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The Banks Put the Brakes On

Credit Crunch Hits Small Businesses

By Beat Balzli and Janko Tietz

Just when you thought the subprime crisis might be reaching its end, along comes the mezzanine crunch. This time it's small and medium-sized companies that are getting hammered, as ill-advised "mezzanine" loans lead to a spate of bankruptcies.

Every two years, Trumpf, a machine tool manufacturer based in Swabia in southwest Germany, invites its clients to its in-house Intech trade fair. The company uses the platform to showcase its high-tech product range, which includes machines, lasers, software and services.

Last week saw this year’s edition of the event. Laser cutters were running full speed in the exhibition hall, while presentations enlightened the trade fair participants about details of production processes and new developments in sheet-metal forming. In just five days, some 1,400 companies from 16 countries visited Trumpf. Most of these are long-term clients, with over half based in Germany.

The mood ought to have been very positive. Economic growth in Germany is stronger than it has been in years and machine manufacturing has recorded its fourth boom year in a row. Companies are operating at full capacity and want to invest.

But a shadow lay over Intech, darkening the mood of organizer and visitors alike: the American subprime mortgage crisis, whose aftershocks have reached as far as provincial southwest Germany.

Many Trumpf clients would love to buy new machines -- if only their bank would play along. Unfortunately that is often no longer the case. Even long-standing clients with spotless balance sheets are suddenly being treated like unreliable loose cannons by their banks, who are acting on the premise that every loan that is not granted is one fewer risk.

"The financial crisis has now lasted so long that it is affecting banks’ willingness and ability to give loans to businesses," warned Morgan Stanley analyst Joachim Fels in an Internet forum aimed at small and medium-sized companies.

As early as three weeks ago, Jan Hatzius, chief economist at US investment bank Goldman Sachs, shocked the world with his predictions of a nightmare scenario. With banks involved in the mortgage business standing to lose up to $400 billion, they may be forced to cut lending by up to $2 trillion. “It is easy to see how such a shock could produce a substantial recession … or a long period of very sluggish growth," wrote Hatzius.

And he’s not alone in his concerns. “The credit crunch is a danger we must take seriously,” says Michael Heise, chief economist at the financial giant Allianz and at Dresdner Bank. And the longer uncertainty surrounds the scope of losses and the longer the liquidity squeeze continues, the greater the crunch will become.

German financial institutions are particularly hard hit by the crunch. They pumped billions into the risky high-interest investment vehicles that US banks used to palm off their skillfully re-packaged junk mortgages -- and helped to contaminate the global financial system in the process.

Now no one really knows how much the problematic investment vehicles are still worth and how many billions are still to be written off. Almost every week, another financial institution discloses new write-downs or has to put billion-dollar risks that were previously concealed off-balance sheet onto their own books. Meanwhile taxpayers are having to dole out ever-vaster sums of money to rescue German commercial bank IKB.

As no one knows any more just how affected their neighbor is, banks no longer trust each other -- and, as a result, are reluctant to lend each other money. Which means that time and again, the European Central Bank (ECB) has had to act to ensure the liquidity of the system -- and practically at any price. Otherwise there is the threat that the banks may run short of cash, particularly over the Christmas period when liquidity is tight.

Last Thursday the situation was clearly particularly serious. Following its regular monthly auction, the ECB pumped €50 billion ($74 billion) of three-month funds into the market. Around 180 banks had put in bids for over €130 billion. The banks were prepared to pay an average rate of 4.7 percent. The difference between that rate and the ECB's key interest rate -- currently at 4 percent -- has never been so large.