Germany Ponders Bad Banks Toxic Waste Urgently Seeking Dump

The German government is hosting talks with banking supervisors about what to do about the hundreds of billions of euros of toxic assets still left in the banks' balance sheets. It sounds like a mission impossible -- saving the banks without bankrupting taxpayers.

By Beat Balzli

Bank skyscrapers in Frankfurt, Germany's financial capital.

Bank skyscrapers in Frankfurt, Germany's financial capital.

The president of the German central bank, Axel Weber, was at pains last week to stress how hard it will be to recover from the current economic slump. "The paths out of the crisis will be stony and hard," he told a conference of the Hamburg Chamber of Commerce last Wednesday. "We'll need good boots and we'll have to push obstacles out of our way."

The biggest obstacles are lurking in the banks' balance sheets. "Uncertainty about the solidity of the banks" hasn't been removed yet, said Weber.

The International Monetary Fund estimates that banks worldwide hold more than €3 trillion ($3.88 trillion) worth of toxic assets which could yet cause a collapse of the financial system. German banks have just under €300 billion of that total on their books.

The aim is to remove that toxic waste from balance sheets. This Tuesday, Chancellor Angela Merkel will host a meeting of top representatives from the German central bank, or Bundesbank, the Soffin bank bailout fund and government officials to discuss what to do with the toxic assets. Their task sounds impossible -- saving the banks without bankrupting taxpayers. The aim is to set up a national network of state-guaranteed waste dumps for financial products, so-called Bad Banks. These banks will take the risk of asset writedowns out of the banks' books.

Josef Ackermann, the CEO of Deutsche Bank, Germany's biggest commercial bank, says such a plan would help restore confidence in the financial system.

He said earlier this year that his own bank didn't need a Bad Bank. But its rivals do, urgently. Commerzbank has toxic assets of €55 billion since its takeover of Dresdner Bank. Publicly owned regional banks such as HSH Nordbank have similarly alarming holdings of toxic assets.

No Central Bad Bank for Toxic Assets

So far, no rubbish dump has been found for their toxic waste. Merkel's coalition has been arguing about a solution for months. Only one thing seems clear -- there is unlikely to be one central toxic waste dump because that would be too big, too risky, and too expensive. It's also unlikely that private investors will be drawn in to the process, like in the United States, or that there will be a government insurance against losses, like in the United Kingdom.

Finance Minister Peer Steinbrück agrees with Bundesbank President Weber that separate waste dumps are needed on a bank-by-bank basis. Steinbrück wants the process of cleaning up balance sheets to be transparent and practicable, and sufficiently plausible for politicians to explain it to the public.

They also want it to be simple and quick because the crisis is continuing to eat its way into the supporting pillars of the financial system. In the US, so-called monoline bond insurance companies that guarantee bond repayments are starting to look wobbly. According to a new study by Britain's Royal Bank of Scotland, banks worldwide now face writedowns of a further $80 billion.

Deutsche Bank alone has €36 billion worth of investments secured by "monoliners" on its books. At Commerzbank, such investments also run into the billions.

News earlier this month illustrated how serious the situation has become -- rating agency Moody's cut its ratings on a mighty US bond insurer, Ambac Assurance, to junk territory.

Despite Encouraging Bank Results, No Sign of Turnaround

There are virtually no indications of a sustained recovery even though financial stocks have recently been rising. The latest profits being reported by Wall Street banks largely result from changes in accounting rules.

Wells Fargo only managed to shine because it was suddenly allowed to book its share in a joint venture with insurance giant Prudential as an asset. The balance sheet jugglers of Goldman Sachs were allowed to make similarly profitable accounting changes. A change in its accounting period allowed it to keep a major loss out of its recently published quarterly results. In the classic investment banking business, Goldman Sachs earned even less than in the previous quarter.

The only area where Goldman made serious profits was in the crisis-driven government and corporate bond business where its rivals J.P. Morgan and Deutsche Bank have been delivering similarly strong profits.

"One swallow doesn't make a summer," Manfred Weber, president of the Association of German Banks, warned recently. "We're experiencing such a sharp economic downturn that the banks' credit risks will increase massively in the coming quarters."

This would sap banks' equity capital and could "in the worst case lead to a general credit crunch."

Lingering Risk of Credit Crunch

Weber has proposed placing the toxic assets in separate accounts in a fund held by Soffin. In return, the banks would receive state-guaranteed, interest-paying bonds issued by the new fund. Any losses would be divided up "fairly" between the banks and the taxpayers at the end of the bonds' expiration, he proposes.

But Weber hasn't said how those losses should be divided up. Will the taxpayer have to foot the bill for all the losses in 10 years' time when certain banks have long gone bust, have merged or remain too weak to cover the losses? It's a risky business given that the losses could run into hundreds of billions of euros.

Valuing the assets remains the biggest problem. Banking federation chief Weber argues that because the price question can't be answered, the assets should be priced at their current balance sheet values. But insiders believe that up to 90 percent of securities held in bank balance sheets are overvalued.

It's also unclear what Steinbrück's plan for the private commercial banks entails. He wants to demand a high fee for guaranteeing the rotten assets. He recently proposed that the various bad banks should only be allowed to hold illiquid -- untradable -- securities. He wants the banks themselves to handle toxic assets such as securitized US mortgage loans.

But where should the dividing line be between illiquid and toxic? Banking supervisors are already scratching their heads about whether securitized US credit card debt is just illiquid or toxic.

Credit Suisse has come up with a particularly original idea for getting rid of its junk assets. Instead of paying out bonuses to its investment bankers, it gave them shares in the bank's own bad bank.

The German government wants to decide by the summer recess what to do with the toxic assets. This Tuesday's meeting is unlikely to produce any decisions, said government spokesman Thomas Steg.


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