The downfall early this decade of Union Labor Life Insurance Company, better known as ULLICO, triggered widespread public outrage and extensive Congressional investigations. During the turn of the decade, the firm’s board of directors, which included America’s top labor chieftains, made off with an estimated $7 million in what looked like insider-trading profits from failed high-risk stock investments. Yet the ULLICO scandal is small beer compared to the losses occurring around that same time at another union-sponsored financial intermediary across the Atlantic in Austria. The entity is Bank fur Arbeit und Wirtschaft AG (“Bank for Employment and Commerce”), or BAWAG. Revelations for a little more than a year now indicate that bank officials managed to lose, and then hide, as much as 1.45 billion euro (US$1.8 billion) in risky hedge funds and other investments. The crisis at the Vienna-based BAWAG has led to quick exits from the suites, large-scale withdrawals by depositors, and the evaporation of the strike fund of Austria’s labor unions.
The bank has its roots in the aftermath of World War I. Austrian Chancellor Karl Renner, a Socialist, set up BAWAG in 1922 as a “workers’ bank”; it would manage and lend money to members of that country’s unions, and promote commerce. As of 2004, the institution had about 1.3 million customers and assets of 56 billion euros. From the start, the bank has been owned by the Austrian Trade Union Federation, or OGB, the equivalent of our country’s AFL-CIO. Late in March, the federation announced plans to sell the bank, hiring the Morgan Stanley brokerage to find a buyer. “It was a painful decision, but it was the right decision to get BAWAG out of the political mire,” said Rudolf Hundsdorfer, OGB’s acting president. What went wrong? In a nutshell, the people who ran BAWAG, Austria’s fourth-largest bank, got greedy. Nicola Venedey, a senior analyst at Moody’s Investor’s Service in London, put it this way: “Their risk appetite was very high, and their transparency was very low.”
As with ULLICO, the management of BAWAG grew restless with its traditional asset base. These were the high-flying Nineties, and serious money was to be made. Under successive CEOs Walter Flottl and especially Helmut Elsner, BAWAG invested heavily in risky derivatives managed by Ross Capital Markets Ltd., a Bermuda-based hedge fund run by Walter Flottl’s son, Wolfgang. The investments proved profitable – for a few years. Then, they soured, primarily the result of bad bets on the Japanese yen and interest rate movements. Additionally, the bank lost its estimated $13.2 million stake in a gambling casino in Jericho in the Palestine West Bank. Run by an investment group fronting for PLO Chairman Yasser Arafat, the casino raked in large profits, but closed about a month after a violent Palestinian uprising in October 2000. Rather than admit to its mounting losses, which might trigger a depositor run, BAWAG officials concealed them. It shifted its uncollectible loan portfolio into various Caribbean-based companies, mainly on the island of Anguilla. Managing the funds was the New York-based commodity futures giant, Refco, Inc., in which BAWAG had purchased a 10 percent stake in 1999.
BAWAG was a house of cards ready to collapse, but its losses were not made public until last year. That’s because its fortunes were so heavily tied to Refco, itself a well-disguised house of cards. Reckoning day came on October 10, 2005. Refco, facing $970 million in unpayable debts, filed for bankruptcy. A U.S. investigation revealed that BAWAG had transferred a reported $410 million to Refco CEO Phillip Bennett only hours earlier in order to cover his company’s losses; Refco stock, ostensibly the collateral for an emergency loan, was now worthless. Worse, Refco held as much as $525 million in BAWAG securities with identification numbers not corresponding to registered bonds. Austrian officials issued a warrant for Bennett’s arrest. They will have to wait their turn. American authorities arrested the British-born Bennett on multiple counts of securities fraud, wire fraud, and filing false reports with the SEC. He has pleaded not guilty. Meanwhile, U.S. lawyers have filed class-action shareholder suits to recover funds invested in Refco. And Austrian prosecutors have charged Wolfgang Flottl, Helmut Elsner, BAWAG Supervisory Board Chairman Gunter Weninger, and several other persons.
Weninger and OGB President Fritz Verzetnitsch both stepped down from their posts in March. Four of BAWAG’s eight board members also were ousted that month following revelations that BAWAG-controlled companies in Anguilla held unregistered bonds in Refco-managed accounts. CEO Elsner’s replacement, Johann Zwettler, had resigned in October 2005. His successor, Ewald Nowotny, took office in March 2006, promising to cease all “exotic trading,” and clean up the bank’s problems. But Nowotny has his own interests; he’s a former Social Democratic politician and during 1999-2003 served as vice president of the European Investment Bank. BAWAG was sued by the U.S. Justice Department and the SEC, but this spring settled out of court, agreeing to pay off Refco creditors at $683 million. Individual officers at the bank remain on the hook.
Why weren’t Austrian bank regulators on top of things? One very likely reason is that BAWAG had acquired the Austrian Post Office Savings Bank from the Austrian government in 2000. Whether as a favor or not, the government did not perform audits during the following years. Neither the governor of the National Bank of Austria, Klaus Liebscher, nor his deputy, Gertrude Tumpel-Gugerell, reportedly thought audits were necessary. Frau Tumpel’s husband is Herbert Tumpel, president of the Chamber of Workers, which is close to the Social Democratic Party, formerly known as the Socialist Party. Significantly, he had been chairman of BAWAG’s supervisory board during the period that Walter and Wolfgang Flottl had been undertaking transactions under the codeword, “Special Business.”
The Social Democrats held power in a coalition government for much of this time; they won a close 68-to-66 seat plurality over their main rival, the Austrian People’s Party, in the National Council elections of October 1. But it’s unlikely any political party could have prevented the scandal, given the country’s long tradition of intertwined socialism, easy credit, and trade unionism. There is a certain irony that the scandal occurred in Austria, the birthplace of modern free-market economic thought. It may be time to put theory into practice. (Bloomberg.com, 3/31/06; Brusselsjournal.com, 4/4/06; other sources).