Germany's Faltering Bank Bailout Program The Bottomless Pit

The German government whipped its €480 billion bank bailout package through parliament in record time, but now the program has run into trouble. The banks are still fighting for survival, the money market isn't functioning properly, and taxpayers' money is being burned.


Who knows Claudia Hillenherms? Almost no one, and yet, for some time now, she has been one of the most powerful women in Germany.

To reach Ms. Hillenherms, one has to pass through a thick, heavy steel door. The painters have left their paint buckets standing in the stairwell of the historic building that belongs to Germany's central bank, the Bundesbank. Everything there smells new and seems temporary.

Josef Ackermann, of Deutsche Bank: promoting a "two-class society in the banking sector"?

Josef Ackermann, of Deutsche Bank: promoting a "two-class society in the banking sector"?

Until two months ago, the villa in the Taunusanlage park in Frankfurt was being used as a training site for six central bankers from developing countries. But then they were suddenly forced to move to a different location because the Special Fund for Financial Market Stabilization (Soffin) needed a home.

Now the building serves as the headquarters of Germany's bank bailout program. Soffin has been charged with making €480 billion ($672 billion) available to German financial institutions. Those who want a piece of the pie must deal with Claudia Hillenherms. Hillenherms, an accountant by trade and a specialist in the valuation of companies, is on loan from her employer, publicly-owned regional bank Landesbank Hessen-Thüringen (Helaba). At Helaba, she was responsible for managing the bank's takeover of a savings bank, Frankfurt Sparkasse.

Her new job as head of the financial stability measures is far more complex. In addition to protecting German financial institutions from failure, she has been charged with ensuring that the banks can continue to pursue their central purpose -- injecting money into the economy.

If this doesn't happen, government stimulus programs, no matter how large, will fail, and the foundations of the German economy will begin to crumble.

Hillenherms and Soffin Director Günther Merl, a former chairman of the board at Helaba, have already met dozens of bank representatives at the Frankfurt villa. "On some days, we sign off on a few billion here," says a senior member of the staff at Soffin who, despite the turbulent times, has preserved a modicum of respect for such big numbers.

To date, Soffin has approved government guarantees for €90 billion ($126 billion) in loans. After prolonged negotiations with the European Union, Soffin now plans to release the first equity assistance package, worth €8.2 billion ($11.5 billion), for the German bank Commerzbank.

Soffin has already received requests for at least another €100 billion ($140 billion) in liquidity assistance. Even German carmaker Volkswagen is now lining up for money.

Mounting Criticism

Nevertheless, criticism of Soffin's work is growing by the day. It is not always clear what exactly is meant by Soffin: the agency itself, which is regarded as rigid and bureaucratic, its government overseers, who give it little leeway and are believed to be deeply divided amongst themselves, or even the structure of the entire bailout package. Some consider its rules too harsh, because of the conditions attached to receiving financial assistance, while others see them as far too lax because they do not force banks to seek the government's protection.

The fact is that the banks' situation has hardly improved since the government decided to put up a protective umbrella for the entire banking sector. The €480 billion ($672 billion) package was approved by the government, whipped through the upper and lower houses of the German parliament and enacted -- all in the space of five days.

All German banks can now take advantage of government guarantees to secure liquidity and, if necessary, obtain capital directly from the government and dispose of risky securities as needed. The goal is to reestablish trust among the banks so that they begin lending money to each other again, a system that came to a standstill after the failure of the US investment bank Lehman Brothers. The hope is that if the banks regain liquidity and can refinance themselves at any time, they will resume their normal role of injecting cash into the economy.

The reality looks different. Bankers are loath to accept government protection out of fear of intervention into their business models and salaries. Those who do accept money complain that Soffin is slow to take decisions. Both circumstances reduce the effectiveness of the government's protective shield.

Piecemeal Rescue

But what happens if the government's billions are spent and the banks are still in trouble? And what if the economy continues to tank and even large corporations can no longer borrow funds?

The rescue package was originally conceived as a protective shield for the entire industry. The government wanted to back off from its previous case-by-case approach, especially after it had been forced twice to rescue the ailing mortgage lender Hypo Real Estate (HRE), where prosecutors conducted searches of executives' offices and private homes last week.

Not many banks have drawn on the rescue fund so far.

Not many banks have drawn on the rescue fund so far.

Although Soffin has now been created, its attempt to bring about a general solution has proven to be a sum of case-by-case solutions -- and a bottomless pit.

HRE is still the most troublesome case. The mortgage bank is requesting new guarantees at a breathtaking pace. At first, the federal government and other financial institutions assembled a €50 billion ($70 billion) packet to provide the necessary liquidity and keep the Munich-based lender afloat.

A short time later, Soffin was forced to approve an additional €20 billion ($28 billion) bailout. The next €10 billion ($14 billion) followed in early December. "What else is coming?" asks a concerned member of parliament, pointing out that a single institution cannot possibly absorb the bulk of the government rescue package.

HRE's management wants to begin by downsizing to a healthier level by cutting a third of the company's workforce of 1,800 people. Management's next step, if it had its way, would be to split the company, with problematic subsidiary Depfa being nationalized and the remainder of HRE getting back to business. But the plan has encountered resistance from politicians who argue that the strategy would only benefit shareholders -- at taxpayers' expense.

Bundesbank President Axel Weber has proposed an alternative solution. To shore up the German bond market, specialty lenders like HRE or Aareal could be made subsidiaries of another bank or merged to form a single bond bank. In both cases, the government would have to reach deeply into the structures of the economy. So far, the government has shied away from taking on a restructuring of the banking industry.

It has also been sharply opposed to nationalizing financial institutions. The government would prefer not to become involved. It could have imposed a certain capital ratio on the banks, thereby forcing the publicly-owned Landesbank regional banks under the Soffin umbrella. It should not have given the banks any choice in the matter. Then it would have been able to force them to merge and develop new business models. Both are overdue, and yet no progress has been made.


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