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'We Suffer the Consequences'

Loan Crisis Hits German Taxpayers

By Wolfgang Reuter

The bailouts of German banks Industriekreditbank and Sachsen LB will come at a serious cost to the country's taxpayers. It could make it harder for German students, small businesses and first-time homeowners to get state-backed loans.

German Finance Minister Peer Steinbrück wasn't exactly mincing his words. "I think I do have a pretty good idea of what it is you're doing," he said, glancing at Friedrich Carl Janssen, a general partner in private bank Sal. Oppenheim.

In addition to Steinbrück, the financial institution had invited a group of roughly 20 bankers to a meeting at Frankfurt's Villa Kennedy luxury hotel. The finance minister's words were met with an awkward silence, but this didn't stop him from continuing. "We suffer the consequences," said Steinbrück, a Social Democrat, "and you just keep on buying (shares) and turning a profit."

That was on Aug. 17, a Friday, exactly three weeks after the full extent of the disaster at Industriekreditbank (IKB) had become clear. On July 27, Josef Ackerman, the chairman of Deutsche Bank, informed Jochen Sanio, the president of the German Federal Financial Supervisory Authority (BaFin), that his bank would no longer issue loans to IKB. The Düsseldorf-based bank was on the verge of declaring bankruptcy after its executives had made poor investment decisions in US mortgage loans. IKB's principal shareholder, the German government-owned development bank, Kreditanstalt für Wiederaufbau (KfW), was suddenly faced with the makings of a massive problem.

The Ackerman announcement quickly led to frantic telephone calls and special meetings of the IKB supervisory board, the KfW Board of Managing Directors headed by Ingrid Matthäus-Maier, a Social Democrat, and the KfW Board of Supervisory Directors, of which Steinbrück is the chairman. Sanio warned that an IKB bankruptcy could set off the biggest banking crisis since 1931. His appeal worked, triggering a concerted campaign to bail out IKB -- as quickly as and by whatever means possible.

As a result, KfW, which is owned by the federal government and the German states, took over IKB's off-balance-sheet transactions and provided the ailing company with €4.8 billion ($7.021 billion) in emergency funding at the beginning of last week. Private and public bank groups each provided €500 million in loan guarantees. This meant that KfW was shouldering 83 percent of the total burden of this bailout program, even though it owns only 38 percent of IKB. KfW also agreed to provide IKB with a credit line of €8 billion.

IKB's remaining shareholders are the beneficiaries of the bailout. Although the IKB share price declined significantly, without the financial bailout the securities would already have been completely worthless three months ago. Thanks to KfW, the damage was kept under control and the losses were for the most part shouldered by taxpayers.

Sal. Oppenheim was one of the beneficiaries. Immediately after the bailout, the bank increased its share of IKB from 3 to 5 percent. Other, smaller investors followed suit.

It would have been fairer and more appropriate to increase IKB's capital. Because time was of the essence, KfW and the remaining participants in the bailout should have either provided loan guarantees or advanced the necessary cash until an extraordinary shareholders' meeting could have formally approved the measure.

The shares of the financial backers would then have increased in proportion to their respective contributions to the bailout. In addition, the ensuing spat with the European Union could have been avoided. Instead, Brussels is now incensed over the unequal distribution of the burden of a government bailout for a private bank and its adverse impact on competition.

The EU's negative appraisal of the bailout is complicated by the fact that the funds contributed three months ago will in fact not suffice to save IKB, which now needs another €350 million. KfW and the private banks will each contribute €150 million, while savings banks and cooperative banks will come up with the remaining 50 million. Once again, the shareholders will remain unaffected. Only when additional capital is needed will they be asked to contribute, Steinbrück said after a special meeting of the KfW Board of Supervisory Directors last Friday to discuss the continuing debacle. This could happen sooner than later, because the KfW board of directors now expects that IKB could need as much as an additional €1 billion.

Matthäus-Maier disappeared right after the meeting, prompting insiders to conjecture that "the woman is being tightly controlled." At the meeting, board members also decided that, in the future, Matthäus-Maier would answer to a newly created, seven-member executive committee to ensure more effective control. In an effort to cut its losses, KfW plans to sell its share of IKW as quickly as possible. This doesn't change the fact that KfW is paying the lion's share of the bailout costs, which could substantially impair its principal business of issuing subsidized loans to students, small businesses and to private citizens for home construction.

Taxpayers will also be footing the bill for solving Sachsen LB's problems. The state of Saxony has assumed the greater part of the risks associated with the emergency sale of Sachsen LB, which essentially imploded as a result of the credit crisis, to Landesbank Baden-Württemberg (LBBW).

Like IKB, Sachsen LB spent vast sums of off-balance-sheet money on speculative investments in risky US mortgage loans. Roughly €17 billion, or more than half of the volume of these deals, is bundled in the Dublin-based special-purpose entity Ormond Quay, for which the state of Saxony and its savings banks are fully liable. The real estate investments are currently expected to result in losses of €3-4 billion over the life of the securities.

Saxony can also expect to incur heavy losses with the remaining special-purpose companies, because LBBW has stipulated that it will only be liable for losses incurred in 2011 or at a later date. Initial estimates put Sachsen LB's losses at €1.7 billion for this year alone.

The state will bear the brunt of these losses. Although the purchase price LBBW will be expected to pay for Sachsen LB will not be determined until Dec. 31, many members of parliament now believe that it won't amount to anything.

"We could very well end up paying LBBW a sum in the double-digit or triple-digit millions, and we could even be required to assume additional risks," says Karl Nolle, the SPD's ombudsman on the committee formed in the Saxony state parliament to investigate the Sachsen LB case, "to prevent LBBW from withdrawing from the agreement."