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GERMANY: THE FAILING BANKING INDUSTRY
Summary
Germany's representative to the European Commission, Guenter Verheugen, on May 18 blasted German banks' investment policies, indirectly blaming Germany (and Europe) for the current European economic crisis. Verheugen's remarks underscore the fact that the current European banking crisis is an inherently German -- and therefore European -- problem.
Analysis
Germany's representative to the European Commission, EU Commissioner for Enterprise and Industry Guenter Verheugen, said May 18 that Germany's banks were "world champions" in making risky investments, German daily Sueddeutsche Zeitung reported. The statement, made to the largest daily newspaper in Germany, was far from a compliment, and Verheugen added that, "Nowhere in the world, not even in America, were banks so ready to take incalculable risks, especially in the regional banks." Verheugen's remarks come on the heels of the German government's "bad bank" plan, agreed to on May 13, which sets up a strategy for German private banks -- but notably not the regional banks Verheugen criticized -- to sequester approximately 190 million euro (about $260 billion) of "toxic assets" off their balance sheets.
Verheugen's comments are notable because they may be the first admission by a senior European official of the extent to which European banking is mired in its own crisis, which is unrelated to the imbroglio sweeping the U.S. financial system. Being the German member of the European Commission is also important, since Germany is the largest economy in the eurozone and has largely blueprinted the European plan (or lack thereof) for tackling the economic crisis. Not surprisingly, Germany's government immediately attacked Verheugen, with the Finance Ministry spokesman countering that the EU commissioner showed "a surprising lack of knowledge of the current situation and a lack of understanding of what has happened in the U.S. and Britain in the past two years."
The German Finance Ministry's denial of Verheugen's comments continues the policy of senior government officials in Europe to shift the blame of the current economic recession onto the U.S. banking sector. Although the financial crisis originated in the United States, the crisis has since unearthed inefficiencies in the European banking system that are unrelated to American banking. These problems include exposure to Central European emerging market economies (as is the case with Austrian, Italian and Swedish banks), owning risky investments in securities markets (as with German, Icelandic, British and Irish banks) or overexposure to domestic housing booms that put the U.S. housing market to shame (such as those that occurred in Ireland, the United Kingdom and Spain).
Germany, for example, is facing serious challenges in dealing with the troubled Landesbanks, regional banks that are partly owned by the various German Lander (states). These banks are facing somewhere between 350 billion and 500 billion euro ($473 billion and $676 billion) worth of toxic assets, a considerable figure for the $3.2 trillion economy. This amount of debt is even more egregious considering that the International Monetary Fund predicts that the eurozone financial sector as a whole faces potential losses of some 700 billion euro ($946 billion). The Landesbanks alone would therefore potentially account for nearly half of all toxic asset write-downs in the eurozone.
Faced with the low profit margins of the German banking system, caused by a fragmented banking system of more than 2,000 banks and a tepid domestic retail banking market, the Landesbanks sought new moneymaking opportunities in the burgeoning field of securities trading. The Landesbanks therefore used their access to government guarantees -- as they are partly government-owned -- to borrow money with which to fuel their risky forays into the security markets, a field of investment banking in which they lacked managerial acumen compared to their private sector competitors.
What further complicated the Landesbanks' banking strategy was that they were often laden with the unprofitable capital expenditures of the municipalities and the Lander that partly owned them. The price of government guarantees, therefore, was playing the role of banker for various German pork-barrel projects through close links to the regional political machines. For example, the Bavarian prime minister and minister of finance, both members of the powerful Christian Social Union (CSU), were also key officials in Bayerische Landesbank, the second-largest Landesbank by assets in Germany. Their involvement in the bank's dealings with securities ultimately cost CSU the September 2008 state elections, its first loss in Bavarian elections since 1962.
Verheugen specifically pointed to the Landesbanks' role in securities trading in his criticism of the German banking system. The problem, however, is that reforming the regional banks is going to be quite a challenge for the German government. The bad bank plan already excludes the regional banks from sequestering their toxic assets, because the federal government wants to see the sector restructured, probably meaning that some of the Landesbanks would not survive. But that will mean that German Chancellor Angela Merkel will have to challenge regional political bosses, some of whom are from her own party (or from close allies like the CSU), before September general elections -- not exactly the kind of challenge one hopes for during an electoral campaign.
As such, it makes sense that Verheugen, the one senior German politician whose job does not depend on domestic politics in Germany, is the only one calling the banking crisis what it is: an inherently German -- and by extension, European -- problem. For the rest, it is much easier, politically speaking, to continue shifting the blame to the United States. Unfortunately for Europe, what may make sense politically only further embroils the continent in an economic crisis.
Copyright 2009 Stratfor.
Germany: The Failing Banking Industry
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