The Bundesbank, Germany's central bank, doesn't like to see its employees working too late, and it expects even senior staff members to be headed home by 8 p.m. On weekends, employees seeking to escape the confines of their own homes are required to sign in at the front desk and are accompanied to their own desks by a security guard. Sensitive documents are kept in safes in many offices, and a portion of Germany's gold reserves is stored behind meter-thick, reinforced concrete walls in the basement of a nearby building. In this environment, working overtime is considered a security risk.
But the ordinary working day has been in disarray in recent weeks at the Bundesbank headquarters building, a gray, concrete box in Frankfurt's Ginnheim neighborhood, where the crisis on international financial markets has many employees working late, even on weekends.
Last Sunday, most of the atypical activity was taking place on the 12th floor, which houses the senior management offices. Bundesbank President Axel Weber was repeatedly in touch -- both by telephone and via videoconferencing -- with his US counterpart, Federal Reserve ("Fed") Chairman Ben Bernanke, as well as with the heads of the central banks of other key industrialized nations. And, of course, with German Finance Minister Peer Steinbrück.
Bernanke told Weber about his organization's failed attempt that Sunday to orchestrate a last-minute bailout for the battered investment bank Bear Stearns. The venerable New York-based company, Bernanke argued, was simply too big to be allowed to go under, and the consequences of such a failure would be incalculable.
None of these crisis managers had forgotten the images of last September's debacle in England, when customers were lined up in front of the branches of Northern Rock -- a bank that had been pushed to the brink of failure by the American subprime mortgage crisis -- to withdraw their savings. As it turned out, the British had taken far too long to guarantee customer deposits.
For some time, there has been a tacit agreement among central bankers and the financial ministers of key economies not to allow any bank large enough to jeopardize the system to go under -- no matter what the cost. But, on Sunday, the question arose whether this agreement should be formalized and made public. The central bankers decided against the idea, reasoning that it would practically be an invitation to speculators and large hedge funds to take advantage of this government guarantee.
Everyone involved knows how explosive the agreement is. It essentially means that while the profits of banks are privatized, society bears the cost of their losses. In a world in which the rich are getting richer and the poor poorer, that is political dynamite.
Nevertheless, central bankers are running out of options. They are anxious to avert the nightmare scenario of a financial crisis like the one that rocked Germany in 1931, when the failure of a major Berlin bank prompted a massive run on other banks by a nervous public, which plunged those banks into insolvency. For decades, a repetition of that disaster had seemed unthinkable. But ever since former Fed Chairman Alan Greenspan dubbed the current financial crisis the worst since the end of World War II, old certainties have no longer applied.
A Fair Price to Pay?
So, what does apply? Should the state use taxpayer money to help greedy bankers repair the damage caused by their unscrupulous speculation? Should it invest billions to save ailing financial institutions, thereby engendering new risks and side effects? And should the government, to use the words of a Frankfurt investment banker, "treat a drug addict with cocaine"?
How does one explain to honest taxpayers that they should pony up their hard-earned money for a bank like Bear Stearns, whose long-standing CEO forked out $28 million (€18 million) for a 600-square-meter (6,500 square-foot) duplex apartment on New York's Central Park shortly before the collapse of his company? Or that UBS, the crisis-ridden, major Swiss bank, fired three of its senior executives for poor performance only to turn around and pay them roughly 60 million Swiss francs (€38 million/$59.2 million) in golden parachutes?
The central banks and governments of the major industrialized nations are still dodging the answers to these questions. They see themselves in the role of an emergency room doctor, whose job is to provide acute treatment. Like a dangerous virus, the crisis in the US real estate market has infected large parts of the worldwide financial system. After being burned by scores of bad loans, the banks have become deeply distrustful of each other. They have gambled away their most important asset: trust.
As the weeks progress, the disaster scenarios painted by prophets of doom, such as the American economist Nouriel Roubini, are becoming more and more likely. For months, Roubini, a professor of economics at New York University, has warned of the risks of a "core meltdown" of global financial systems and has summarized his thoughts in an analysis entitled "The Twelve Steps to Financial Disaster." According to an assessment by the International Monetary Fund, the crisis could lead to global losses exceeding $800 billion (€520 billion).
