The German Banking System Post author By Philip Lane Post date April 6, 2011 The FT provides a detailed analysis of the state of the German banking system here. Categories In Banking Crisis Tags German banking system 60 Comments on The German Banking System ← Business and Finance Article on EU-IMF Negotiations → The Outlook for Credit in the Irish Economy 60 replies on “The German Banking System” “Altogether, €7,600bn of German banking assets are supported by less than €350bn of equity and reserves” Shocking stuff. I have a vague pet theory that the German banks have bought chunky amounts of both international and domestic bank unsecured senior debt. That is why they and so by extension the German government cannot afford senior bondholders in Ireland to be haircut. Anything that makes senior bank debt less than money-good risks a rolling collapse of the German banking system and with it the euro. One of the interesting points in the article: “The German economy has a remarkable asymmetry. On the one hand, many companies that are … world leaders. On the other side, only one globally successful German bank,” says Josef Ackermann in a reference to Deutsche Bank, the country’s biggest banking group, which he heads – and which the chancellor exempted from her criticism. Dr. Ackermann, who is Swiss, said in Feb: “It is a dangerous illusion to believe that Germany could de-couple itself from the problems in Europe and prosper as if it were on some sort of ‘paradise island.’ I am convinced that now is the time to push for renewed integration in Europe, that the time is right to further intensify the integration in the EU and above all the Economic and Monetary Union. This is the only way to safeguard the political, economic and cultural power and independence of our continent in a new world order. This also is in the best interests of Germany, which is one of the countries that has profited most from a united Europe and a stable euro.” @PL Excellent overview on the BIG_BIG Black Hole – & ‘asymmetry’ in treatment across EZ correlated with Political Power … worth a mention in your address today @MH Careful on mentioning unmentionable Swiss+Banks at the mo – bit of a schemozzle on the edge of the ionian blog going on (-; Which is why the ECB is providing open-ended liquidity support to Irish banks to prevent this very contagion. Does anyone else reckon that, over time as the ECB seeks to unwind this liquidity support, it will take a hit on all of the pieces of paper it has with a harp on them – and the other EZ players will quietly – oh so quietly – recap it to compensate for these losses? It’s the only possible ‘burden-sharing’ I can see happening. The graph showing hybrid as a percentage of total Tier 1 is a stunner. However the name of the game is power and when the 2 Brians signed off on the guarantee they sold Ireland down the river. @ Michael Hennigan An interesting question arises as to how German banks got themselves into this situation. Does one explanation lie in the build-up of enormous commercial balances with other countries in Europe which had to find a home somewhere? Martin Wolf has been drawing attention to the dangers of such imbalances for several years. On the point made by Ackermann, the Euro Plus Pact is the tangible evidence of the political willingness to do as Ackermann suggests but without an accompanying willingness to embark on further institutional integration as opposed to economic and financial integration. The setting up of the ESM outside the treaties under public international law, and seeking an amendment to the TFEU to ensure that even the German constitutional court can have no grounds for striking it down, is irrefutable evidence of the first. For the rest, the intention is evidently to try and use the enhanced cooperation procedure as introduced by the Lisbon Treaty. I have endeavoured to draw attention to this broader background in the context of the debate on the CCCTB. Such an approach risks splitting the EU. The core would continue to enjoy access to the internal market across the EU while applying inventive restrictions domestically on the basis of the defence of the social market economy. (Germany is a past master at this, closely followed by France, but the result is not good; low overall growth combined with skewed labour markets). It is remarkable that, having negotiated and agreed the new operating procedures for an enlarged EU over a fraught ten year period, there is so little disseminated knowledge of them among those that have actually to use them. They – the procedures, that is – are well capable of coping with the demands of the EU for the foreseeable future. “What Berlin has done is to develop one of Europe’s first bank restructuring acts, approved in recent months along lines proposed for all of Europe by the European Commission. The law is intended to create the conditions for failing banks to be reorganised without spooking markets, “bailing in” creditors by enforcing debt-to-equity swaps if needed, and winding down the businesses.” The new Irish government could