Germany: Just Another Weak Man of Europe?

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Wolfgang Munchau, in the Financial Times, revives a line of thought that was voiced from time to time during the financial crisis: that some countries (the UK, Germany, the Netherlands, Switzerland) had banking sectors that were so large that it was an open question as to whether they could credibly backstop them. One of the peculiar conventions of modern banking that goes unaddressed post crisis is that the country that is the headquarters of an international financial firm is perceived to be responsible for it. So let us say Citigroup has a run in Europe. That is not the problem of the regulators in the countries in which Citibank does business; Citigroup is expected to supply funds to meet depositor demands, and if they need emergency help to do so, they look to Fed (the other model would be to have any banking operation in, say, Italy, to be subject to national rules regarding capital adequacy, a sort of “each tub on its own bottom” approach).

Munchau explains that when you look at the obligations of various states in Europe and include contingent claims, particularly those issued to banks, the strength of fortress Germany comes into question. From the Financial Times:

Is the eurozone insolvent?…

The first thing to note is that you cannot answer that question with a cursory reference to the debt-to-gross domestic product ratios of eurozone countries. …The problem is that those headline numbers exclude contingent debt and the interconnectedness of financial flows.

The biggest category of contingent debt is made up of the various guarantees the eurozone has been handing out in the last couple of years. European Union governments have effectively guaranteed the liabilities of their entire banking sectors. They have guaranteed all bank deposits up to a certain limit. The eurozone member states guaranteed Greek debt for the next three years, and then extended the scheme to the rest of the eurozone. And those guarantees will probably have to be doubled again….

What is the size of the problem? International Monetary Fund estimates suggest that the eurozone is well behind the US in terms of writing off bad assets. I have heard credible reports suggesting that the underlying situation of the German Landesbanken is even worse than those estimates suggest. Last year, a story made the rounds in Germany, according to which a worst-case estimate would require write-offs in the region of €800bn – about a third of Germany’s annual GDP. If you were to add this to Germany’s public debt, you might jump to the conclusion that Greece should bail out Germany, not the other way round. While that is probably a little exaggerated, there are serious questions about whether the eurozone is still in a position to issue such massive guarantees. So, given what happened to those subprime CDOs, what hypothetical rating should we then attach to that €440bn eurozone SPV? A triple A?….

Of course, another positive exit scenario would be a combination of strong growth and low interest rates – to help the banks generate big profits to allow them to write off their bad debts in small instalments year after year. The Credit Suisse report asked whether the slowdown in global growth might have the same effect on the eurozone that the slowdown in the US housing market had on subprime CDOs. As long as the eurozone governments can generate sufficient tax revenues, all is well. But if that were to stop, the eurozone’s debt edifice might break down like a house of cards. Even a 150 per cent debt-to-GDP ratio would be feasible if the eurozone had an intelligent growth strategy. But it never did, and it still does not.

I make no predictions here. But recent financial history teaches us that we must ask those questions and not blindly trust implausible promises, whether made by bankers or by politicians. I suspect that for as long as those Landesbanken and cajas stay unreformed, investors have good reason to treat the eurozone in the way they should have treated subprime CDOs.

Yves here. The Landesbanken were major stuffees for toxic US debt, in particular, subprime. So the continued wobbliness of the eurozone is in part a lingering aftereffect of the 2007-2008 crisis.

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  1. Martin

    Muenchau is wrong.

    First, those guarantees can be revoked any time. It is not reasonable to treat guarantees, that seem to be given to banks implicitly, as national debt. The gov’ts will keep the guarantee, if they have the money, but they won’t risk their own solvency to bail out banks.

    Second, it is pretty much unbelievable, that the Landesbanken have to write off 800 billion. This would be about half their balance sheets. It is credible for all banks together – public and private – but that private banks will be bailed out at such costs, is even more unlikely.

    1. Yves Smith Post author


      Revoking guarantees is not realistic unless the parties who got the guarantees have strengthened their balance sheets in a meaningful way. That has not happened. And the trend since the Great Depression has been to enlarge the safety net under the financial system

      Muchau did not say that that amount would be written off, but that that was the worst case. Reader Hubert (who is pretty plugged in) agrees with his tally of bad assets, and thinks the losses will be more than 50% of the total. From comments in an earlier post:

      On Germanys currency reserves: What the private sector earned, the financial sector has squandered. Publicly owned banks have bad assets at around 800 bn Euros – let us say 300bn of it will be payed back (an optimisitc ssumption in my view) – then there are no surpluses left. In addition you have some rogue actors like Daimler mamagment buying Chrysler or Deutsche Post with DHL in US wasting resources.

