The sun had just set when a group of Germany's top business leaders gathered in the festively decorated banquet room at the Chancellery in Berlin. Deutsche Telekom CEO René Obermann, Lufthansa Chairman and CEO Wolfgang Mayrhuber and more than a dozen other senior executives from Germany's leading corporations were assembled around a long birch table covered with a white tablecloth. Bankers were not invited.
They were there to discuss a historic bailout package for the banking industry. Chancellor Angela Merkel had gained cabinet approval for the measure a few days earlier. Now it was time to seal the program with a symbolic closing of ranks between the worlds of politics and capital. There was much at stake, Merkel explained, including both the future of the German financial industry and "the acceptance of the social market economy as a whole."
Jürgen Thumann, the president of the Federation of German Industries (BDI), assured the chancellor that she could depend on the "full support of industry." At the same time, however, the business leaders made it clear that the bailout plan had by no means dispelled worries about the future. On the contrary, the CEOs, one after another, explained to the chancellor how the economic climate has worsened in recent weeks.
Ekkehard Schulz, the chairman of steelmaker ThyssenKrupp, complained that there has been such a significant drop in demand in the steel industry that even scrap metal prices are falling. Many car dealerships are in trouble, Daimler CEO Dieter Zetsche reported. And Ulrich Lehner, the head of consumer products giant Henkel, told Merkel that the chemical industry is having trouble paying for rising environmental costs.
The meeting continued into the late evening hours, and when it ended, Merkel sent the corporate leaders on their way with an urgent request. "Talk to your employees," the chancellor recommended. "We must explain to people that we are in a unique situation."
That was putting it mildly. The global economy faces its most serious challenges since the 1920s, Merkel said the next day in a speech to the German parliament, the Bundestag. Back then, the world economic crisis shook the country to its core, both politically and economically. Germans lost their savings, millions became unemployed and the Weimer Republic foundered.
In that earlier crisis, the political establishment failed to prevent the calamity. In fact, it even made it worse with its poor decisions. And today?
Biggest Aid Program since Reunification
In a sudden and historically unprecedented move last week, the Bundestag and Germany's second chamber of parliament, the Bundesrat, gave their blessing to an equally unprecedented €500 billion ($675 billion) rescue package designed to prevent the worst from happening. With government guarantees, the administration hopes to revive the banks' now-defunct lending business and strengthen ailing banks with government injections of capital. It is the biggest state aid program since German reunification.
It is not just Germany's business and political elites who are caught between hope and fear. Worried bankers and citizens alike are speculating over whether the emergency measure will be sufficient. Never before has the state intervened in the economy to such an extent, and never before have the risks been so great. Will confidence among lenders return? Can a catastrophic collapse of the entire banking sector be prevented? Will Germans be spared the plunge into a depression?
The population is deeply anxious. According to a recent SPIEGEL poll, 58 percent of Germans consider the bailout package to be necessary. At the same time, a quarter of Germans worry that their own bank accounts are no longer sufficiently protected -- still, this was an improvement over the previous week's figure of 41 percent.
Nevertheless, these numbers are far from a vote of confidence. That sentiment has disappeared and is unlikely to return anytime soon. Germans must get used to the idea of hard times ahead, of the end of comfort and the beginning of a period of challenges. Only a few weeks ago, Germany's economic outlook seemed better than ever. Unemployment was steadily falling, companies were reporting record profits, the recovery was finally making itself felt among ordinary citizens and, after years of stagnation, wages were rising once again.
Because things were going so well, IG Metall, the powerful German metalworkers' union, demanded an 8-percent wage hike for its members. This demand is still on the table today, although it seems like something from another world.
Suddenly economists are adjusting their forecasts downward at a record pace, almost to zero, and they are warning that even these forecasts are merely best-case scenarios, and that things could end up being much worse.
The credit crisis has already destroyed an enormous amount of value, both on the markets and banks' balance sheets. Just as enormous are the amounts of money the government will now provide to avoid the worst.