The American economy is presumably already in a recession, which affects the rest of the world. Experts also predict noticeably less growth and fewer new jobs for Germany. If the economic situation worsens, the state could face tax losses in the billions. This could force Berlin's ruling grand coalition of Social Democrats and Christian Democrats to shelve its plan to consolidate public budgets.
In this situation, even the most zealous disciples of the free market are calling for more government intervention. "I no longer have faith in the ability of the markets to heal themselves," Deutsche Bank CEO Josef Ackermann confessed in a speech delivered last Monday in Frankfurt. Ackermann said that the American example shows that governments and central banks must now play a stronger role.
Even his counterpart at Commerzbank, Klaus-Peter Müller, agreed, saying that the current situation has the potential to develop into "the biggest financial crisis in postwar history" as long as "the markets are allowed to continue operating unchecked." According to Müller, "It would make sense to permit the banks -- retroactively to Jan. 1 -- to account for securities differently by eliminating the daily revaluation requirement." He argues that this would stop the downward spiral on the banks' financial statements.
The German Finance Ministry promptly rejected such calls, saying: "We see no need to become active at the national level." But this assertion is far from the truth. The ministry has become a place of nonstop crisis meetings, the chancellery is kept constantly apprised of the latest developments, and the Federal Financial Supervisory Authority (BaFin) has already set up a task force to address the issue. No one in the government has the slightest doubt that it will intervene the minute another bank begins to falter.
Germany's state-owned banks, which have been especially careless in recent years about investing in American securities backed by subprime loans, are considered greatly at risk. One of them, Bayerische Landesbank, is currently considering writing off €1 billion ($1.54 billion) -- or possibly even more -- in bad debt. In the first two months of 2008 alone, the Bavarian bank's troubled securities portfolio has lost €1 billion in value, and it has fallen even further since. "There could be another billion in losses on top of that," says one banker.
At another state-owned bank, Dusseldorf-based WestLB, €5 billion ($7.7 billions) in government bailout funds are apparently not enough. The bank is already losing its next billion.
"The numbers are completely irrelevant," says a senior executive at one state-owned bank, "but it is clear that before a bank goes under, the central bank will push a red button and provide as much money as is needed."
This blatant display of nonchalance irritates Commerzbank CEO Müller, who is also the president of the Association of German Banks. "We must achieve greater transparency," says Müller. "It doesn't help when some banks hide behind outdated accounting regulations. All facts must be on the table and current."
Hitting Big Business Where It Hurts
The state-owned banks are not alone. The German economy is also suffering from the effects of the financial crisis. "Germany cannot uncouple itself from the world economy," says Walther Otremba, state secretary in the German Ministry of Economics.
Otremba has kept careful track of what bankers, business owners and the officials of major trade groups have been telling him. German exporting companies are showing the first signs of the coming slump. Orders once considered dependable are being cancelled, costs are on the rise and loans can only be had with markups, even for low-risk projects.
It's like the beginning stage of the flu, when the patient still appears healthy and strong. But the virus is already replicating in the body, and the patient is beginning to feel the effects of joint pain and crippling fatigue.
For years, the German economy benefited from the fact that German sports cars and high-end kitchens were seen as hip in the United States. But now the chain reaction set in motion by declining real estate prices, increasingly scarce credit and recession fears is depressing US demand for such products.
Even worse, because the US Federal Reserve, fearing a nationwide bank crash, is flooding the markets with cheap money, the dollar has plunged to a new record low, with bitter consequences for German producers. Since the beginning of the year, the products sold by their American competitors have become almost 7 percent cheaper, and profits from US sales are melting away as the dollar weakens even further.
The plunge of the US currency has already shaken the core of German industry: machine building, aviation and automobile manufacturing. Together these industries employ more than a million people and play a key role in preserving Germany's status as the world's largest exporter of goods. The weak dollar threatens thousands of jobs. Companies are forced to outsource some of their production to the dollar zone, and they are urging their suppliers to follow them on their trek westward.
BMW serves as an example of the consequences of the weak dollar. According to an analysis requested by CEO Norbert Reithofer, his company loses €80 million ($123 million) for each cent the dollar falls. This led to losses of more than €500 million ($770 million) last year. Now BMW plans to cut 8,100 jobs, most of them in Germany, while at the same time investing $750 million (€487 million) to expand its plant in Spartanburg, South Carolina, where it will add 500 new positions. Reithofer hopes that these steps will enable BMW to reduce its dependency on the dollar exchange rate.
