Guest Post: “Beyond Repair”

Reader Hubert sent along this post, with permission, and the following note:

My friend Erwin has published a book out of ten years of columns for the German paper “Die Welt”. He put an Intro in front of it where he lays out why Germany will go down the tubes as everybody else. It is a lively written polemic with much insider understanding of political Germany….

I enjoyed the piece (even thought it is a tad apocalyptic), but it was too long for a post, so I’ve extracted key sections. I focused on his discussion of Landesbanken, since they played a more important role in the crisis than is generally recognized (Germany investors, Landesbanken in particular, were major stuffees of late-cycle subprime dreck).

The author, Erwin Grandinger, is an independent political economist, and in addition to his work as a columnist, has over 20 years of experience in financial markets as an analyst and advisor to clients all over the world.

The following text is from an English translation of the introduction to the German-language book:
“Beyond Repair. Deutschland im Systemwandel [Germany in the Midst of Systemic Change]“. The full German-language version of “Beyond Repair” is available as a 320-page ebook. Please apply at office@epm-group.eu

What many have not understood is that the 15th September 2008 revealed the biggest political scandal in Germany since 1949. It is not just the banking caste that has to be exposed to ridicule, but also the political elite, the ministerial bureaucracy and the central bank ideologues. All have worked hand in hand with the financial industry for decades (always to the disadvantage of the citizen – better known as the taxpayer). That was the reason why the political backlash against erstwhile-pampered allies in the world of finance was so brutal. The scapegoat may only be assigned to one camp. The legal, tax-related, monetary, fiscal and personal links existing between the finance ministries, the Bundesbank, the Federal Financial Supervisory Authority (BaFin), other supervisory authorities, Landesbanks, private banks and leading political parties have a complex, deep, broad and dense nature…..

Between 2002 and 2008, the taxpayer subsidised every single job at WestLB Landesbank in North Rhine-Westphalia for EUR3.4 million. Does that make sense? WestLB was not and never will be system-relevant. It is purely a political instrument wielded by the political elite of North Rhine-Westphalia. The same applies to all German state Landesbanks…

Originally the aim of a Landesbank was to provide credit to the German “Mittelstand” (small and medium-sized companies) in the post-war “economic miracle” years (alongside the credit provided by the private banks). Of course, the Landesbanks quickly became the extended arm of the then ideology of state policy. The Landesbank was always ready to “serve” politicians and readily guaranteed exalted civil servants lucrative positions and, more importantly, pension payments. While proprietary trading was originally neglected and such trading was exploited only to manage own capital, the pressure on the Landesbanks to generate profits exerted by the respective state governments since the 1990s was turned up to the maximum.

Later, in an ultimate perversion of purpose proprietary trading pushed all other Landesbank business activities aside. Only a German civil servant could term this “alternative credit business” (“Kreditersatzgeschäfte”). The perfect political hedge fund was born.

An up-and-coming SPD state politician called Peer Steinbrück, then finance minister of North Rhine-Westphalia, had made sure that all German Landesbanks which enjoyed state guarantees until 2005 (when the states’ liability was abolished) were permitted to borrow vast quantities of money on international financial markets. After that the Landesbanks did not know what to do with the money. The Mittelstand, already well beyond the economic miracle years, was sufficiently saturated with credit. There was no credit crunch, as there was after the collapse of Lehman Brothers Holdings Inc., rather it was the stark opposite. The way to the state hedge fund – which turned a gigantic wheel of speculation under state control and with the active support of the respective state politicians – was cleared. Not one of these Landesbanks was, is or ever will be system-relevant. One could have closed all German Landesbanks in 2008, latest 2009. Instead the losses of these banks were socialized, that is passed on to the citizen, while the profits, if there ever were any, in the previous decades were always privatized (bonuses for employees). This socialization is a further nail in the coffin for the solidity of German state finances. In Germany the damage to the taxpayer amounts to over EUR800bn so far. Not one single politician is prepared to answer for that or to assume the responsibility. As a political proxy one battles with bank management over bonus payments. Poor Germany….