Who will pay for all of this? If things go well, the money will not be needed. And yet the price will be high nonetheless. Tax revenues are down, partly as a result of the billions in write-offs being taken by the banks and partly because of the slowing economy. Money will be lacking where it is most urgently needed: in education, climate protection and fighting poverty.
The Worst Is Yet to Come
The markets' reaction to the newly uncertain situation has ranged from mood swings to borderline hysteria. On Monday of last week, traders celebrated the government's emergency plan with the sharpest price increase in history for the German stock index, the DAX. On Wednesday and Thursday, prices dropped almost as sharply as they had climbed at the beginning of the week. By Friday, the market ended its wild roller-coaster ride in positive territory once again. Business papers described it as a week of "unprecedented price fluctuations."
Like the average citizen, stockbrokers wondered which was more important: relief over the quickly approved bailout package or the most recent warnings coming from the financial sector. The word at banks and insurance companies was that the worst is yet to come.
The vital inter-bank lending system, which had ground to an almost complete halt during the course of the crisis, had hardly been revived by the end of last week. Experts warned of gaps in the bailout package and new risks on the banks' balance sheets. And then, to make matters worse, there was a rush of disastrous economic data.
The government plans to increase the amount of the bailout if the current series of measures fail to meet expectations. The relevant ministries are already pondering mandatory measures for the financial sector and new programs to jump-start the broader economy. "We need additional impetus for growth," says German Economics Minister Michael Glos.
Most of all, the government is plagued by concerns that its massive bailout package may not even reach those who need it most. Unlike Great Britain and the United States, the German government has structured its program as a voluntary effort. According to its provisions, only those who expressly request the government funds can receive them.
Financial Institutions Play Hard to Get
The problem is that no banker wants to be the first to drop his guard and make the pilgrimage to Berlin to request the government's cash. Unless this changes, experts fear, the package could end up unused and ineffective. By Monday, only the Bavarian public sector bank BayernLB had indicated that it would avail of the aid, while Commerzbank has merely said it would look closely at the deal.
In Great Britain, all banks whose so-called core capital ratio is less than 9 percent at the end of the year must accept the government's purchase of some of their equity -- whether they want to or not. Three of the five largest banks have already had to seek government protection.
But the German bailout package only requires a minimum capital ratio for banks that want to be bailed out. Among the publicly traded financial institutions, Wiesbaden-based mortgage bank Aareal, Commerzbank and Deutsche Postbank can claim only a thin layer of equity capital. But all financial institutions are playing hard to get, and none of them wants to be the first to request the bailout funds.
Deutsche Postbank, with a 6.3-percent equity ratio, has been bled almost dry. Commerzbank and Aareal Bank both have a low core capital ratio of 7.4 percent -- not enough, in uncertain times. To address this problem Klaus-Peter Müller, the president of the Association of German Banks and chairman of Commerzbank, called last week for the government's crisis talks to yield a clear legal announcement.
The British solution has "an indisputable advantage," Müller said in an interview with SPIEGEL. "Acceptance of the rescue program cannot be used to draw discriminating conclusions about the economic situation of the banks."
The banking executives continue to insist on taking a wait-and-see attitude. Nevertheless, banks could soon begin lining up for bailout funds, and the €80 billion ($108 billion) the government has set aside to acquire equity stakes in banks could be used up quickly.
'Survivial not Profits'
The more profitable elements within the German lending industry, especially Deutsche Bank and its CEO, Josef Ackermann, are opposed to any mandatory government measures. In a speech to about 150 of the bank's senior managers, Ackermann made it clear that he would not consider government subsidies from the bailout fund. "I am a purist," he said, "and I would be ashamed if we were to accept government money in this crisis." On Monday the government lashed out at Ackermann's comments, calling them "unacceptable." Merkel's spokesman said the criticism could end up dissuading needy banks from availing of the fund.
