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.
Von SPIEGEL Staff

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.

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.

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.

A Waste of Taxpayers' Money

Instead, the damaged Landesbanken continue to plod along, frittering away taxpayers' money. HSH Nordbank is a case in point. For weeks now the bank, under new CEO Dirk Jens Nonnenmacher, has had its back to the wall, and it is believed to be facing a loss of up to €2 billion ($2.8 billion) for the year. At the end of November, after lengthy negotiations with Soffin, HSH Nordbank secured a liquidity guarantee for €30 billion ($42 billion).

Despite the government bailout, however, the Hamburg-based institution still has not managed to raise €3 billion ($4.2 billion) in the capital markets with a three-year corporate bond. Officially, the bank claims that the potential investors' books were already closed. In reality, says a Frankfurt banker, it was "the market's fatal vote of no confidence." In the same week, the major French bank BNP Paribas and the Italian bank Intesa Sanpaolo had no problems placing their new bonds -- without government guarantees.

The strike by investors shows that hardly anyone believes that the owners of HSH Nordbank want to or are capable of raising additional equity. Its government owners, Schleswig-Holstein and Hamburg, two financially strapped German states, are in dire straits. Among the other owners, the local savings banks want out completely, and US private investor J.C. Flowers is also proving to be uncooperative.

Deutsche CEO Accused of Stigmatizing Bailout

Insiders expect HSH to be knocking on Soffin's door in January. It is not likely to be the only one. This year's fourth quarter has been disastrous for banks. Even Deutsche Bank was hard-hit. According to estimates by JP Morgan, Deutsche Bank will have to write off an additional €2.3 billion ($3.2 billion), leading to widespread speculation over whether the industry leader will be able to manage without government funds in the long run.

Deutsche Bank CEO Josef Ackermann wants to avoid the walk to Soffin, only a few hundred meters from his corporate headquarters, at all costs. His name has been closely associated -- in good and bad ways -- with the government's rescue package from the beginning.

Ackermann was the first to call for a general bailout for the industry.

But the government is also convinced that Ackermann stigmatized the package when he said, at an internal event, that he would be ashamed to see his bank requesting help from the government.

Finance Minister Peer Steinbrück was livid when he heard the news. Ackermann, he said, had paved the way "for a two-class society in the banking sector: into those that don't need help and those that are at risk of relegation. This is dangerous, because the markets respond to it." A man like Ackermann should have known better.

At a Dec. 14 economic summit at the Chancellery, the office of Chancellor Angela Merkel, Ackermann proposed the idea of what he called a Bad Bank -- a government institution that would buy risky securities from the banks and hold onto them until they matured. In this way Deutsche Bank, too, could shed excessively high-risk securities without having to apply directly for government assistance.

It is already possible to transfer bad loans to Soffin as part of the rescue package. But no one has made use of this option yet, because the toxic loans can only be outsourced for three years, at which point they are transferred back. This restrictive provision led to the failure of talks between Postbank and Soffin. Postbank wanted to get rid of high-risk securities worth €5 billion ($7 billion). If the bank had come to an agreementwith Soffin, Deutsche Bank would also have benefited from the government bailout, because it recently became a major shareholder in Postbank.

Approaching Soffin directly would come at a heavy price for Deutsche Bank and its chief executive. Ackermann has stated his position so adamantly that he could hardly hold onto his job if his bank were forced to apply for government bailout funds.

Soffin already has its hands full. Hillenherms, who sees everything from minor exploratory inquiries ("What would it cost us to secure equity capital from you?") to urgent calls for help ("We'll be bankrupt tomorrow") cross her desk, is currently reviewing a preliminary inquiry from Aareal Bank. The publicly traded mortgage lender is not in critical straits but merely wants to recapitalize, says an individual familiar with the situation.

Aareal Bank has not submitted an official application yet, but its options include guarantees as well as equity capital injections from the government. The bank has declined to comment.

Too Slow

Many applicants complain that Soffin is taking far too long to process their requests. It can take weeks before they are even looked at, and applicants say that the decision-making criteria are vague.

The 21 employees at Soffin, most of them on temporary loan from the Bundesbank, see themselves as whipping boys, forced to take responsibility for everything that goes wrong in the bank rescue effort.

Karlheinz Bentele, the former president of a savings bank and a member of the managing board of Soffin, returned to his regular job after only a few weeks. Soffin Director Merl has yet to sign a valid contract, and the names of potential successors are already being mentioned in the industry, including that of former Finance Minister Hans Eichel. The source of the trouble is a tangible dispute over competencies. Even though Merl heads the managing board of Soffin, a steering committee must approve key decisions. The Finance Ministry and even the Chancellery are involved in major cases.

A senior staffer at Soffin complains that the agency operates in a gray zone between business and politics. This is complicated by the fact that even the government's representatives cannot always agree on what the right approach should be.

What is clear, though, is that the system cannot continue in its present form. The weaknesses are all too obvious, including those of the underlying legislation that created the system. As long as old toxic debt can only be outsourced for three years and is capped at €5 billion ($7 billion), a permanent clean-up will be impossible.

The risks continue to hover around the banks. Even senior Soffin representatives are now convinced that the creation of one or more Bad Banks, as Ackermann proposes, is inevitable. Finally, the government will have to clarify when and under what circumstances banks should be nationalized.

Most of all, however, the money market needs to be revitalized. Before the crisis, the banks would lend each other up to €500 billion ($700 billion) every day. This flow of money back and forth between banks during normal times is extremely important for the economic cycle. It ensures that the banks use the capital available to them in an optimal way. This, in turn, benefits corporate customers that require larger loans.

Conversely, if this interbank market no longer functions properly, the banks must stockpile liquidity -- that is, form reserves -- to be able to service all obligations at all times. As a result, they are left with little or no latitude for new business. Mid-sized companies, in particular, are currently feeling the impact.

A government clearing house could be a possible solution to this problem. Banks would no longer lend money directly to other banks.

Instead, all cash would flow through this central clearing house and would be guaranteed by the government. The Bundesbank has been asked to examine such a measure, and the government plans to discuss it in January.

But what happens if this solution is also ineffective? Or if the banks start lending money to each other again, but not to companies, because they see commercial lending as too risky?

If that happens, the government will face calls to start lending money to companies directly.

Reported by BEAT BALZLI, ARMIN MAHLER, CHRISTOPH PAULY AND WOLFGANG REUTER.

Translated from the German by Christopher Sultan