Germans must get their head out of sand on banks

Submitted by Edward Harrison of Credit Writedowns.

Germany never participated in the upswing of the housing bubble. This fact has led German politicians of all stripes to mistakenly believe their banking system was somehow immune to the problems infecting bubble markets like the US or Spain.  Unfortunately, it has not worked out that way because the globalization of finance has shifted risk far and wide within the global financial system. 

German banks have long had low returns on assets with bloated balance sheet and low margins in both retail and wholesale banking, particularly at the state-owned Landesbanken. This has caused the largest German financial institutions to either move into investment banking or reach for yield abroad. 

During the credit bubble years that meant loading up with higher yielding but supposedly bullet-proof AAA paper in markets like America’s residential mortgage-backed security market.  Unfortunately, many of these assets were toxic. And as these market bets have gone pear-shaped for Germany’s banks, these poorly capitalized institutions have become weak, limiting their ability to serve their traditional function domestically.

To date, there has been relatively little open debate about how sick the German banks are. Sure, HRE has been nationalized and Commerzbank has been topped up with cash.  But, the Landesbanken have become a bottomless pit, with repeated bailouts having been necessary. Government officials have threatened the Landesbanken. But little else has been done. Most German leaders – politicians, bankers and academics, have had their heads in the sand, thinking minimal recapitalization and reform efforts along with manoeuvres to fix a few bad apples would do the trick.

Have things now changed?  Read the excerpt from an FT editorial below. It was written by the president and research director of Financial Markets at DIW Berlin, the German Institute for Economic Research. I see this as a very public call for reform by high profile German finance professionals.  Let’s see what kind of response it receives.

Germany has seven independent state banks, or Landesbanken, which are jointly owned by the state governments and the savings banks. Established to provide state guarantees for regional business development, this practice was essentially outlawed by the European Commission back in 2002. Since then, Landesbanken have faced corporate governance problems. For example, the advisory boards of Landesbanken are supposed to control the top management but professional expertise plays no role in the allocation of seats. In some Landesbanken, neither the management nor the board had reliable information about their holdings of subprime mortgage products when the crisis hit.

Worse, the already doubtful sustainability of their business model – international wholesale banking – has been shattered by the financial crisis.

To compensate for their low rates of return compared to private banks of equal size, many Landesbanken before the crisis created structures to hold assets outside their balance sheets. Protected by state guarantees, they borrowed large sums of money in capital markets, which they invested in supposedly high-yielding subprime products with good credit ratings. When the products were subsequently downgraded, two state banks were forced to merge immediately. Four of the remaining seven state banks lost much of their equity and had to be bailed out by various state governments with tens of billions of euros.

This situation could get much worse: If the Landesbanken fail to clean up their balance sheets, the next decline in equity capital could prove lethal. To avert such an outcome, it is imperative to establish a “bad bank” to receive their toxic assets – and then continue the clean-up by reducing the number of Landesbanken through mergers.

The full Op-Ed is provided at the link below with recommendations and preamble lamenting a similar lack of reform-mindedness in America.


No time to waste in reforming German banking – Klaus Zimmermann and Dorothea Schäfer, FT

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About Edward Harrison

I am a banking and finance specialist at the economic consultancy Global Macro Advisors. Previously, I worked at Deutsche Bank, Bain, the Corporate Executive Board and Yahoo. I have a BA in Economics from Dartmouth College and an MBA in Finance from Columbia University. As to ideology, I would call myself a libertarian realist - believer in the primacy of markets over a statist approach. However, I am no ideologue who believes that markets can solve all problems. Having lived in a lot of different places, I tend to take a global approach to economics and politics. I started my career as a diplomat in the foreign service and speak German, Dutch, Swedish, Spanish and French as well as English and can read a number of other European languages. I enjoy a good debate on these issues and I hope you enjoy my blogs. Please do sign up for the Email and RSS feeds on my blog pages. Cheers. Edward


  1. Scott

    I completely agree. A big chunk of the FRB swap lines extended during the heat of the global crisis were to support German banks. Deutsche Bank had leverage of 30:1.

  2. Hubert

    Head in or out of sand – no big difference!
    the money is gone. The holes are too big for state budgets, so the whole thing gets buried in some federal government off balance sheet vehicles. German taxpayer has the future privilege to come up with the filling.

    The Landesbanks are political creatures and their historic record is worse than Citibank. Their combined losses might also be. Now some additional job parking opportunities come up for their "bad bank" entities.