      So Wolf misses the story. I am wondering how brilliant people like him can be so blind. Please – where are Germany’ s big FOREX reserves – or where are the big amounts of FDI, overseas assets? Chrysler ? Goldman Subprime Mortgage CDO 123 ? German CA surpluses hopefully will be a problem 5 years from now; the old ones have evaporated….

      Over 200 bn Euro in US CDO´s which can be considered next to worthless. On Top of that all the Souvereign debt. So I stand by the numbers. They will even get bigger with time.
      Real estate Funds in Germany overpaid by maybe 20-30% for maybe 10 billion investments. Landesbanks overpaid bx 100% for over 200 bn. Numbers matter.

      Daimler at the time of the merger was still primarily owned by Germans. It paid in stock for Chrysler.

      Landesbanks are too politically connected to fail. The Bad Bank scheme is on. It is just a way to keep it off-balance sheet as they are supposed to pay back the Bund. Just how? It is too much money and the banks are too stupid to earn it. But they will still try with new liquidity. Somebody wrote somewhere that HRE has already invested some 5 bn new money from the State in Greek state bonds.

      I think you have disagreed with him before, but he is thorough in his research and also has a good network of contacts.

      1. Martin

        yeah, sure I disagree often with him – and with you in case you say the guarantees can’t be revoked. They won’t be revoked, unless the gov’ts face the real possibility of default, an 500 bn of extra debt will not even bring Germany close to default. But in case it would, the guarantees would be revoked (who wants a guarantee from a likely defaulter anyhow? and the question, if it can be done has more to do with the question, if a banker can die, when a bullet is put into his head than capital market conditions). Regular bunds are saver than bonds of public German banks. And well, I guess the market agrees with me, or do German public banks pay as low interest rates as bunds?

        With respect to Hubert’s comment: I partially agree, but he misses, that as well foreign enterprises wasted tons of money in Germany.
        – Walmart entered the German market and made only losses until they sold their business, just like DHL in the US.
        – Dresden sold its public housing with quite favourable conditions as US investors thought, housing can as well in Europe only go up, but I think they didn’t get lucky.
        – AIG sold quite undervalued credit default swaps to some German banks. And actually, if banks are now the savest enterprises, that exist, Germany is in a really nice position – a large part of the foreign assets of Germany is lending to foreign banks.
        – JC Flowers bought HypoReal Estate for a substantial amount – and complained when getting still some money back for an institution that obviously had zero value without state guarantees.
        Failure and misinvestment is not as one sided, as Hubert makes it up. As a nation with a CA surplus, and unfortunately often economically quite illiterate people, Germans wasted indeed more in foreign nations than vice versa. Others are smarter investors, but not that much smarter.
        With respect to Wolf Hubert is of course right. There are no FOREX reserves, and the foreign investment with value is not under the control of the state. So a “solution” to unwanted imbalances can’t be easily manufactured – and the “solutions” that Münchau offers to export dependence are generally don’t help the slightest bit (even if they might be reasonable policy on other grounds).

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    3. Badtux

      German banks doing business in Euros will collapse at about the same time as U.S. banks doing business in dollars. Hint: The Eurozone could not survive such a thing, so the ECB would do exactly what the Federal Reserve did — “quantitative easing” that in essence consisted of moving 1’s and 0’s from one register to another to magically create bank reserves out of thin air. Trash (the assets that otherwise have to be written down) for cash. Presto chango, the banks are solvent again!

      In other words, the doom-and-gloom sorts forget that there is this marvelous invention created in the 1450’s called the PRINTING PRESS and thanks to Alan Turing and John Von Neumann, it doesn’t even require actual paper anymore! Now, granted, this would require extraordinary action from the ECB, action that is arguably not part of its charter. But then, the same could be said about the Federal Reserve’s actions in the “trash for cash” that it did to backstop U.S. banks…

    4. Crocodile Chuck


      In early 2009 Chris Whalen of Institutional Risk Analyst was quoting 800B euro as the quantum of bad debts of the Landesbanks as a result of their ‘investment’ in US mortgage backed ‘structured credits’.

