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This paper explores the origins of German banks’ risk-taking in the years preceding the 1931 crisis. The 1920s were marked by a large and prolonged increase in capital flows into Germany, chiefly from the United States and the United Kingdom. This coincided, at the individual bank level, with a rise in leverage and a fall in liquidity. We examine possible connections between the two phenomena. Our analysis is based on a combination of historiographical work and statistical modelling based on a newly hand-collected bimonthly dataset on German reporting banks from 1925 to 1935. Bank by bank we examine the effects of foreign inflows on decisions related to leverage, lending, and liquidity. The Dawes Plan of 1924 and the relative absence of a too-big-to-fail (TBTF) environment allow us to mitigate endogeneity concerns. We suggest that while capital inflows did not seem to impact banks’ liquidity decisions, their impact on leverage was non-negligeable.

Both the Conservatives and Labour are keen on a ‘Covid bond’, which would encourage savers to fund the post-pandemic recovery. But the economic rationale is not immediately clear. Natacha Postel-Vinay (LSE) looks at how bonds could help the government navigate two possible challenges: rising inflation and tax hikes.

This month’s episode of the LSE IQ podcast investigates whether cryptocurrencies are the future of money, a speculative bubble that will burst, or something else.

This article reassesses the causes of Chicago state bank failures during the Great Depression by tracking the evolution of their balance sheets in the 1920s. I find that all banks suffered tremendous deposit withdrawals; however banks that failed earlier in the 1930s had invested more in mortgages in the 1920s. The main problem with mortgages was their lack of liquidity, not their quality. Banks heavily engaged in mortgages did not have enough liquid assets to face the withdrawals, and failed. This article thus reasserts the importance of pre-crisis liquidity risk management in preventing bank failures.

Natacha Postel-Vinay finds a strong link between mortgage lending and bank failure in the 1930s

The idea that real estate could have contributed to banking crises during the Great Depression has been downplayed due to the conservatism of mortgage contracts at the time. For instance, loan-to-value ratios often did not exceed 50 per cent. Using newly discovered archival documents and data from 1934, this article uncovers a darker side of 1920s US mortgage lending: the so-called ‘second mortgage system’. As borrowers often could not make a 50 per cent down payment, a majority of them took second mortgages at usurious rates. As theory predicts, debt dilution, even in the presence of seniority rules, can be highly detrimental to both junior and senior lenders. The probability of default on first mortgages was likely to increase, and commercial banks were more likely to foreclose. Through foreclosure they would still be able to retrieve 50 per cent of the property value, but often after a protracted foreclosure process. This would have put further strain on banks during liquidity crises. This article is thus a timely reminder that second mortgages, or ‘piggyback loans’ as they are called today, can be hazardous to lenders and borrowers alike. It provides further empirical evidence that debt dilution can be detrimental to credit.

Bank lending was at the heart of the Global Financial Crisis when it began in 2008, with the collapse of subprime and ‘piggyback’ loans having detrimental effects. Using newly-discovered archival documents and a newly-compiled dataset from 1934, Natacha Postel-Vinay looks at the lessons of the Great Depression. She writes that the prevalence of ‘second mortgages’ (loans which supplemented regular mortgages due to borrowing limits) led to higher rates of foreclosure. This, in combination with a protracted foreclosure process, helped to severely weaken the liquidity of banks in the 1930s, contributing to their failure.

The Clash of Economic Ideas interweaves the economic history of the last hundred years with the history of economic doctrines to understand how contrasting economic ideas have originated and developed over time to take their present forms. It aims to trace the connections running from historical events to debates among economists, and from the ideas of academic writers to major experiments in economic policy. This is an ambitious and largely successful attempt at a big-picture overview of decades of debates and experiments in economic policymaking, writes Natacha Postel-Vinay.

In 2011, the International Monetary Fund invited prominent economists and economic policy makers to consider the brave new world of the post-crisis global economy. The result is a book that captures the state of macroeconomic thinking at a transformational moment. Among the new realities they consider are the swing towards regulation, the need to incorporate behavioural economics, and the importance for macroeconomic policy to target financial stability. Natacha Postel-Vinay finds it an absolute must-read.

In the midst of the current crisis that is threatening to derail the historical project of European unification, Jürgen Habermas has been one of the most perceptive critics of the ineffectual and evasive responses to the global financial crisis. In this book, his central argument is that the European project must realize its democratic potential by evolving from an international into a cosmopolitan community. Natacha Postel-Vinay finds that although readers will appreciate the philosopher’s thoughts on such a topical issue, they might find the journey a bit rough. The Crisis of the European Union: A Response. Jürgen Habermas. Polity. April 2012.

Natacha Postel-Vinay is impressed by the radical and bold conclusions presented in this study of the ways in which institutions can affect our voting behaviour.

This dissertation analyses the long-term behaviour of bank financial ratios from 1923 to 1933, focusing on a population of 193 Chicago state banks. These banks are divided into earlier and later failure cohorts. The main conclusion is that a turning point in banks’ vulnerability is identifiable before the first banking crises, between the end of 1928 and June 1930. A second, related conclusion is that this upsurge in vulnerability (as expressed by such variables as retained earnings and other real estate) is made even more significant when considering banks’ behaviour in the preceding decade. In almost all cases earlier failures behaved more riskily in the 1920s, which explains their earlier and higher vulnerability at the start of the depression.

Natacha Postel-Vinay takes a closer look at Fault Lines, a book which remains at the centre of debate and controversy.

The City of Glasgow Bank failure in 1878, which led to large numbers of shareholders becoming insolvent, generated great public concern about their plight, and led directly to the 1879 Companies Act, which paved the way for the adoption of limited liability for all shareholders. In this paper, we focus on the question of why the opportunity was not taken to distinguish between the appropriate liability for ‘insiders,’ i.e. those with direct access to information and power over decisions, as contrasted with ‘outsiders.’ We record that such issues were raised and discussed at the time, and we report why proposals for any such graded liability were turned down. We argue that the reasons for rejecting graded liability for insiders were overstated, both then and subsequently. While we believe that the case for such graded liability needs reconsideration, it does remain a complex matter, as discussed in Section 4.