Not one of the state-owned Landesbanks is allowed to die. A Landesbank is a political instrument in the party toolkit. It is a political means to dispense discretion, money and to satisfy greed. For that reason, a Landesbank only sinks when the system (the state) goes down. The political signal to the public sector is clear and was repeated many times over: we will not leave you in the lurch. The public sector is the most reliable voter and pillar of the state supporting parties – which, by definition, all parties represented in the Bundestag are, whether one likes it or not….

Our basic problem is not however the remuneration or punishment of the captain and the ship’s complement, rather it is that Germany’s fiscal and monetary bases have irreversibly changed, at least
since 15th September 2008. The financial crisis hastens the way into the abyss, particularly when one also takes into account the development of Germany’s age pyramid. From the Greek example one can understand how rapidly a financial crisis can turn into a state crisis. In Germany in the years 2008, 2009 and even in 2010, the privately existing debt obligations of the banks will ultimately be transferred to the public sector (even quantitative easing is ultimately a reallocation of private debt to the public sphere). To pay for the sins of others (bankers, politicians, ministerial bureaucrats), the burden has been placed on present and future taxpayers. Now we move towards a sovereign risk / government bond bubble. This is usually the last bubble before the downfall. Contemplating this ultimate bubble, in conjunction with the Germany’s debt-financed welfare state, leads this book’s author unavoidably to the appointed unsavoury hypothesis that the days of this system are numbered. In 2009 alone the level of German federal public debt climbed a nominal 7.1%….

The class struggle PR-activism (bonus structures, hedge fund regulation, Tobin-tax and tax havens
to name just a few ideological battle fronts) celebrated by the G-20 politicians and media does not
change the situation: the system is broken…..

Young systems often fail due to violent overthrow. This is often caused by an overhang of recalcitrant
young men who readily resort to violence. Gunnar Heinsohn describes them as “angry young men” and refers to them as the “youth bulge” in his book “Söhne und Weltmacht” (“Sons and Global Power”). Some systems fail for the opposite reason: that is a DDR-style demographic structure of an aging leadership elite. Such a situation prevents violent revolution since a combination of natural aging leading lights and rotten finances causes the state to virtually disintegrate all by itself. Still, for reasons of ideological identity-creation for the subsequent generation, one prefers to speak of a “peaceful revolution” since it is human to romanticise the past. But the actual and observable overthrow of the regime is only the logical end point, the basis of which is the soundless and invisible erosion of state finances. This can be protracted over decades (and, in the case of ancient Rome it took centuries). The damage below the water line is subject to the uncertainty of timing criterion.

Many systems, often long-established, whether totalitarian, democratic or communist, thus fail rather mundanely – in line with the laws of nature – owing to compound interest, pension obligations, fiscal, demographic or monetary collapse (in other words, owing to all sort of cycles) and not directly as a consequence of total destruction in the wake of a war. Niall Ferguson’s “The Ascent of Money” is a tour de force through the failings of states that foundered and of their respective currencies, which went up in smoke. Carmen Reinhart and Ken Rogoff’s “This Time is Different: Eight Centuries of Financial Folly” follows in a similar vein. This book comes up with a frightening conclusion: practically no financial or currency system has managed to survive without breaking apart.

Germany is no exception. The number of currency reforms and failed states, which the last few
generations have gone through, should be sufficient warning: they speak for themselves. The last collapse (state collapse and currency reform) occurred only 20 years ago – and is almost already forgotten! No, even better: the “old” system is idealized (see by way of example the DDR-kitsch at Potsdamer Platz in Berlin). Wealth corrupts and obscures a clear perspective. Those in receipt of a pension do not commit a cold-blooded, violent coup d’état. They have too much to lose for that and protecting their vested rights is their aim. The following generation, which is often jobless and “educationally disadvantaged” – to adopt the euphemistic post-‘68 sociological German (in other words, typically lower class) – is altogether still too tame. Thanks to the electronic accomplishments of modern life, as well as the targeted-catering of the social state, this class is kept in a peaceful and sufficiently comfortable state for it not to wreak actual damage; that is overthrow. In a society with an inverted age pyramid, there is no imminent revolutionary danger from this underclass. The actual danger is subversive and, by its nature, it takes a slower course. The state financial architecture is faltering: this is the icy cold water of the North Atlantic that is filling the bulkhead of the ship’s body and it is invisible to the public.