Another Landesbank bites the dust

By: Wolfgang Münchau

Three German financial institutions have filled the traditional news gap during this summer. WestLB, IKB Deutsche Kreditbank and SachsenLB, are all, or partly, publically owned banks, and they suffered severe liquidity problems, partly as a result of exposure to subprime investments. Two questions arise from this fact. The first is: Are German banks more exposed than others? The second question is: is it accidental that these are all public sector institutions. The answer to these two questions is no, and yes.

 

Germany is not particularly exposed to subprime, not more than the UK and other countries. I bet that we are going to get some very bad news from some UK-based investment banks this autumn.  Another country with a significantly larger exposure to subprime credit is China, from where news of problems has barely surfaced. If German banks have a crisis, Chinese banks must be down under.

 

The more interesting point is whether it is accidental that all the German banks in trouble are essentially publically owned. The German public sector banks enjoy effective protection against default. This is important. Their default-free status is not implicit, as for example similar to the status of the US mortgage institutions Fannie Mae and Freddy Mac. Their protection is guaranteed, and everybody who works for these banks knows it. It is this guarantee that has made investment managers and traders – and their superiors - far more risk-prone than their counterparts in the private sector. Of course, Deutsche Bank has also suffered some losses, but its risk management systems are far more sophisticated than at those provincial banks.

 

The episode tells us, once again, that Germany has too many banks, and in fact, too many bankers. Most of the supervisory board members of these insitutions are themselves financially illiterate and do not fully understand the ins and out of investments in new financial instruments, such as CDOs or CDS. They have failed to implement proper risk managerment systems – something which a private bank could ill afford. They are the kind of banks that yields few public benefits to society in an age of deregulated financial markets. Yet their bailout is going to cost the German taxpayer a double digit billion heap of euros. I would not exclude a full-blown savings and loan crisis, as big in scope as the US crisis of the late 1980s. The bailout of these institutions will become a persistent nightmare for successive governments.

 

From a purely European perspective, this crisis is a welcome reminder of how badly the euro area in general, and Germany in particular, needs further banking concentration. The public policy case for Landesbanken has been getting weaker by the decade. Through their subprime adventures, these insitutions now stand discredited. It is time to reduce the public sector involvement in the financial industry, and to allow these institutions to merge and regroup within the private sector. With the strictures of monetary union and the single European market, such a concentration process should not happen at national level, but across Europe. Here I see German banks not as predators, but as prey. The best thing the German public entitites could do now is to extract the highest possible price for the badly managed banks they own. Unfortunately, they seem minded to go the other way, to consolidate among themselves and to form even larger public entities - national champions that are once again “too big to fail”. This kind of merger, as just happened in the case of SachsenLB, is not going to solve a single problem.

 

The public sector banks are at the root of Germany’s system of managed capitalism – the Social Market Economy. But this root has become increasingly rotten. As this crisis moves from subprime to other categories of credit, expect the pressure on the German financial system to mount.

 

 

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