Worst Financial Crisis since 1931? German State-Owned Banks on Verge of Collapse

By Wolfgang Reuter

Part 2: Saving Their Skins

The hard-hit German banks are now trying desperately to save their skins. The situation is most dramatic at Düsseldorf-based IKB, the first German bank that was almost driven into bankruptcy by the US real estate crisis. Last week, once again, IKB's equity capital vanished into thin air. Jochen Sanio, president of Germany's banking supervisory agency BaFin, threatened to close the bank on Friday unless it could raise €1.5 billion ($2.2 billion). But KfW, IKB's biggest shareholder, was no longer able to bail out the Düsseldorf bank without jeopardizing its official mission, namely supporting small and mid-sized businesses.

IKB has received several state bailouts.

IKB has received several state bailouts.

In the end, the federal government and private banks came up with the funds for the bailout. For Finance Minister Peer Steinbrück, it was critical that IKB not be allowed to go under. The bankruptcy of a bank with such a high credit rating would trigger an unprecedented loss of confidence in the German financial market. In addition, a number of other banks had deposits at IKB worth a total of €18 billion.

"The issue here is ultimately about choosing the lesser evil, and about what is less damaging to the economy," Steinbrück explained at last Wednesday's meeting of the KfW supervisory board, shortly before the board decided to bail out the bank once again. Last Friday, the finance ministry justified the financial injection in a letter to the budget committee of the German parliament, the Bundestag: "Otherwise, we could have seen massive effects on the banking sector, with corresponding effects on the real economy."

A short time earlier, it had been WestLB that was almost ruined by the US subprime mortgage crisis. In a crisis meeting two weeks ago, the two savings and loan associations in North Rhine-Westphalia that own half of WestLB had to admit that they were unable to come up with €1 billion in fresh capital for the ailing bank. They insisted that it was up to the state to cover another €3 billion in risks.

But the state refused, arguing that the savings banks had declined to pledge their shares in WestLB to the state in return for its assumption of the risk, just as they had refused to bring in a private investor. The two sides became embroiled in heated negotiations, until Axel Weber, the head of the German central bank, the Bundesbank, intervened.

Weber proved to be persuasive. Köln-Bonner Sparkasse, a savings bank, had €340 million in deposits with WestLB, which it would be forced to write off if the bank went under. In other words, Weber argued, a 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, Weber argued, 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.

In an effort to confront the crisis head-on, Jürgen Rüttgers, the governor of North Rhine-Westphalia, has urged Finance Minister Steinbrück to set up a round table of all the parties involved so they can discuss the issue and reach some kind of solution.

The federal states could still restructure the state-owned banking sector -- by allowing private minority shareholders, for example, or by merging their banks. If a crash does occur, third parties will be dictating the conditions. There will be fire sales, as was the case in Saxony, at significantly less-favorable prices.

But Steinbrück is hesitant. He recently told advisors that if he gives in to Rüttgers' demands, he could end up being "stuck" with the problems. There are also growing calls for the federal government to bail out the states and help them solve their problems. But this is something Steinbrück is apparently unwilling to consider.

The minister also has other things on his agenda -- his fellow SPD member Matthäus-Maier's contract, for example, which will not be extended, but also isn't set to expire until mid-2009. That's when someone else will take over at the helm of KfW -- and that person will be nominated by Angela Merkel's Christian Democrats.

Translated from the German by Christopher Sultan


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