The German Bad Bank

3rd June 09 - The German bad bank

As the credit crisis moved into its action planning phase, the German authorities were highly critical of the fiscal and monetary stimulus policies adopted by the UK and US governments. The jury is still out on whether the German stance was correct or mis-guidedly piggy-backish. Certainly there are serious worries that the world will be swamped with the ensuing debt in supporting banks (see the entry dated 1st June 09). But, the Germans have done something - and maybe will soon do more in an attempt to save their domestic car manufacturers - they have created a "bad bank". 

The bad bank plan allows individual banks to spread losses over 20 years in an off-balance sheet vehicle. This approach has been likened to the error of Japan in the 1990’s in creating "zombie" banks that can only limp along unpurged. The point is that off-balance sheet stores are little different to the "SIVs" that hid the extreme leverage in the first place. We should recap that Europe has been hit much harder than was first envisaged. For example, Germany (the largest economy by far) has a GDP dented to the tune of 6.9% over the past year. The IMF has called for a stress test for Europe’s banks along the US health screen lines. It says the region "urgently needs to weatherproof its institutions."

How bad are things in mainland Europe and particularly in Germany? Jochen Sanio, the president of BaFin Germany’s financial regulator said the danger is a series of "brutal downgrades of mortgage securities by the rating agencies which could eat into the depleted capital reserves of the banks and cause broader stress across the credit system. We must make the banks immune against the changes in ratings". He went on to say that the markets will "kill" banks that try to go it alone without state protection warning that banks have 200bn euros of bad debts on their books.

So, does one hide the debt, pass some ownership to the state in return for help or run the risk of large-scale downgrades by rating agencies. The choice is yours. But the causal factors and the problem remains.