Global Capital Injections
|Bank guarantees, recapitalization and direct purchase of bad loans, in billions of euros|
|Over 3.1 trillion euros in total|
Ackermann fears that the European governments that are bailing out banks left and right will in fact behave in a far less neutral way than they currently claim. He said that banks could run the risk of becoming national institutions. Citing the Netherlands as an example, Ackermann said that the government there had prevented Deutsche Bank from acquiring a stake in the Dutch bank ABN Amro, even though the agreement had already been reached and was ready to be signed.
For this reason, he told managers -- some of them watching the speech from their offices in London, New York, Singapore and Hong Kong -- that Deutsche Bank must remain independent at all costs. In fact, Ackermann said, being independent would be "a great opportunity" for his bank in the crisis.
"The market is currently geared toward pure survival, not toward achieving profits," Ackermann said. In doing so, he questioned the 25-percent return on equity he has repeatedly claimed for the bank. The figure, he said, was "always just a number, a number to indicate that we are among the best. And that has not changed."
Other Time Bombs Ticking Away
Ackermann feels secure. Unlike other bankers, he took steps early on to remove the most toxic, high-risk securities from his bank's portfolio. But his ability to make that claim puts him in a minority. Indeed, more time bombs are ticking away on the balance sheets of the German financial industry.
The bursting of the American real estate bubble was only the beginning. Artfully packaged US subprime mortgages, sold worldwide, ignited the flames, while additional exports from the US financial industry only added new fuel to the fire. For years, Americans have paid for their consumption by borrowing. They paid for almost everything with their credit cards, and going into debt was easy. As long as the economy boomed, everything went smoothly. For years, the total of bad credit card debt hovered at a relatively manageable level of about $25 billion (€18.5 billion).
But that too has ended. According to new estimates, non-performing loans on credit cards could quadruple to almost $100 billion (€74 billion) during the course of the recession next year. There are similar problems with car loans, the only difference being that "they were approved even more readily," says a senior executive at a German bank.
He should know. Many German banks bought the loans from US banks and are now forced to write them off as bad debt.
An even greater drama is unfolding in the global casino for the insurance of corporate loans. Lenders use credit derivatives known in the industry as credit default swaps (CDS) to hedge against their customers no longer being able to service their loans. The worse off a company is, the higher the premium for the insurance. Be it Deutsche Telekom, General Motors or Bank of America, there are CDS contracts for almost every major company and bank in the world.
But what began as a reasonable instrument to hedge against risk developed a dangerous double life in recent years. Banks, insurance companies and hedge funds began speculating with the premiums as if they were chain letters. The risks were passed on x number of times.
In the last four years, the market volume for CDS contracts has grown tenfold to its current level of €55 trillion ($74 trillion), which equals the gross domestic product of the entire world. This murky network of reciprocal payment guarantees now threatens to come apart the seams. The upcoming recession will drive up the number of corporate bankruptcies dramatically, suddenly causing a series of credit insurance policies to mature. "We had ideal conditions in the market for years," says Unicredit analyst Philip Gisdakis, "but now we are in for a real thunderstorm."
The Crisis Leaps to the Broader Economy
It has long been clear that the financial sector will have to shrink significantly in the coming years. In the boom phase after the turn of the millennium, banks greatly expanded their activities by outsourcing risks and granting new loans. To reestablish a healthy level, says Bernhard Blohm, chief economist at HSH Nordbank, the banks will have to cut back their business volume by about 40 percent.
The consequences are foreseeable. If the banks issue fewer loans, companies and consumers will lack the funds for investments and big-ticket items. The crisis will make the leap from the financial markets to the broader economy, as has already begun to happen in recent months. The outlook -- and the mood -- will worsen at an alarming rate.
As a result, almost all economic indicators point toward the red. Exports are declining, investments shrinking and consumer demand bobbing along at a low level. Only one variable will increase in the coming year: unemployment.
