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Generational Dynamics Web Log for 25-Feb-08
Der Spiegel: Germany's public banks are near collapse

Web Log - February, 2008

Der Spiegel: Germany's public banks are near collapse

The "subprime virus" is spreading rapidly through Europe now.

These days, when pundits refer to a bank as "going to the confessional," they mean that the bank is making its latest announcement of how many billions of dollars it's losing because it has to write down worthless or near-worthless CDOs in its asset portfolio. Some banks and financial institutions have been to the confessional several times.

But in fact very few banks been to the confessional. Most have been sitting on their assets, waiting until either the problem goes away, or until someone sticks a gun to their backs.

German bank IKB - a bottomless barrel <font size=-2>(Source: Spiegel)</font>
German bank IKB - a bottomless barrel (Source: Spiegel)

That's what's happening to many of Germany's state-owned banks right now. The result is that these banks are turning to Angela Merkel's German federal government for bailouts.

The most dramatic situation is at Düsseldorf-based IKB Deutsche Industriebank AG. It began requiring bailouts with the international "credit crunch" financial crisis that began last August, and has has required one additional bailout after another, with a €1.5 billion ($2.2 billion) approved just last week. And there's no guarantee that further bailouts won't be required.

Another state-owned bank, WestLB, has received a €5 billion ($7.4 billion) rescue package. Sachsen LB has received €2.73 billion in loan guarantees from the states, as well as €14 billion from other state-owned banks. Nordbank needs €1 billion, while BayernLB just reported a €1.9 billion writedown, as a result of infection by the subprime virus.

Where did these German banks obtain all these CDO securities that were supposed to make them rich? Why, they obtained them from Swiss banking giant UBS AG, which itself has been to the confessional several times, has had to take a whopping $18.4 billion in writedowns.

Germany's Nordbank, for example, purchased some $15.6 billion worth of CDOs from UBS six years ago, as a low-risk high-yield investment. On Saturday, Nordbank announced that it was suing UBS, claiming that the investment had a much higher risk than UBS let on.

So let me get this straight. The guys at Nordbank (which, incidentally, is worth about €207 billion in assets), were so dumb that they let those sharp cookies at UBS snooker them into buying $15.6 billion of CDOs that are now turning out to be near-worthless. It's nice to know that, as we head for a time when great masses of people are going to be unemployed, bankrupt and homeless, that Nordbank's lawyers and UBS's lawyers are going to have plenty of money to spend on their yachts and mistresses.

Unfortunately, German bankers are still fooling themselves, if we're to believe the words of Rainer Skierka at Bank Sarasin. He referred to a recent announcement by Credit Suisse of massive further writedowns and said, "Credit Suisse was seen as transparent and more credible than other (banks). This has now all disappeared and it has lost substantial credibility over recent days."

But then he says that for other banks, there's only one problem left: "The only problem is the monoline insurers and what implications (weakness in that sector) might have for banks," he said.

This is a common fantasy that we've mentioned before. The "monoline" bond insurers are part of the alchemy that gave near-worthless CDOs their AAA ratings.

(For those interested in the math behind the creation of CDOs from mortgage-backed securities, and how they get AAA ratings from "monoline" bond insurers, see "A primer on financial engineering and structured finance.")

So the fantasy is that all these bailouts of all these banks can be avoided, if only the bond insurers are bailed out first. Then the bond insurers can work their magic again, and near-worthless CDOs in everyone's portfolios would suddenly get back their old bubble value, and the bubble can start growing again.

Incidentally, there's presumably been a high-profile working session going on all weekend, headed by New York Insurance Superintendent Eric Dinallo, who's trying to get everyone to agree to a bailout of the bond insurers. There are all sorts of screwy ideas on the table, but since the intention is to find a way to get the bubble to start growing again, they're all mathematically impossible.