      1. Martin

        Well, we will see.

        Such losses can’t be hidden for long. Not the best accounting tricks can make the cash flow match with so much negative equity. Interest on debt must be paid. If there is no income stream, its over soon.

  2. attempter

    Of course, another positive exit scenario would be a combination of strong growth and low interest rates – to help the banks generate big profits to allow them to write off their bad debts in small instalments year after year.

    LOL, that’s good. How much bogusness can be packed into one notion?

    “Growth” – All the alleged growth of recent decades has now been proven to be a sham and has vaporized, but let’s try to figure out a new way to spin more into paper being.

    “Low interest rates” – Indeed free money (itself worthless) seems to be one key to the position.

    “Big profits” – The US banks have already achieved prodigies of accounting fraud to drum up the simulacrum of
    “profits” (so they can loot “bonuses” on a personal level), so who knows how far such fraud can go, as long as the Bailout gravy train is flowing. There’s those low interest rates again.

    “…write off their bad debts in small instalments year after year” – That’s gonna take a lot of years, more than they have, I bet. Especially since the only thing which can prop up their power to is to keep the bad debt machine going, to keep adding new bad debt. But how many new bad debts can they socialize through the GSEs and the Fed?

    1. DownSouth

      “Low interest rates” – Indeed free money…

      That’s one of the design features of this organized robbery that is the most pernicious.

      People like my 93-year-old mother depend on income from their savings to pay the bills. She’s getting raped so that the banksters can “earn” their way out of the hole they’ve dug for themselves.

  3. IF

    “lingering aftereffect”. Sweet. British understatement?

    Lets say it is all true what the Keynesians (US government economists!) argue – and the biggest exporters China and Germany get bankrupted each in their own way over exporting too much. And lets say the world understands this. Who is going to volunteer to be the next exporter? World trade kaputt? But that is not the goal, after all globalization is bringing in the goods. Very curious.

    1. dk

      The reason European banks loaded up on toxic American assets was Basil 2. In Basil 2 (which does not apply in the US) banks can use their own risk models to lower capital requirements for specific instruments.

      Holding MBS required very little capital because A) the rating agencies gave them high ratings and B) they could buy some protection on the assets from, mostly, AIG.

      The ratings and protection could be put into their internal models and greatly reduce the amount of capital that needed to be set aside for them..

      A major reason the AIG bailout has been so expensive to US taxpayers is because European banks bought so much protection on these assets. Unlike Goldman, who bought the protection because it wanted protection, European banks bought protection in order to increase their leverage.

      You may want to use “toxic American assets” as a way to bash the US but US taxpayers have spent tens of billions of dollars to bail out European banks from their bad decisions.

      If this had not been done those 10 of billions would have been spent by European governments.

      I have never seen a single German leader acknowledge this.

      1. IF

        You are being rather diffuse with your numbers. The article mentions 800 billion Euros, which is one order of magnitude larger than AIG. And trust me, the AIG money did not as a block flow exclusively to German banks. Basically you arguing about noise in the picture that Yves is painting via Munchau.

        Furthermore, the European governments only can spend Euros, not dollars. It is an interesting situation if all of a sudden you have a large hole in a currency you are not allowed to print.

        In any case, it globalization used to be goods for paper. Now it is goods for dodgy paper. And soon enough goods for nothing? Sounds like globalization is ending there.

      2. ImperialStormtrooper

        How so ?
        If Germany bails out Hypo Real estate -which it did and Hypo lost its money in the US then the German taxpayer bailed out the US not the other way around. Also the only reason Europe is in trouble is BECAUSE OF THE Bailout of the US in 2009.
        Germany for one had no housing bubble. Its so ironic that company’s like Goldmann would speculate against weak Euro debt when that debt was caused by US company’s in the first place.

      3. Eric

        if they paid for the insurance, why should they be thankful to the US?
        It was the US government who made a bad decision allowing these CDS, not the banks buying it.

  4. bitter_renter

    Hmm – German banks (particularly Landesbanken) are full of toxic American assets, so Germany must be insolvent.

    Which just might explain why Germans have so little patience in dealing with the tender feelings of Wall Street, even as the threat of ‘insolvency’ is held over German heads. Or that German faith in an industrially based society (Germany’s banking sector is not larger, at least in terms of political power, to German industrial Verbände – and yes, Verband has several meanings within it) is misplaced.

