By Tim Bartz, Markus Becker, Simon Hage, Martin Hesse, Alexader Jung, Armin Mahler, Christian Reiermann and Marcel Rosenbach
A week ago Saturday, the opening night celebration went late into the night at the new restaurant Blaue Blume in Hamburg’s Altona district. There’s still a bottle of champagne on one of the tables, evidence of the party. "It was packed," says restaurateur Karin Wege. That was only 10 days ago, but it already feels like a different era.
Wege and her partner have run the Blaue Blume, a restaurant for home-style potatoes and beer, for 17 years. Six months ago, they lost their lease, but they lucked out when they found a new location around the corner, a prewar building with arched windows and exposed brick walls. "The location is a gift from God,” says Wege, but the opening couldn’t have come at a worse time. Wege stands directly behind the tap and looks fatigued as she gazes out into the empty room.
Severe restrictions have been in place at eateries across Germany since last Wednesday. And as of the weekend, no guests were allowed inside restaurants -- with takeaway now being the only option. It’s a blow for the business, a disaster for the restaurateur and her 10 employees. She slaved away for months organizing the move, sanding down wooden tables, having a new kitchen installed, and now this? Wege says she’s invested an incredible amount in the business. Now the bills from all the carpenters and craftsmen are coming due, but revenues have dried up.
How long will she be able to hang on? Weeks? Months? The restaurateur doesn’t want to think about it. She’d rather fight. "Closing isn’t an option,” she says almost defiantly.
Weeks? Months? These are the questions everyone is asking now: Business owners and normal folks, but also governments and central banks. How long will it take to stop the corona pandemic? And how long can the economy survive a forced shutdown like this?
No one can answer that question. Health comes first and the economy is secondary right now. But the consequences are devastating and the economic forecasts are growing grimmer by the day. The stock markets are in a state of panic and the share price gains that took many years to achieve have disappeared within a matter of just weeks. There has never been such a short amount of time.
This crisis is unprecedented, and that’s what makes it so dangerous. It’s hitting every country, industry and company.
"This is the biggest crisis we have had in the postwar era,” says Hans-Werner Sinn, the longtime president of the Munich-based economic think tank Ifo. "This even overshadows the Lehman crisis."
Global Recession or Prolonged Depression?
The corona shock is striking an economy that was already weak before the pandemic and a financial system that has never really recovered from the consequences of the 2008 financial crisis. If companies aren’t given prompt assistance, we could be facing a domino effect that takes everything down. Banks could face possible collapse and members of the eurozone would need to be bailed out again. Then the inevitable global recession that we are certain to face could potentially turn into a prolonged depression like the one that followed the Wall Street crash in 1929.
The reactions from central banks and governments around the world are indicative of how dramatic the situation is. Some are flooding the markets with money. Others are passing rescue bills on an unprecedented scale. Whatever it takes. The mantra adopted by Mario Draghi during the last crisis when he was president of the European Central Bank to save the common currency has now been taken up by governments around the world, including Berlin.
What companies need mostly right now is cash. Entire industries have been put into an artificial coma to combat the spread of the coronavirus. If the economy isn’t provided with the capital it needs right now, it will suffer from irreparable damage once the shutdown is over. And then what?
Tom Neukirchen has already switched his company Fundgiver into "emergency operations,” as he puts it. He had originally planned to travel to Berlin for a two-day workshop this week and then to Würzburg for a training session. Neukirchen has spent the past 20 years advising organizations on how to effectively raise funds.
An Economic Pandemic
His appointments have been cancelled, orders have dried up and he has served notice that he will lay off his employees on June 1. He says he has experienced financial crises before as a business owner, but this time a much longer and more serious order drought has begun to take shape. "Many others are in the same position," he says. "The government should also pay more attention to the economic effects when making decisions, otherwise the viral pandemic will soon be followed by an economic one with millions of unemployed."
In addition to BMW, Opel and Daimler, Volkswagen has also announced it will close its plants in Europe for at least two to three weeks. The world's largest car manufacturer, which only recently announced a record profit, is now preparing for a deep crisis. Indeed, the German economy’s most important growth engine, the automotive industry, is on hiatus for the time being.
"In many European markets, business has practically come to a halt,” states a letter from the VW management board and its works council to employees. "Demand is declining noticeably.” In order to save jobs, however, manufacturing has to be restarted at some point. The letter states that Volkswagen is a strong company, "but even we can’t carry this burden for too long.” The company is now planning to implement the German government’s short-time work relief package in order to mitigate the consequences of the suspension of production. The government subsidy, which can last for up to a year, offsets the labor costs and social insurance benefits for employees who might otherwise be laid off.
"The most important goal in the coming months is to avoid bankruptcies,” says one high-ranking automobile industry executive. He says that once carmakers restart production, supply chains and sales channels also need to be able to function immediately. It’s also important to ensure that the supply of parts from Europe to other regions of the world, such as China, where production is already underway again, is secured.
But even if suppliers, manufacturers and dealers are able to resume their work soon, no one can know for sure today when people will start buying cars again. There is already talk in the industry of a worldwide "demand shock,” which is likely to result in losses for manufacturers, some of which will be considerable.
Whether it’s small business owners like Neukirchen or a major global corporation like Volkswagen, and with it the entire automobile and supplier industry, the crisis has affected the entire spectrum of the German economy. The situation doesn’t look any better in other countries, either.
Profiting from the Crisis
Ironically, times of crisis like this are good for people like Boaz Weinstein. When the economy staggers, he’s never far from the scene. As a star trader at Deutsche Bank, he and his team gambled away $1.8 billion during the financial crisis. He had to leave the company and he then founded the hedge fund Saba. Since then, he has sought to profit from crises by speculating through credit default swaps (CDS) that companies will go bankrupt. Business had been pretty mediocre and the numbers of bankruptcies low in recent boom years.
But business is picking up now. At the start of the coronavirus, he began buying CDS so he could profit when tourism companies like Royal Caribbean Cruises or United Airlines ran into trouble. Since the beginning of the year, the value of his fund has risen by 67 percent.
Weinstein’s happiness is the misery of others. In New York, London, Frankfurt and Tokyo, indeed all around the world, investors are unloading all sorts of asset classes to retain their liquidity. Share prices are plummeting, securities in emerging markets are collapsing, and gold, silver and even U.S. government bonds are in such turmoil that the Federal Reserve had to intervene to prevent the market from freezing. "The only safe haven right now is cash,” says Jochen Felsenheimer, founder of the Munich-based hedge fund Xaia.
The situation is threatening to spiral out of control. Central bankers and politicians are still trying to calm people, saying that a financial crisis like the one in 2008 with bank collapses and nationalizations isn’t foreseeable. And what else could they say without shaking up the markets?
The greatest danger for the banks comes from companies that are no longer able to service their loans. And there are many signs that this threat is real -- exploding CDS prices, for example. Or the prices of corporate bonds, which seem to be falling into a bottomless pit. Thanks to the almost 10-year upturn in the global economy, even the "junk bonds” for companies considered shaky were finding buyers for years without any problems.
The article you are reading originally appeared in German in issue 13/2020 (March 21, 2020) of DER SPIEGEL.
Low interest rates allowed companies to go deep into debt, which fueled growth that was largely built on borrowed money. That is now coming back to haunt us.
And it’s not only a question of bank loans. In recent years, many companies, especially in the United States, have increasingly been issuing bonds to buy back a huge amount of their own shares using borrowed money. The aim was to drive up share prices, but also executives’ bonuses. Some of these companies may now have to be bailed out using taxpayer money.
"Encouraged by the ultra-easy monetary policies of central banks, the global debt bubble has continued to grow in recent years," says William White, former chief economist of the Bank for International Settlements and an oracle of the last financial crisis. "The coronavirus appears to be the needle that will burst that bubble."