Assembly lines are already idle in many factories. One of the hardest-hit industries is automobile manufacturing. German carmaker Opel has taken to periodically furloughing its employees, and luxury carmaker BMW plans to close a number of its plants for several days at a time.
German Finance Minister Peer Steinbrück gave automobile manufacturers a small ray of hope last week, when he said that the car companies' own banks would be eligible to benefit from the bailout fund for the lending industry.
Of course, this will not improve economic prospects for the coming year. It is already clear that there will be a barely perceptible growth rate next year -- that is if it remains in positive territory at all. The leading economic research institutes predict slim growth of only 0.2 percent for Germany in 2009 -- assuming all goes well.
But if things do not go as well, the institutes predict, the Germany economy could shrink by 0.8 percent in 2009. The economists say that there is a one-in-three chance that this grim scenario will materialize.
Either way, tough times are ahead for Germans. The economic institutes predict that about 350,000 workers will lose their jobs next year. The government, too, will have to deal with all too familiar problems. The current crisis is already reducing tax revenues and increasingly social expenditures.
A balanced federal budget is becoming an increasingly distant goal for Germany. On Tuesday of last week, the chancellor assured her party's parliamentary group that she is sticking to her target of submitting a federal budget without new debt, but not for the year 2011.
The coalition government in Berlin is serving up a gloomy scenario. Whether its bailout program will work is anything but certain, and the economy threatens to slide into a serious recession next year. 2009 is an election year in Germany, and yet it could be overshadowed by the kind of economic slump the country experienced in the early 1980s and at the beginning of the new millennium.
It is no surprise, then, that there are growing calls on the backbenches of parliament and in the hallways of ministries for bold government intervention. Strengthening the banks is not enough, say critics of the current measures. They are convinced that the entire economy needs support.
Even the bank bailout package is not necessarily a fait accompli. There is a logical escalation step, in which the administration could use government funds to buy stock in selected banks, thereby improving their equity ratios. One of the proposals being floated is to require any bank that holds less than 8 percent of its total lending as equity capital to participate.
Even this measure does not come with a guarantee of success. Should the mandatory government cash injection also fall flat, the German government will have only one trick left up its sleeve: placing the entire banking sector under government supervision. In that case, it would no longer matter whether the banks wanted to lend each other money or not. A government banking commissioner would simply order them to do so.
Things have not come to that point yet, and Finance Minister Steinbrück still hopes that his current, softer version will be sufficient. But these are days when governments are sometimes tossing out their resolutions by the hour, and the same applies to Germany's massive bailout package. The ink on President Horst Köhler's signature last Friday had hardly dried before the government was adding enhancements to the program.
Governments Take Increasingly Drastic Measures
The final package approved by the cabinet on Monday morning is significantly more flexible than the existing law on issues such as how high the fee should be for government assumption of loan guarantees. Steinbrück's staff originally envisioned a fee of at least 2 percent of the amount guaranteed. Now the package mentions "compensation in line with the market," consisting of "a percentage of the maximum amount of the guarantee as well as a risk-oriented margin." In other words, according to the Finance Ministry officials who helped draw up the legislation, the fee can also end up being lower than originally planned.
The German government was also serious about imposing a cap on executive salaries. Companies approved for the government aid would be required to "limit the compensation of their executive bodies, employees and key vicarious agents to an appropriate level." According to the cabinet, a salary in excess of €500,000 ($675,000) would be considered "inappropriate."
The government also wants executive pay disclosed. "The fund can demand that the compensation of senior executives be publicized in an individualized way and broken down by its various elements in a compensation report." In other works, each individual member of an executive board would be forced to provide a maximum degree of transparency. Executives would also be expected to do without their bonuses "for as long as the company takes advantage of the fund's stabilization measures."
The program shows that in many respects the German government is applying the same approach to dealing with the crisis that the United States and Great Britain have already taken. Elements that prove to be ineffective are changed. And if the first government intervention fails to provide relief, the second one will have to be all the more drastic.