    Yes, some of them might be merged, so there might be less of them around to blow up German finance next time – provided there is a next time; some "if" when one reads about over 800 bn Euros of impaired assets.

    In Germany we might be able to handle the implosion of our export model and the implosion of our banks – but not both at the same time, as they are mutually reinforcing and supported by shifting demographics.

    Game over, here too.
    People and politicians do not get is so far. So we might see some funny maneuvering in the next years.

  3. Anonymous

    I never understood why so many people care about the Landesbanken. Nobody needs them, they bought so many trash assets because they have nearly no customers. They have no real function for the economy, so it doesn't matter if they're zombie banks or not.

  4. VG Chicago

    I wonder how many of those mortgages for properties in Spain have been made by Landesbanken banks. But seeing just how many Germans have retired in Spain, I imagine there must be an awful lot.

    Considering Germany is such an export-dependent nation, and also considering that Germany has lost control of it’s once powerful currency (Deutchmark), I’d think Germany is in trouble.

    Additionally, considering that the Euro zone is now made up of such loser, backward, peasant nations such as Spain, Italy, Greece, and Ireland, makes one wonder how long before the Euro goes the way of the Zimbabwe Dollar… and takes down the Fourth Reich with it too… oh, pardon me, I meant to say “takes down the European Dream with it too”… same thing…LOL

    Vinny Gold – “no nonsense common sense”

    PS – last time I drove through Germany, a few months ago, I was appalled by the decaying state of the once impressive autobahn. I suggest that the German road maintenance people pay a visit to the United States to see how a properly-paved and painted expressway look like. Ah, the United States… that hated and envied nation across the Atlantic that Europeans can only dream of emulating…

  5. Joseph Dietrich

    RE: the state of the Autobahn, it's an interesting viewpoint and almost exactly the opposite of my own experience when I travelled on the US Interstate system last year (I-16 was a real treat, and I-95 was a mess). Which, I guess, just goes to show that ancedotal experience tells us little, and especially ancedotal evidence about something completely unrelated to the topic at hand.

  6. Anonymous

    RE: state of Autobahn. I'm an American living in Germany. The autobahns are in fine shape. I'm actually sick to death of number of construction sites all along the autobahns, which causes terrible traffic jams. They are constantly expanding/upgrading/repairing their freeway system, sometimes unnecessarily it seems to me.

  7. VG Chicago

    Joseph Dietrich: I don't know what you mean by "anecdotal evidence", considering that I spend half of my time in the USA and the other half in Europe, driving extensively across both continents.

    Regarding I-16, it is not really an "interstate" since it lies entirely within the State of Georgia. It is likely not a federal standard interstate at all. As far as I-95 is concerned, I have not noticed any problems on it, and indeed it's a route I take often. Would you be more specific with regards to the portion you are you referring to?… because I-95 spans from North Maine to South Florida… which is about twice the length of the entire freeway system of that medium size European nation known as Germany…LOL

    Now, regarding the German autobahn, try driving on it when it rains (which is about 300 days per year, in Germany), and the markings are almost invisible, making it extremely difficult to know whether you are in your lane, or completely off-road. And speakig about off-road, that also is hard to distinguish from the autobahn, considering the crater-size potholes it is plagued by…

    I'm afraid Germany is fresh out of money. So, here are a few things you can blame it on: blame it on the Turks, Jews, Russians, Poles, Americans, or any other non-German ethnic group your otherwise arian nation has picked on across its disastruous history…LOL

    Vinny Gold

  8. Anonymous

    Vinny – German, Austrian, Swiss, Italian, Spanish and French transportation infrastructure is not as you describe.

    Road engineering quality including safety features, drainage systems, surface and capacity to accommodate high speeds can't even be compared to the U.S. in most cases. Let's also not forget railways.

    Have you driven in the Alps lately? Seen those tunnels and bridges? That kind of extensive investment in road infrastructure exists no where else in the world.

    Also and more on topic, since German and other continental European companies and citizens rely much less on credit than US or UK counterparts I can't see how a banking crisis in Europe, while obviously not helpful, will be anywhere near as devastating.

    Germany's problem is a decrease in exports to the US. However, when in China, I notice that German goods are regarded as items of prestige (as they are in most places). From appliances to automobiles, the Chinese sure do seem to like German stuff.

    The current US centric dynamic of world trade may very well be shifting towards Europe, Asia and everything in between. It makes sense geographically and demographically for the Eurasian space to continue expanding trade and political ties.


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