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CHAPTER 26: The Economic Crisis and Lessons for Banking Policy 1 - Ludwig von Mises, Selected Writings of Ludwig von Mises, vol. 1: Monetary and Economic Problems Before, During, and After the Great War 
Selected Writings of Ludwig von Mises, vol. 1: Monetary and Economic Problems Before, During, and After the Great War, edited and with an Introduction by Richard M. Ebeling (Indianapolis: Liberty Fund, 2012).
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The Economic Crisis and Lessons for Banking Policy1
The events of the last few weeks have made obvious to everyone the defects in the German and Austrian banking systems, which previously were recognized by only a few.
At least until very recently, English and American banks have acted, in principle, purely as bankers in the classical sense of the term. That is, they have viewed their primary business to be the lending of money. The development of German banking activity made them not merely banks but also put them in the business of being industrial holding companies and investment trusts. This development did not occur through any logical process. In the beginning, German banks also limited themselves to the granting of credit. They ended up becoming partners in the businesses to which they had granted credit because they lent too much to these enterprises in proportion to their own capital. These banks were plunged into difficulties when there were attempts for immediate conversion of those enterprises’ stocks and debentures into cash.
Gradually, banks were pushed out of the role of creditor into the role of the chief interested party. As a result, these banks no longer faced those enterprises with the critical eye of a banker who carefully judges the businesses’ prospects as debtors, and who constantly evaluates the borrower’s creditworthiness in order to limit or withdraw lines of credit if changing circumstances warrant it. These banks no longer looked at businesses’ activities from the standpoint of a lender but from the viewpoint of the borrower. When the monitoring function that the lending institution normally exercises over businesses fell by the wayside, an essential regulator of the money market disappeared in fact if not in name.
The news media would appropriately offer strong criticisms of any combination of the banking business with production and trading activities, when individual enterprises and business firms made attempts to publicly raise investment money. But it was overlooked that at many respected banks that had readily put money into risky ventures (including three major banks in Vienna and Berlin that have recently failed) conditions were no better.2 The independence of these banks from industrial enterprises was in many cases purely formal in the legal sense.
The representatives of the banks who had to decide on the granting of credit were, unfortunately, in many instances, identical with the representatives of the debtors who appealed for loans and credit expansion. When writers on the economy spoke out against this combining of banking and industry, those in banking labeled them ivory-tower theoreticians. Modern conditions, it was said, absolutely demand the amalgamation of banking and industry. The failure of this system clearly proves who was right. The more cautious the bank was in the establishment of its associations, the better off it is today.
The most pressing reform that must be pushed for is the elimination of the existing close ties between the banks and industrial combinations. Everyone agrees with this. Of course, this goal can be only slowly achieved. It will be years before it will be possible to transfer the large debts of many enterprises from the banks to the public through the issuing of stocks and bonds. Recent experience has caused severe mistrust of stocks and bonds issued by industry, and this mistrust will not be quickly overcome. But the distrust is even stronger against stocks issued by banks, due to the serious doubts about their connections with industry.
This situation will necessarily lead these banks to loosen their ties with industry, or in any case to structure them so transparently that, at least to some extent, an outsider will be able to evaluate the relationship. Banks will, no doubt, be pushed in this direction due to the greater carefulness that American, English, and Dutch banks will practice in extending credit in the future. It may be expected that bankers in these foreign countries will want to see their debtors carry out that highly valued system of division of labor in the banking industry.
The intimate connection between banking and industry resulted in banks investing in industrial undertakings from which it was impossible to quickly withdraw the money invested, while they were committed to pay back money in the short term to their depositors. The well-known golden rule of banking, that a bank should never extend credit in the form of gold-backed banknotes and checkable deposits for a period longer than it receives funds from its depositors, is, of course, not possible for banks that issue currency and fiduciary media. But it should be strictly followed in all other banking matters. It is unnecessary to emphasize that it is not very wise to take in hundreds of millions under the obligation to pay on demand or at short notice, and to use an equivalent sum of money to buy industrial stocks or lend to enterprises that use the borrowed funds for longer-term capital investments.
Concerning interest rates, a clearer distinction will have to be made than in the past between deposits that are payable on demand or on short notice and deposits that are left on deposit for longer periods of time. Particular care must be taken that the savings of the general public are deposited only on a long-term basis to minimize the danger of bank runs. But it must also be insisted that in their regular reports banks should provide precise information about the dates when money they have lent will be repaid in relation to their outstanding deposit obligations.3
Secret dealings have turned out to be especially harmful for the banks. It has been discovered that often there were reasons for the taciturnity in bank reports as a means of covering up the losses being suffered. Oversight by the general public is an indispensible element in maintaining the soundness of our banking institutions.
Interventionism, Collectivism, and Their Ideological Roots
[1. ][This article originally appeared in German in the Allgemeiner Tarifanzeiger (August 1, 1931). For Mises’s general analysis of the causes, consequences, and cures for the Great Depression, see Ludwig von Mises, “The Causes of the Economic Crisis,” (1931) in The Causes of the Economic Crisis, and Other Essays Before and After the Great Depression (Auburn, Ala.: Ludwig von Mises Institute, 2006), pp. 155-181; also, Mises, “The Economic Crisis and Capitalism,” (1931) in Richard M. Ebeling, ed., Selected Writings of Ludwig von Mises, vol. 2, Between the Two World Wars: Monetary Disorder, Interventionism, Socialism, and the Great Depression (Indianapolis: Liberty Fund, 2002), pp. 169-73; and for a general exposition of the Austrian theory of the trade cycle in the context of an analysis of the causes of and policy cures for the Great Depression in comparison to the Keynesian approach, see Richard M. Ebeling, “The Austrian Economists and the Keynesian Revolution: The Great Depression and the Economics of the Short Run,” in Political Economy, Public Policy, and Monetary Economics: Ludwig von Mises and the Austrian Tradition (London: Routledge, 2010), pp. 203-72.—Ed.]
[2. ][A leading Austrian bank, Credit-Anstaldt, declared bankruptcy on May 11, 1931, when under Austrian banking law it had reached the threshold of losing more than half of its capital, due to demands from foreign and domestic depositors and lenders for withdrawals of sums owed to them. In May 1931, as well, the prominent German Danot-Bank fell into bankruptcy due to demands by depositors. The same happened to a series of other German banks in the weeks after Danot-Bank’s collapse.—Ed.]
[3. ][See Ludwig von Mises, “Senior’s Lectures on Monetary Problems,” (1933) in Richard M. Ebeling, ed., Money, Method, and the Market Process: Essays by Ludwig von Mises (Norwell, Mass.: Kluwer Academic Press, 1990), pp. 104-9, especially pp. 107-8: