German leaders have long boasted about the stability of their financial system, and lately have been blaming the global credit crisis on American irresponsibility. German finance, they brag, is dominated by stodgy insurance companies and public banks; fueled by a high national savings rate and capital surplus; and governed by consumer-lending practices so strict that an American subprime-mortgage borrower wouldn't even qualify for an ATM card. Why, then, are German banks holding hundreds of billions worth of impaired assets? The IMF won't release country?-by-country figures, but it expects total financial--sector write-offs to be higher in Europe than in the U.S. through 2010; of those, a large part will likely come from German banks. EU Commissioner Günter Verheugen last month slammed German banks for having been "world champions in risky banking transactions." BaFin, the German financial regulator, leaked a list in April that put German banks' troubled assets at €800 billion, a figure the agency has since denied. Considering that one single bank, Munich-based Hypo Real Estate, has already racked up more than €100 billion in liquidity support (and counting), the number doesn't seem so far off.
German banks weren't just victims of Anglo-Saxon cowboy banking, but were among its most aggressive players from the start, pouring the country's capital surplus (second only to China's over the last five years) into high-risk areas like U.S. toxic assets, Spanish real estate and Irish hedge funds. Private institutions like HRE and Dresdner, both now partially nationalized, and Deutsche Bank, whose investment-banking arm was deeply involved in toxic securities, were highly leveraged. By some estimates, German banks at the outset of the crisis had an average ratio of debt to net worth of 52 to 1, compared with 12 to 1 in the U.S. Even those supposedly conservative public banks, or Landesbanken, are fast turning into bottomless pits for the German taxpayer. Together with the public savings banks, the Landesbanken control 40 percent of the German banking market. Mismanaged, opaque and supervised by local politicians, these banks have for decades abused their government ownership to get themselves into crisis after crisis. Last week another €4 billion of public money (bringing the total to €9 billion) went to keep afloat Düsseldorf-based WestLB, which EU Commissioner Neelie Kroes blasted as another sign of the public banks' "chronic disease."
If Germany's politicians prefer to look to outsiders for blame, perhaps it's because they were closer to the genesis of Germany's version of the banking crisis than they care to admit. The most significant event was probably a 2001 deal, signed by Finance Minister Peer Steinbrück, among others, that extended an unlimited state guarantee for all debt issued by Germany's state-owned Landesbanken until 2005. For the Landesbanken, which had already been struggling from bailout to bailout, it was like giving an alcoholic the key to a liquor store. The Landesbanken used the guarantee to load up on cheap debt and plowed the money into risky securities, much of it off the balance sheet. Like America's AIG, which used its AAA rating to sell a mountain of credit insurance, WestLB used its government backing to guarantee shady off-balance-sheet conduits, thus multiplying taxpayer exposure. SachsenLB, the world's first bank to collapse from the financial crisis, in 2007, bought asset-backed securities and derivatives worth 27 times the bank's equity in order to generate the 15 percent profit demanded by the state's politicians, who needed money to top up Saxony's state budget.
The extent of the banks' exposure to bad assets is still secret. So far only one German banking case, involving the tiny state-run IKB in Düsseldorf, has reached a conclusion, with the state spending €9.2 billion to cover losses from the bank's investments in toxic U.S. assets. That does not include losses in the fire sale of IKB, bought by a private-equity investor for €137 million, a fraction of the bank's peak market cap of €18 billion. "That's a staggering cost to the taxpayer, given IKB's size," says Nicolas Veron, finance expert at Bruegel, a Brussels think tank. If it's any indication of what other German banks were getting into, he says, the country's taxpayers are in for some very bad news. Hans-Joachim Dübel, a financial consult-ant and former World Bank adviser in Berlin, estimates the bill to bail out the Landesbanken alone could ultimately cost German taxpayers more than €100 billion.
Right now, politicians are avoiding a reckoning. Steinbrück says he will not stress-test individual German banks, and even if he did, he wouldn't make the results public. With a national election coming up, no politician wants to risk a big new round of bank bailouts. As the U.S. and U.K. crack down on banks, Germany dodges and dithers; its problems will likely get worse before they get better.