that went with being a senior partner at J. P Morgan & Co: “One last
thing, Mr. President, if anything by any chance ever comes out of this suggestion, we should wish to be forgotten in the matter. This is your plan and nobody else’s.”

In response to Lamont’s call, that same afternoon Hoover summoned his trio of senior advisers—Secretary of State Henry Stimson; Secretary of the Treasury Andrew Mellon; and Mellon’s undersecretary, Ogden Mills—to work out a moratorium along Lamont’s lines. Mellon declared his “unqualified disapproval” of such a move but left on vacation the very next day for Europe.

Stimson, however, was enthusiastic. A true American aristocrat, born into a wealthy New York family, a graduate of Phillips Academy in Andover, Yale and Harvard Law School, a member of Skull and Bones, and a partner in the white-shoe Manhattan law firm of Root and Clark, Stimson was the first of that breed of Wall Street wise men. He brought to the State Department a Victorian sense of propriety—he and his wife, for example, refused to receive divorced people in their home—and a strongly anti-isolationist international perspective. So committed was he to promoting goodwill among nations that when, in 1929, he discovered that the State Department’s “Black Chamber” had been routinely breaking the coded communications between foreign embassies and their home governments, he immediately closed down the practice, arguing later that “gentlemen do not read each other’s mail
⁶⁵⁷
.” Relying on his fellow Bonesman and internationalist, George Harrison of the New York Fed, to feed him advice on world finance, he had ever since taking office been an advocate of forgiving war debts.

On the very day that Hoover was proposing a moratorium to his cabinet colleagues, Chancellor Brüning had launched his own initiative. On June 5, he unveiled a new package of austerity moves that included a further lowering of civil servants’ salaries, a cut in unemployment assistance, and new taxes. In order to sweeten the pill, Brüning accompanied the measures with a manifesto. Sensational and provocative in tone, the German proclamation announced that “the limit of privations that we can impose on the nation have been reached.” The economic assumptions on
which the Young Plan had been based had proved to be wrong, and thus “Germany had to be relieved of “the intolerable reparation obligations” and “tributary payments” to which it was subject.

That very weekend, Brüning was in London on a long-planned visit to the British prime minister, Ramsay MacDonald. The German delegation was spending the weekend at the prime minister’s official country house, Chequers, in the Kent countryside, where Norman joined the party on Sunday, June 7. After a leisurely lunch for nineteen, which included such guests as John Galsworthy and George Bernard Shaw, both authors very popular in Germany, the officials withdrew to discuss financial issues. Brüning described the terrible situation in Germany. That year, when the Reichswehr needed six thousand new recruits, eighty thousand men applied, half of them undernourished. People were in despair. The social fabric was unraveling. The menace of Nazi and Communist agitation was growing by the day.

While Brüning was holding forth, several frantic telegrams arrived from the British ambassador in Washington, who had just heard from Stimson, who was infuriated by the manifesto’s confrontational tone. On no account, warned the secretary of state, should the Germans take any unilateral action, which could only trigger a massive flight of short-term funds out of Germany that would rob Hoover’s planned moratorium, which was still a secret, of much of its benefit. The telegrams threw the British into shock. It was the first they had even heard of the manifesto, which had not even been published in the British newspapers. Their guests had omitted mentioning it, for it was a document designed for internal consumption and Brüning had no real plans to renegotiate reparations at least until the fall.