As early as autumn of 2019, even before the corona crisis, the International Monetary Fund painted a gloomy picture of the market for corporate debt in larger economies. It warned that in an economic crisis only half as bad as that of 2008/2009, around 40 percent of interest and repayments could be lost - a figure of no less than $19 trillion.
At the time, it was just a calculation, but it has the potential to become a real horror for the banks. The rating agency Standard & Poor’s expects that more than 10 percent of bank loans to U.S. companies are likely to be defaulted on. For Europe, the losses could end up in the upper single-digit percentage range. That would mark a tripling of the normal rate and would also match the level seen in the 2008 financial crisis. The fact that banks have been so willing to issue loans in recent years is now coming back to haunt them.
The Hour of the Central Banks
Once again, this is the hour of the central banks. The European Central Bank (ECB), the Fed in Washington and the Bank of England have all made clear that they will continue to provide their commercial banks with free liquidity so that lending doesn’t collapse.
The ECB acted hesitantly at first, but made up ground last Thursday by announcing it would buy another 750 billion euros worth of bonds from companies and countries to prevent another euro crisis from flaring up. "Extraordinary times require extraordinary action,” ECB President Christine Lagarde tweeted on Wednesday. "We are determined to use the full potential of our tools, within our mandate.”
In contrast to the actions taken after the Lehman bankruptcy, however, the trillion-euro announcements made by the central banks have so far provided only brief respite on the markets. They can’t prevent a crash in stock prices on their own, because this time it’s not a purely financial crisis – this time entire industries are shutting down. And no matter how cheap the money is, no one wants to invest in a completely uncertain future.
The central banks are now firing their bazookas just to do something, but it’s possible they won’t achieve much in the end. At the same time, there still hasn’t been a credit crunch and the markets are functioning, even if they’re in a state of free fall.
But that’s the most positive thing that can be said right now. The central banks may have created the perception of omnipotence during the Lehman crisis, but they appear to be at a loss today. For the most part, the central banks have already exhausted their firepower. Key interest rates worldwide are at or close to zero, and there’s no more downward potential.
The Last Line of Defense
The last line of defense is governments. They will have to jump in as the lender of last resort. And they seem very determined to take on this role, regardless of the cost.
U.S. President Donald Trump, who until recently didn’t even take the disease seriously, is planning a $1 trillion aid package. It includes, among other things, a form of wage subsidy and aid for vulnerable companies as well as direct payments to the people. The talk is of every American getting a check for $1,000.
In a country where there is no universal unemployment insurance system, those kinds of payments may well be useful for protecting those who are now suddenly left without any income. The measure is being sold as "helicopter money,” but it isn’t really, because the $1,000 would come from the government budget and would not be money printed by the Fed.
The actual concept of helicopter money goes back to the U.S. economist Milton Friedman, who considered what it might look like if a central bank dropped cash from a helicopter. It hasn’t been seriously considered in its pure form so far, because critics argue that it would undermine confidence in the monetary system.
But programs aimed at stimulating consumption bypass the current problem anyway, because they only make sense once the industries that have been put into an artificial coma have been taken out of it. Only at that point can demand be stimulated, because you first need supplies, with the companies producing and restaurants and shops open again.
Right now, though, nobody knows when that point will come. For the time being, governments need to try to save as many companies as they can, to preserve as many jobs as possible and to try to prevent a situation, to the degree possible, where people are no longer able to pay their bills or rent.
That’s actually the good news: Most countries have sufficient possibilities for generating the sums of money necessary to do just that. In times of zero and negative interest rates, government bonds sell like hotcakes, especially for a country with an excellent credit rating like Germany. That’s why the German government has been as relaxed about this issue as it has been. Over a week ago, German Finance Minister Olaf Scholz and Economics Minister Peter Altmaier presented a vast relief package for the economy, promising bridge loans for companies quickly and with as little red tape as possible.
In addition to the liquidity support, a bailout package for companies has also been presented. On Monday, Scholz announced a 500-billion-euro bailout fund to protect companies from bankruptcy by providing credit guarantees for their liabilities or by actually injecting capital in what would amount to partial nationalization. In the current situation, many companies need not only loans, but also direct financial assistance to pay wages, rents or loan installments.
The model for the measure is the Special Fund for Financial Market Stabilization (Soffin), with which the government stepped in to save banks from financial difficulties during the financial crisis 12 years ago. At the time, it had a volume of 480 billion euros, the majority of that sum in the form of credit guarantees. But it also had the ability to borrow on its own, if necessary. That’s also likely to be part of the rescue package for the real economy. Sources in the German government say that the structure proved itself during the last crisis.
"Multiple Organ Failure”
The government programs cover virtually the entire economy. The German government wants to revive Soffin in case the current crisis leads to a new situation where credit institutions start to fail. Meanwhile, the government has established up a lavishly endowed "solidarity fund” for self-employed individuals who are no longer getting any work.
The finance minister’s plans mark the final farewell from the German government's policy in recent years of balanced budgets. The federal government will have to incur enormous debts in order to slow the economic collapse. One senior government official describes what is currently happening to the economy and society as "multiple organ failure.”
Volker Brühl, managing director of the Center for Financial Studies at Frankfurt's Goethe University, sees the risk of a depression with deflationary tendencies if the coronavirus continues to traumatize markets and the economy into the second half of the year. Deflation would be an economic horror. If that happened, there would be more supply than demand, prices would fall and the economy would continue to shrink.
But that scenario cannot be ruled out, especially if the economic coma lasts for months. Should that happen, only the government could turn things around. It could attempt to revive the economy with a gigantic stimulus package.
Finance Minister Scholz would be willing to do so, and he has sufficient resources to mobilize funds on an unprecedented scale. A volume of up to 5 percent of gross domestic product is under discussion. In absolute figures, this would be around 180 billion euros.
According to government experts, that sum could be increased almost at will. "Even if we were to increase the national debt to 80 percent in a short period of time, Germany would still get the best rating from the rating agencies,” says a senior government official. "We've already been through all that."
The government could borrow more than 700 billion euros in new loans before it reaches that threshold, the source said. "We are thinking about orders of magnitude that have never existed before," says a person working with Scholz.
But outside of Germany, what countries can even afford that? In Italy, which is suffering the most from the corona pandemic, sovereign debt is already at 130 percent of gross domestic product. And the risk premiums on Italian government bonds have begun increasing on financial markets.
Before the latest bailout package, the ECB made clear that it wouldn’t stand by and watch as the creditworthiness of eurozone member states corrodes. But at some point, even the ECB will reach the limits it has set for itself. At that point, an actor will come into play that hasn’t had to intervene so far: the European Stability Mechanism. It has 705 billion euros of share capital, of which 410 billion euros are currently available.
That money could be used to help Italy with emergency loans. But even this money would have to be paid back at some point.
In that sense, it’s little wonder that the old discussion about common bonds between the eurozone countries, so-called euro bonds, has flared up again. Italian Prime Minister Giuseppe Conte has raised the idea of special "coronavirus bonds.” Germany and other Western and Northern European countries have so far categorically rejected such communitized debts – and that is unlikely to change. The EU should first use the tools it already has, says a diplomat from a Western EU country. "And we believe that these tools will be enough."
If interest rates remain low, European countries could easily increase their debt burden by 10 percentage points, says Guntram Wolff, director of the influential Brussels think tank Bruegel. If this were to lead to the economy returning to its previous level more quickly after the end of the crisis, he says, then debt in relation to economic power would probably not be any greater afterward than if no action were taken now.
But that economic power definitely wouldn’t be any greater than it is now. At the end of the corona shock, the world will be even more indebted than before and the system will be even more vulnerable. The crisis caused by this pandemic is likely to last far longer than the outbreak itself.