    Global economic collapse involves just about everyone – what you are left with afterwards is pretty much your own local resources, social capital, etc. Shame about the Gulf of Mexico, by the way – but after decades of destroying much of a continent’s various watersheds and most productive farmland in the pursuit of an exurban dream, it isn’t really a surprise. Especially when you throw in that whole Tea Party/secret Muslim unAmerican president obsession/papers please for ‘them’/corporate ownership of most American public life.

  5. Abhishek

    Makes you wonder whether the German central bank Bundesbank is as sophisticated and prudent it is thought to be in allowing these Landesbank to invest such huge amounts into such high risk assets.

  6. alex black

    I have this odd fantasy that Bin Laden is no longer studying “soft targets” to blow up, and instead of hiding in a cave, has been smuggled into a luxury hotel penthouse somewhere in Islamabad, Howard Hughes style, surrounded by dozens of computers and operatives, who are all figuring out how to say “The banks are closing! Get your money out NOW!” in every language in the West, and is waiting for the right moment to create viral rumors on the Internet – everywhere – to create massive bank runs.

    Hell, even a bored, disgruntled teenager in Portland might be able to pull this one off….

  7. Swedish Lex

    Munchau answers his own question; as long as there is growth, tax revenues will be coming in that will grant time. Time to stick heads in the sand for longer or to actually address the problems to some degree, at least, hopefully.

    In order for there to be growth, banks have to be kept alive so that they can do their lending (do not forget how inter-connected some German and French banks are with the non-financial sector).

    Had Germany and France instead not allowed banks to mark to fantasy, banks could have become insolvent, in which case a Sweden-style bank re-organisation scheme could have been put in place. Such a scheme would have allowed governments to terminate zombies, separate good from bad and then float the good stuff. That would have permitted to put a number of the bad stuff – which is exactly what Munchau is seeking.

    Since that number would have been/is too high for comfort, with no sane politician wanting to confront such a siutation, the extend and pretend will continue..

    1. Diego Méndez

      No matter how little indebted you are, if you cannot grow, you are potentially insolvent. Growth is they key issue, not debt.

    2. Hubert

      but how do you nationalize banks that are already state-owned, i.e. Landesbanken ? And how do you do it without putting a spotlight on the sorry (political) state of german state-banking? Truth is, the system has failed and does not want to admit to it. This all countries have in common in the abstract. Systems differ but most seem to have failed (except Singapore maybe and a few others….)
      If we imagine Germany Inc. on a balance sheet we are probably as insolvent as others in Europe. Still our Income statement looks good. And if we get some belt-tightening internally and five good years externally, we might be solvent again. I doubt both and further, I am not even sure that it can realistically and should be tried in a system-wide context.
      Germany, like all others just wish the status quo ante to be reestablished – but in Hanky´s terms “the glass has broken”.

  8. John Savicz

    Yves, a side issue here. I’m worried that Australia is the next country to blow up. Please take a look at How to Profit From the Coming Aussie Property Crash (and Banking Crisis).

    It seems that Australian banks is more leveraged on mortgages than US and UK banks. Worse, there’s $13 TRILLION of off balance sheet liabilities in the Australian banking system!!! It’s hell big of a number to bail out if anything blows up!

    Anyone any thoughts?

    1. alex black

      I suppose a lot depends on what kind of RE loans Australian banks like CBA and Westpac have made. 3% down option ARMS? Or 30% down fixed demanding 28% debt-to-income ratios? Anyone know?

      I’m still kicking myself that I got ludicrously generous mortgages from WAMU in 2006, realized how f***ed their portfolio must have been in 2007, and while I bailed out of the stock market then, I was too uneducated to short WAMU to the moon. I’m a little smarter now, maybe. Are CBA and Westpac similar plays in the making?

      1. ozajh

        Almost all ARM’s (but almost no Option ARM’s; lesson learned from the 80’s there).

        Home mortgages are full recourse in Australia, and the banks DO come after a defaulter’s assets.

        The other BIG factor at the moment is that there’s been yet another runup in prices over the last couple of years. Think California 2006.

    2. Skippy

      Yep..biggest boom I’ve seen, that’s counting Calif, Colorado, Arizona..etc.

      Know how it feels[?] to watch the house next to you sell every 4 to 6 months for 40K to 60K every time and every one is foaming at the mouth for 4 years….buy now or all hope is lost and ye will be passed by.