This was the pattern followed, for example, by the historic nationalization program with which US Treasury Secretary Henry Paulson assumed partial ownership of the country's nine most important banks last week. Their chief executives were summoned to Paulson's office like unruly schoolchildren being called to the principal's office. They were given a tongue-lashing and then told what the disciplinary measures would be -- and it was made clear that resistance was pointless.
In better times, such a meeting would have signified the greatest possible humiliation for any Wall Street executive. It would have been an insult and an impertinence, and would have been rejected in the sharpest of terms.
Not so in the course of last week, inside the new heart of American high finance, the Treasury Department. Each of the top bankers was handed a sheet of paper, and Paulson made it clear that they were to sign the one-page document before leaving the building. This inflexibility gave rise to a number of agitated conversations at first. But in the end, officials close to the negotiations say, "Everyone knew that there was only one answer."
By 6:30 p.m., Paulson had all nine signatures, and one of the most astonishing about-faces in American capitalism had been sealed: $250 billion (€185 billion) in taxpayer money would go directly to the largest banks in the United States. Goldman Sachs, Morgan Stanley, Citigroup, JPMorgan Chase and five other large banks, as well as many regional banks, now have a new major shareholder. The government has become a part owner of the financial industry.
Until recently, Republican market fundamentalists were warning loudly against the introduction of socialism in the United States. And now their own president, George W. Bush, is launching the partial nationalization of Wall Street.
"We regret having to take these actions," says Paulson, adding that it is "objectionable" but, unfortunately, necessary to reestablish confidence in the markets. A few days earlier Paulson, a former CEO of Goldman Sachs, had had a completely different position on rescuing the financial world, when he proposed that the government simply buy up the banks' toxic mortgage securities. Freed of old debt, Paulson hoped, the banks would quickly land on their feet again, and it would be back to business as usual.
For two weeks in September, the United States was the scene of a bitter battle over this plan, over justice and the pure theory of the free market economy. Those on the left were against Wall Street's evildoers being bailed out by the government while normal citizens had to look on as they lost their houses. On the right side of the aisle, market fundamentalists fought against massive government intervention.
But then, when the markets kept plummeting lower and lower, consumption declined and the private retirement funds of millions of Americans began melting away, most of the resistance to a government bailout vanished.
Federal Reserve Chairman Ben Bernanke has long argued behind the scenes for direct government investment in banks, in his view the clearest and most efficient solution. But this did not agree with Paulson's understanding of the market, who had considered nationalization the very last resort. He stuck to his guns until the markets forced him to rethink his position early last week. The New York Times called it a "bold move for a desperate time."
While the ailing American financial industry continues to undergo emergency surgery, the drastic consequences of the bailout for the US government budget are already becoming apparent. The next president will inherit a heavy burden following the multibillion-dollar injections from Washington -- a circumstance that has been ignored in the final phase of the presidential election campaign.
The US budget deficit already almost tripled in 2008 compared to the previous year, from 1.2 to 3.2 percent. Next year, according to Jeffrey Sachs of Columbia University, it will likely grow to 5 percent.
The situation is hardly better in much of Europe. In Berlin, as well as in almost all European capitals, giant bailout packages for the banking industry are currently being assembled, each of them packed to the gills with taxpayers' money. The British government's program will cost about €570 billion ($770 billion), while France is providing €360 billion ($486 billion) in government guarantees for its banks. Even a relatively small country like Austria finds itself forced to pony up about €100 billion ($135 billion) to support its banks.
The series of government bailouts throughout the entire European Union promises to amount to about €2 trillion ($2.7 trillion).