As of this writing on Sunday evening, the Wall Street Journal is reporting that Ambac, the second-largest of the bond insurers, has obtained $3 billion in financing, allowing it to continue in business at least on the municipal bond side of its business, with the CDO side of its business still in doubt.

However, that's far from enough to reflate the credit bubble that's now leaking like mad.

So that leaves the German public banks left in their state of crisis. According to Der Spiegel:

"If an industry giant like WestLB were forced to its knees -- which almost happened two weeks ago -- at least two other state-owned banks and a dozen savings and loan associations would crumple along with it. The member banks of the German Savings Banks Finance Group (Sparkassen-Finanzgruppe) are closely interlinked, and they are required to vouch for each other -- as long as they are in a position to do so, that is. The failure of a major state-owned bank like WestLB would also inevitably affect corporate customers, even forcing some into bankruptcy.

It is a nightmare scenario that the government financial supervisory authority now believes is increasingly likely. Germany's public-sector banks speculated far more heavily than private banks in American subprime mortgage securities. Now these banks' beleaguered executives are calling on the government to bail them out from a disaster of their own making. ...

In other words, [the argument went,] WestLB failure would deeply jeopardize Köln-Bonner Sparkasse, as well as at least three other savings banks in North Rhine-Westphalia.

If that happened, the corporate customers of the affected banks could end up without access to their money for weeks, possibly even months. Despite the fact that the customers' deposits are in fact guaranteed, any bank insolvency is preceded by a moratorium on all bank transactions. This ... would only lead to further bankruptcies, especially since the remaining savings banks in North Rhine-Westphalia, as their association presidents conceded, would have trouble satisfying the regional economy's liquidity requirements, because they already have a total of €43 billion in WestLB loans on their books. Furthermore, many of these banks also invested in American subprime mortgage securities, which they too would have to write off. The Westphalia-Lippe savings bank association, for instance, invested €100 million in the securities that triggered the worldwide financial crisis.

The officials involved painted grim scenarios. What would happen if customers were to withdraw their deposits from the savings banks en masse? And what if the insolvency of WestLB led to difficulties at two other state-owned banks, HSH Nordbank and BayernLB? How would that affect Bavaria and Hamburg, where the banks are headquartered? Would the public-sector banking system even be capable of surviving the failure of three state-owned banks? Could this in fact lead to the collapse of the entire economy, which would affect growth rates, unemployment and, ultimately, the well-being of society for many years to come? In the end, the participants were so drained that they agreed to a compromise.

Six months ago, BaFin president Jochen Sanio was heavily criticized when he warned of the "worst financial crisis since 1931." But now many politicians are convinced that the situation is far more serious than they had assumed until now."

The date 1931 is as symbolic to German financiers as 1929 is to Americans, as described in "The bubble that broke the world."

On May 11, 1931, the Credit-Anstalt bank of Austria failed. This triggered mass panic and bank failures throughout Central Europe, and generated a worldwide banking crisis. On July 13, the German Danatbank failed. Foreign investors in Germany quickly withdrew their capital from Germany, heightening the crisis, leading to the complete collapse of the German economy. By the end of the year, there were over 6 million unemployed, and the resulting social tension gave rise to Communism and Naziism.

And so, there are many justified fears about what's going on in Germany today. The German public banks are heavily interlocked with one another, and are required to support each other when one is in trouble. I don't know the history of German banking, but I'd be willing to bet that this interlocking scheme was put into place in order to avoid another disaster like the one in 1931.

If a bank is in trouble, its peer banks are supposed to help out, rather than allow a bank to fail, with the resulting public panic. But how is that supposed to work when all (or most) of the public banks are failing? What if they all got infected by the "subprime virus," because they all invested heavily in AAA rated high-yield CDO securities? How can they bail each other out, when they ALL need bailing out?

That's the situation facing Germany today; that's why the federal government is being forced to provide bailout money to the banks; and that's why everybody in Germany's financial community is scared to death. (25-Feb-08) Permanent Link
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