use this bank restructuring act as a model for “bailing in” the creditors of Irish banks. If it’s good enough for Germany it cannot be denied to little Ireland. Looking at the actual numbers the problems in Germany seem minor compared to what happened in Ireland. – Total exposure by German banks to peripheral sovereign and bank debt (including Spain) is less than 2% of bank assets – German NAMA/bad bank is estimated to have losses of €20bn to €30bn over 20-30 years. Irish NAMA crystallized losses of €40bn in one year. – Federal recapitalization costs are €30bn, however some of the banks that received money are profitable and so the German government can expect to get some of this money back. Over and above the NAMA triggered losses of €40bn, the Irish government has pumped in another €30bn in recapitalizing Irish banks, for a total of €70bn, and can expect to get practically none of this back. – €40bn of German liquidity guarantees remain in use. In Ireland emergency liquidity is approaching the €200bn level. Even in absolute terms the losses in the Irish banking system seem a little greater, to date, than those in Germany. In relative terms, given that the German economy is 16 times bigger, the difference is staggering. Also the ratio of bank capital and reserves to total assets in Germany, at 4.6%, is no worse than it has been for the last decade, at least according to this chart. At €350bn the reserves would easily cover a 100% haircut on all PIGS sovereign and bank debt. I’ve never really bought into the slippery slope/contagion argument on bondholder haircuts, which starts with a haircut from AIB or Anglo, say, and ends with the collapse of the German banking system and the Euro. To me it is a bit like the argument that if you smoke a joint you’ll soon end up a homeless crack cocaine addict. I don’t see the cause and effect linkages between the various stages on the path from a haircut of €10bn (say 60% of the unguaranteed seniors) to the collapse of a system that has assets 760 times this, or where any multiplier effect comes from, and all this within a system where many banks are now reporting good profits. I wonder what might happen to asset prices and, by extension, those banks if as is likely the Yanks end the QE programme in June. The correlation between the S&P 500 and the amount of money shovelled into the markets by the Fed is noteworthy http://www.ft.com/cms/0bc44cf0-5c8c-11e0-ab7c-00144feab49a.jpg “But it is equally clear that Berlin is praying its financial support is repaid so it avoids a loss for taxpayers.” This article makes me sick to my stomach. It illustrates that at the end of the day the EU is no kind of a union at all, just a collection of selfish states looking after their own interests. All sovereign states are equal in the EU but since Germany has 82m people it is more equal than others with 4.5m and our taxpayers are faced with an enormous burden to save German voters from a minor irritance. Axel Weber will hammer this point home by raising interest rates beause the peripherary means nothing to him – all he cares about is the wage demands of the German Chemical Union. I pray for the day that our government stops pandering to an EU, that repeatedly puts our interests at the bottom of the list, and deals directly with the IMF to sort out this mess. @MH … should, of course, have referred to the edge of the bobbio_nion blog … @Aidan C ‘If it’s good enough for Germany it cannot be denied to little Ireland.’ It is … and it has. @Bryan G, Immediately post-Lehman Brothers I think there was a genuine risk of EZ meltdown and an even greater fear of this. Once the decision was made to keep senior bank bondholders in Ireland whole there was no going back and the ECB was on the hook with open-ended liquidity support. And, at the time, many core EZ banks were exposed to the dodgy, toxic stuff emanating from the US – and nobody knew to what extent in total (even if a lot of this was been ‘warehoused’ subsequently). @ Paul Hunt ‘warehoused’ as in that room in Bluebeard’s castle? Headline of the year — Ireland Bails Out Germany Again (WSJ). Isn’t it strange that the Irish bank which are owned by the state will be able to return to money markets before the sovereign can? Maybe we should get the baks to fund the sovereign on the sly from now on!!! Isn’t it strange that the Irish banks which are owned by the state will be able to return to money markets unassisted before the sovereign can? Maybe we should get the banks to fund the sovereign on the sly from now on!!! @Bryan G “I’ve never really bought into the slippery slope/contagion argument on bondholder haircuts, which starts with a haircut from AIB or Anglo, say, and ends with the collapse of the German banking system and the Euro. To me it is a bit like the argument that if you smoke a joint you’ll soon end up a homeless crack cocaine addict. I don’t see the cause and effect linkages between the various stages on the path from a haircut of €10bn (say 60% of the unguaranteed seniors) to the collapse of a system that has assets 760 times this, or where