For now, these sums are nothing but numbers on a piece of paper. They represent amounts that will be made available, but not necessarily spent. No one knows how much of this money the financial sector will claim in the coming months. It is also unclear how much it will be able to repay after the bailout programs end and how much will ultimately be lost in the maelstrom of crisis. It is clear, however, that even a relatively small share of the total will add up to large sums. For instance, if the banks end up using only 12 percent of the EU emergency funds, the grand total will still equal the German government's entire tax revenues for 2008 -- roughly €240 billion ($324 billion).
In light of such numbers, it is hardly surprising that economists are overcome by grim forebodings. Even if the worldwide bailout programs for the financial industry succeed, they will come at a high price. Citizens will pay dearly for these gigantic packages. Depending on the scenario, societies could experience many years of rising inflation rates, higher taxes and an economic downturn with declining income and mass unemployment.
In the worst of cases, something could happen that the huge bailout packages are in fact meant to prevent: a meltdown, which would destroy the financial system to its very core.
"Meltdown" has the potential of becoming the word of the year, even though no one has a concrete sense of what this phenomenon would actually mean. The only thing that is predictable is where it will end.
"The end point will have been reached when a government is no longer receiving any capital," says Henrik Enderlein, a professor political economics at Berlin's Hertie School of Governance. In other words, when it can no longer service its debt and is essentially bankruptcy. A prime example in recent weeks has been Iceland, which is fast approaching this final stage.
The German economy is in much better shape than the Icelandic economy, and yet it is by no means invulnerable. Its Achilles' heel is government debt. Skeptics believe that if there is a sharp rise in government debt, even the most solid community can be forced to its knees -- or even destroyed.
Inflation or Deflation?
Today, Germany's combined federal, state and local debts amount to just under €1.6 trillion ($2.16 trillion), or 65 percent of GDP. If the federal government had to write off one-fifth of the €500 billion ($675 billion) bailout package, the additional debt would still be manageable, but barely. But if it had to come up with the entire sum for the bailout, it could reach its limits, says economist Enderlein.
The amount of the debt is less of a problem. At a rate of 85 percent, Germany would still be well ahead of Italy (117 percent) or Japan (170 percent). The difficulty, instead, lies in the rate of acceptance of the funds. The country would have to take up new loans on a large scale. Tax increases would hardly do the trick, because taxes would not be a sufficient source of income. For instance, increasing the value-added tax by three percentage points would provide the treasury with all of €24 billion ($32 billion) in additional revenue. The other way to raise capital would be to issue securities. In other words, the government would have to float large volumes of federal bonds.
Of course, this step would mean that Germany would lose its current perfect AAA bond rating. Investors would no longer be satisfied with miniscule interest, as they are now. The more the government's reputation as the last safe haven suffers, the higher it will have to raise interest rates to market its bonds.
In such a tricky situation, there is one seductively simple solution: Countries keep interest rates artificially low and reduce their debt by printing money. Inflation devalues money and the state expropriates its creditors.
But the meltdown must not necessarily end in inflation. It could also lead to deflation, or a gradual decline in prices, an outcome that many economists consider possible.
This would happen if all government emergency bailout measures remained ineffective, in other words, if the central banks were unable to reinvigorate the markets no matter how much money they pumped into them, if the banks permanently lost confidence in each other, and if even the last conceivable interest rate reductions failed. If all of this happened, the world economy would be caught in the liquidity trap British economist John Maynard Keynes described in 1936.
Businesses would no longer receive loans and would stop investing, and consumers would horde their cash. It would mark the beginning of a phase of economic decline, lasting years if not decades, complete with waves of bankruptcies, negative growth and job cuts.
At this point it seems highly unlikely that this will happen in Germany. And yet it cannot be ruled out, especially if the giant bailout package for the banks does not live up to its promise.
BEAT BALZLI, FRANK HORNIG, ALEXANDER JUNG, CHRISTOPH PAULY, CHRISTIAN REIERMANN, WOLFGANG REUTER, MICHAEL SAUGA, HANS-JÜRGEN SCHLAMP
Translated from the German by Christopher Sultan