The VW Group has also lost money in North America in recent years because of the weak dollar -- to the tune of about €3.5 billion ($5.4 billion). In an attempt to rectify the situation, Volkswagen CEO Martin Winterkorn plans to build a new assembly plant in the United States with annual production capacity of about 200,000 vehicles.
Aircraft manufacturer Airbus is suffering the most from the dollar's weakness. Aircraft sales worldwide are transacted in dollars, but Airbus incurs a large share of its costs in euros. To respond to the problem, the company plans to drastically reduce costs with its "Power 8" restructuring program. The plan will mean the loss of 10,000 jobs and the sale of seven factories.
But now another side effect of the financial crisis is jeopardizing Airbus's restructuring plan. Because of the weak credit markets, Airbus may not even be able to sell its plants. "Some of the potential buyers are having trouble raising the money for the acquisition," says Louis Gallois, CEO of Airbus parent company EADS. The banks are turning off the money supply. According to a survey by the Bundesbank, "standards for commercial loans are being tightened across the board for all types of companies and loan terms."
The financial managers of construction material giant Heidelberg Cement are already feeling the new ice age. Last year Heidelberg acquired British competitor Hanson, financing a portion of the takeover with two publicly traded bonds. Within four months, rising credit market interest rates led to an additional cost of €7.5 million ($4.9 million). "Market conditions are totally absurd," says one Heidelberg manager.
Hitting Them While They're Down
Even worse off are companies that fell into the hands of corporate raiders like Blackstone, Permira, Carlyle and Fortress during the takeover frenzies of recent years. From frozen fish stick maker Iglu to model train builder Märklin to the media group Kabel Deutschland, well over 600 German companies -- altogether employing about a million people -- are now controlled by the international private equity industry. Hungry for profits, the banks financed their corporate takeovers at exorbitant prices because, until recently, they could quickly sell the carelessly approved loans to greedy investors.
But no one is buying anymore. The market for billions in takeover loans is dead, as are many of the deals that had attracted corporate raiders. In the slump, the investment companies are trying to squeeze what they can out of their new acquisitions.
Last Wednesday, for example, Fortress demonstrated how to milk a German company. The US financial investor owns 80 percent of real estate management giant Gagfah, which was originally owned by the German retirement insurance system. Now that the company has selectively raised rents, laid off personnel and reappraised its inventory of 170,000 apartments, the owners want to see their money and have ordered Gagfah to significantly increase its profit distributions.
Permia and KKR, two other private equity firms, are taking a similarly brazen approach to plundering their television empire, the ProSiebenSat.1 media conglomerate. They are having the company pay out dividends that are three times as high as its 2007 profits. This has resulted in the company's debt growing by more than €3 billion ($4.6 billion), putting it in a position in which any crisis could jeopardize its existence.
And the crises will come, especially now that German economic growth is declining. "It cannot be ruled out that the weak phase in the United States will last the entire current year," says economic guru Bert Rürup, "which means that the climate for the German economy will likely become more difficult next year."
The Coming Paradigm Shift
If the economists are right, there will soon be a fundamental shift in the political agenda. The government and the opposition are still discussing how to distribute the fruits of Germany's economic recovery more broadly among social classes. But soon the focus could shift to keeping growth alive within domestic industry.
For some time German Economics Minister Michael Glos, a member of the conservative Christian Democratic Union (CDU), has had a plan on the back burner with which he hopes to stimulate the economy with additional tax reductions.
The government is also prepared for a continuation of the bank crisis. If other banks run into trouble, Finance Minister Peer Steinbrück plans to come to their aid with fiscal tools, even if it gets expensive for the government. "Preventing a bank crash," say officials at the finance ministry, "takes precedence over budget consolidation."
In the wake of the financial crisis, a new debate has begun over the role of the state. For years, the prevailing dogma was that the international capital markets ought to be left largely to free market forces. But now even financial investors and top bankers are calling for more government control.
This also revives a government initiative that was a dismal failure last year. In the face of US resistance, Berlin failed in its attempt to introduce tighter regulations for hedge funds. "But now," says an advisor to Chancellor Angela Merkel, "even the Americans see the issue in a new light."
Beat Balzli, Konstantin von Hammerstein, Dietmar Hawranek, Wolfgang Reuter, Michael Sauga
Translated from the German by Christopher Sultan