Germany’s bad bank fudge

April 23, 2009

REUTERSpaul-taylor– Margaret Doyle and Paul Taylor are Reuters columnists. The opinions expressed are their own –

LONDON/PARIS, April 23 (Reuters) – Germany is to set up a system of bad banks before the summer recess to hold some 250 billion euros of toxic assets. Finance Minister Peer Steinbruek has assured taxpayers that his solution — called “eine Bad Bank” (there is no German word for the concept) — will not weigh on the budget.

He is fooling them, if not himself. If the rescue really were such a free ride for the taxpayer, some savvy commercial investor would have stepped in. Under the proposed scheme, the taxpayer will end up carrying the risk of “Schrottpapiere” (scrap paper).

Like governments everywhere, the Germans are desperate to get their banking systems moving again — to save the economy by saving the banks, as British minister Baroness Vadera put it.

The snag is simple. Crystallising all the losses in the banking system might lead to widespread nationalisation of banks — something most governments are keen to avoid.

But the alternative is equally unpalatable: that the state buys lots of “Schrottpapiere” from troubled banks at unrealistic prices, essentially mutualising all the losses and leaving the banks to keep their profits in private hands.

A German Finance Ministry document seen by Reuters admits this, saying, “Finance ministry examination has shown that in all models, there remains an insurmountable contradiction between the aim of removing assets from the balance sheet and the protection of the taxpayer: if the bank is to be unburdened, the taxpayer has to take on a substantial part of the risk.”

The German plan is to allow banks to recognise losses on structured products over their lifetime, perhaps up to 20 years. The government would still guarantee those assets, but would only pay up at maturity if the final value of the assets is less than the “fair value” for which the banks must make provision.

That means any nasties would be pushed out — certainly well beyond this September’s Federal election, and probably one or two beyond that.

By giving the banks time to reserve for impaired assets, it allows them to earn their way out of trouble. And, the politicians get to pretend that there is no damage to Germany’s vaunted fiscal stability.

However, it leaves a question-mark over the health of the banks. There is no real severance between the good and bad bank. And the need to build up reserves over a protracted period could act as a drag on the performance of banks — and their willingness to lend.

It is puzzling why the German government needs to go down this tortuous route of creating special vehicles, with neutral parties to value assets and new accounting rules for reserving.

It is widely acknowledged that the biggest users of the scheme will be the Landesbanks, most of which are themselves owned by regional governments (although some have minority private sector shareholders). They have long been accused of using cheap state-backed credit to provide unfair competition to the commercial banking sector.

That these institutions, created to support regional economic development, ended up buying risky U.S. structured products shows just how far they had strayed from their original purpose. The state could in theory just break them up as it saw fit.

Pushing any assistance out into the future — and structuring any asset protection on the basis that it can be argued that the shareholders had to take a hefty first whack — seems designed to obfuscate the scale of any such rescue.

It is always a mistake, as Barack Obama’s chief of staff Rahm Emanuel, memorably observed, to let any crisis go to waste.

A better course of action in this instance would be for Berlin to admit that the Landesbank model is broken, insist that their assets be run off over time, and give the private banking system a better chance to flourish when conditions improve.

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