      Skippy…years of priming the pump..when she brings forth, her waters it wont be pretty.

      1. alex black

        More, Skippy, more! Please elaborate on the Aussie housing boom. Aside from price rises far beyond their inflation, what kinds of loans have the banks been making?

        Amazing graph in the slide show John linked, showing US banks with 10% of their portfolios in RE loans, UK banks with 17% of RE loans in their portfolios….. and Australia’s two biggest banks with 40% and 50% of their portfolios in RE loans.

        1. Skippy

          That would be *D* all the above, and to all the people that tomorrow could be job hunting ie: hairdressers, retail staff, the people that build the dam things (poorly I might add), lo-doc, alt a etc.

          20+ million people living out their daily lives on a continent the size of the USA and when it comes down to it, it’s mining, wheat, livestock and who’s buying…China and Japan, if they sneeze, the record stops, if for only a quarter.

          Skippy…ever play crack the whip…

          1. alex black

            Yeah I Googled around and saw lots of lo-doc 5% down loans, neg-am, etc. – but as far as the banks, they only seem to make 20% down loans – a lot more cushion than WAMU or Wachovia had. To get 5% down loans the borrower has to buy private mortgage insurance, which seems to be sold by large insurance companies which are highly diversified – so I don’t see a concentrated holder of risk over there if there’s a housing slump.

            Got any insight into that?

            Yeah, crack the whip was fun when I was a kid.

          2. Skippy

            Sure alex…the lions share of investment capital used in the Austrian housing boom comes from Singapore et al, with the capital banks here in aus being the spigot.

            Most of the building/capital mobs over here are just the certificate holders (see: bag holders), many don’t even know that as market competitors that they share the same master.

            The big difference I see with regards to US vs AUS reaction to the GFC has been the tightening of lending standards (mortgages) post haste…self employed being required 30% down to even stand a chance of buying for the first time, even with 5/10 year good track records. Also large amounts of downsizing going on, people selling large, high maintenance, luxury homes at par or less, only to move to more reasonable accommodation or renting (debt deleveraging).

            Skippy…only thing holding our head above water, is China buying minerals, there is your *concentration of risk* one industry from which all out comes flow.

            PS. just go to Steve Keen’s Debtwatch for your charts and graphs.

          3. Skippy

            *the lions share of investment capital used in the Austrian housing boom*

            Australian amends

    3. alex black

      “Anyone any thoughts?”

      The heart has reasons that reason will never know.

      You didn’t say they had to be on-topic, John.

  9. dearieme

    “Anyone any thoughts?” Invest in NZ; they don’t have any banks of their own to prop up.

    1. Skippy

      Too late, for over 5 years the property sector over there has been pumped by overseas investors looking for the best of all worlds…sparse population, good views and cheep labor…its a bubble too.

      Skippy…it also has an over leveraged finance sector like Iceland…boutique syndrome.

  10. za

    Hasn’t Germany had at least 3 bond auction failures in the last 18 months? This is supposed to be the adult supervision of the EU?

  11. TimOfEngland

    View from outside the planet:

    I have read all the comments tonight they point to one thing and one thing only:

    Personal, National and International debt default sometimes known as a debt jubilee.

    There is no choice left. We either choose the moment or we just let it happen when it will.

    I choose choice.

  12. Steve

    So do you mean to say that the HIGHLY REGULATED German banking system – where the government has RESISTED CONSOLIDATION – could be a disaster?

    So much for the received wisdom on these pages.

    Due to fragmentation and other structural issues, German banks can’t make a reasonable return via “normal” banking. So they do abnormal things, such as buying subprime CDOs, investing in private equity (WestLB, I’m thinking of you) and buying Club Med sovereign debt which they were told is as good as AAA.

    How exactly will the financial reforms we hear about have prevented this? If we make it hard for banks to make money, then you are encouraging more leverage and/or riskier assets. Just a thought for you reformistas

    1. The Rage

      Steve, ANY banking system can fail, however, Germany’s is the least worry. This article is full of hot air with little backbone.

      The US and Aussies are by far the worst risk for blowup.

  13. Gale Schleimer

    Awesome post, If only more people would try and start speaking spanish. Fluent spanish is a beautiful language to speak and to be spoken to. Great info here keep the articles coming please.

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