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  The Calm Before the Storm: Bracing for the Global Downturn

The Calm Before the Storm Bracing for the Global Downturn

By SPIEGEL Staff

Part 3: An Economic Tsunami

No one could have imagined that this event would shake the global economic system to its core, that mortgage loans bundled into securities would trigger such an economic tsunami, and that the waves could reach as far as the average citizen's savings accounts in the most provincial parts of Germany. "The globalization of the financial industry reaches much further than many had believed," says economist Burda.

All confidence within the financial industry has been lost and has yet to be restored. The banks are hording their money. Within the euro zone, for example, banks have roughly €130 billion ($173 billion) on deposit with the European Central Bank, compared with less than €100 million in early September.

The banks are still afraid of lending money to each other, and even more hesitant to lend to their customers. It has even become difficult for financially sound companies to secure fresh capital. As a result, they are borrowing less and cutting back their investments, only adding to the adverse interaction between the financial crisis and the economic downturn.

TMD Friction, a manufacturer of brake friction parts in the western city of Leverkusen, has seen massive declines in orders from carmakers like Mercedes, Porsche, BMW and VW. In an era of just-in-time production, this means that manufacturing is brought to a standstill virtually overnight. The situation escalated last week, when the banks refused to bridge the liquidity gap, and the auto industry supplier filed for bankruptcy -- even though its operating business remained healthy, as CEO Derek Whitworth points out.

The future of many companies remains difficult to gauge. Only those with a healthy cushion of equity capital stand a good chance of surviving the crisis relatively well. Conversely, companies that have relied entirely on debt capital and have developed no reserves could find themselves quickly deflating. Companies that have already been bled dry by outside financial investors will be in similarly difficult straits.

A Wave of Insolvencies

Over the course of the year, well-known German companies like retailer Hertie, watchmaker Junghans and fashion house Wehmeyer have become insolvent, and another wave of bankruptcies could follow in 2009. Experts with Creditreform, a credit management company, already expect the number of bankruptcies to increase by more than 15 percent.

Some small and mid-sized companies have fallen for a special form of financing known as mezzanine financing, a hybrid form of equity and debt capital brokered by banks. Business was booming until recently. Between 2004 and 2007, banks provided 685 companies with about €4.1 billion ($5.5 billion) in fresh capital. The market was structured in exactly the same way as the market for toxic US mortgage loans, with banks packaging and securitizing their mezzanine tranches and selling them to investors -- but without conducting detailed audits and while keeping the transactions off their own balance sheets.

No one wants anything to do with mezzanine financing today. "The standard mezzanine market is dead," says Michael Nelles, a financial consultant in the western city of Essen. Nelles, together with investment bank Lehman Brothers, developed a mezzanine product for companies with modest credit ratings. His original plan was to raise €350 million ($465 million) for 108 companies, including German companies like Schneekoppe, a producer of breakfast cereals, but insurance companies and pension funds were uninterested in the project -- and then came the Lehman bankruptcy. Many of Nelles's small-business clients now lack the funding the project was meant to provide.

"Some will fall by the wayside," says Nelles. Hoping to avert disaster, companies are now selling their futures by mortgaging their assets to leasing companies, and sometimes even their brand names.

Layoffs

Fear has taken hold within many businesses, as employees wonder who will be eliminated next: steelworkers, bank employees, newspaper editors? Everyone is vulnerable. Outplacement consultants, who help laid-off workers search for new jobs, have already noticed sharp growth in new orders.

When laying off staff, companies generally proceed in several stages. First they take the soft approach, by not filling positions that have been vacated, allowing annual contracts to expire and imposing hiring freezes. If this is insufficient, their next step is to let contract workers go or shorten the workweek. The last stage consists of layoffs within the core workforce. The federal government is left with little time to take measures to offset the downturn.

The draft version of the annual economic report summarizes the government's current approach this way: "Global weak development in overseas demand must be offset domestically to avoid negative effects on the labor market." In other words, the government will have to throw its full weight behind billions in bailout programs to prevent new mass unemployment.

Searching for the Right Stimulus

The government now has the means to do so, thanks to disciplined spending habits and coffers still brimming from past tax revenues. Various instruments are being considered.

Stimulus payments, for example, have already been used effectively several times in the United States. However, Americans are famous for their love of consumption, while Germans are known for their fondness for saving money. For this reason, a stimulus program runs the risk of failing in Germany.

Besides, people could easily use their checks for products not made in Germany, such Chinese-made DVD players or Swiss watches. Finally, issuing stimulus payments requires bureaucratic expense, because not all citizens are centrally documented.

Lowering the value-added tax seems to be a simpler approach, but only at first glance. This measure, which Great Britain has just implemented in a great hurry, has its potential downside. Who will guarantee that retailers will in fact pass on the savings to their customers?

A reduction in the income tax, on the other hand, is attractive for several reasons. It reduces the burden on taxpayers, which could help the economy. And it provides partnerships, which are also subject to the income tax, with an incentive for investments.

But cutting taxes also has a significant drawback: Half of all German households pay no wage or income tax whatsoever. These are primarily low-income households, an important group in an economic stimulus program, because they are more likely to spend their tax savings immediately.

Reducing health insurance premiums would be a way to reduce the financial burden for most Germans. Almost everyone pays health insurance premiums, including blue-collar and white-collar workers, retirees and civil servants. To implement such a program, the government would have to increase its tax subsidies to the health insurance agencies, financing the increased expenditure with debt, if necessary.

This would bring down premiums, thereby increasing citizens' purchasing power. The catch? Monthly savings for consumers would be relatively small, raising doubts as to whether the measure could truly trigger a surge in consumption.

In the end, the government will likely employ a mixture of instruments. Chancellor Merkel currently seems to favor reducing the income tax, combined with a stimulus payment, in the form of a check, to those who pay no income tax. She also wants to expand government investment in transportation, schools and universities, programs that work directly by creating work and, as a result, income.

The package will be assembled and approved in the first quarter of 2009. "The federal government will carefully monitor economic development," the annual economic report promises. "In the event of an intensification of the international crisis, it will take advantage of its latitude to take additional stabilizing measures to relieve the burden."

In the end, however, the government cannot set everything straight. In fact, it is probably far less capable of doing so than politicians believe. Companies, for the most part, must overcome the crisis themselves.

For now, it will hardly be possible to avert the loss of many thousands of jobs with carmakers, in the chemical industry and in construction. On the whole, however, Germany stands a better chance than most countries to eventually regain its footing. German companies are world market leaders in many industries, and they will be the first to benefit from a regional upturn.

Hardly any corporate executive doubts that China and India will be important growth markets again after the crisis ends. In anticipation of the future upswing in these countries, Andreas Renschler, head of the Daimler truck division, has instructed his senior executives to push forward with plans to build a plant in India. "You will continue to march forward, just as planned," he told executives at a management meeting, pointing out that there will be life after the crisis. And when that happens, Renschler wants to make sure that the world's largest truck manufacturer will be among the winners.

For now, however, recession is in the cards. Daimler, like many other companies, has no choice but to impose a forced hiatus. Steelmaker ThyssenKrupp, for example, added two weeks to the traditional Christmas vacation at its plant in the western city of Krefeld, where it produces stainless steel.

Before that, the company shipped a 360-kilogram (790-lb.) star to the city where the crisis began: New York. It now graces the top of the Christmas tree at Rockefeller Plaza.

Reported by BEAT BALZLI, DIETMAR HAWRANEK, ALEXANDER JUNG, JANNIS VON OY, CHRISTIAN REIERMANN, JANKO TIETZ

Translated from the German by Christopher Sultan.