any multiplier effect comes from, and all this within a system where many banks are now reporting good profits.” I don’t think the analogy is correct – perhaps one where you take a prescription drug for a minor ailment and it kills you. The risk is now there that the prescription drug will kill other people, but it varies by genetics. Doing genetic tests on all the users of the drug is expensive and time consuming and pushes up the costs for everyone, so it would be best if you didn’t die in the first place. So if Irish senior bank debt is cut, it removes the current certainty (that is entirely false, IMO) that other eurozone senior bank debt will not be cut. Given how thinly capitalised the German banks are, this could be bad. My guess on top of this is that the German banks hold a significant amount of each others paper, so it is nothing to do with the direct effects of the Irish bank debt and all to do with the implications for the rest of the same asset class. Wanna guess what the stress-test haircuts on bank debt are? Go on, guess… Charade II, The Unwelcome Sequel. P.S Irish 10 yrs having another good day today – Yields under 9.40% now, down, from c. 10.2% just before latest recap announcement. This is also happening when German yields are a couple of percentage points higher. Notwithstanding the “Ebbs & Flows”(!), the market is defo likes the latest recap effort… @Frank Galton Ta for that. Much to agree with – but again IFSC figs distorting the story re real facts …. still, helpful from the WSJ. @hoganmahew you may be on ball to fairly large extent: landesbanken are ‘fiction glue’ holding the ‘biggies’ and the small savings(which do good work) together in a system; melt the glue the system collapses …. @ED Get real – anything over 5 is Sovereign Default ……… @ Brian G On the point that you raise in your last paragraph, as I understand it, the problem lies with the coping-stone position of debt held by senior bond-holders – both sovereign and private – in the international financial system, notably the fact that such bonds are considered rock solid and investing banks do not have to hold any reserves against them. To pull out this coping-stone in the present context could cause the arch to fall. Doing so in the context of future bond purchases would be a different matter e.g. the introduction of CACs in the actual bond agreements (as is the practice, I understand, with many developing country bonds) as is now agreed will be the future practice. I am no expert in this area but it seems the most plausible explanation for the absolute refusal of the other euroarea countries to budge and their annoyance at the fact that the issue had even been raised. RTE ran Freefall again last night. One expert said we’re in a war between the banks and society. The banks are winning, IMHO. @hoganmahew re “Altogether, €7,600bn of German banking assets are supported by less than €350bn of equity and reserves” Shocking stuff. Does this mean that if the German banking system had to suffer a 4.6% haircut on loans/assets, then their whole banking system is insolvent? Now I am beginning to undestand why they do not want haircuts on bondholders. Howver I am not able to reconcile the above comment in the statement with the remainder of the paragraph. I don’t understand how how they will be able to meet Basel 111 with an extra €50 billion, unless more than the €350 billion reserves above are taken into account as “reserves”. Full paragraph Altogether, €7,600bn of German banking assets are supported by less than €350bn of equity and reserves, according to DIW, a Berlin think-tank. Franz-Christof Zeitler, deputy president of the Bundesbank, on Tuesday confirmed a November estimate that the sector needed an extra €50bn in core tier one capital by 2018 to meet forthcoming international regulations known as Basel III. “At the moment there is nothing to suggest the new quotas cannot be met,” he added. It’s clear that the banks have been as feckless in Germany as they have everywhere else. And as a catspaw of those German banks, the ECB has played the fiddle while the european banking system burned. The continuing influence of reckless finance, even in the most financially conservative country in the EU, is truly shocking. I cannot understand how the bankers still have so many under their spell. Do everyone’s scruples really evaporate in the face of a fat cheque from the financial sector? I don’t understand how the whole system hasn’t collapsed long before this point. @ David Ouch. Wasn’t trying speculate about ability to avoid restructuring or not, just trying to highlight the significant move in yields since the announcement and how the market has been interpreting the latest policies. Anyways – If we continued to move lower at the pace we have over the last few days, we’d be under your presumingly highly scientific 5% level in a matter of weeks! @ DOCM Prof. Hans-Werner-Sinn has written: Germans loaned out their money instead of investing it. From 1995 up to the outbreak of the crisis in 2008, Germany had an average net investment rate of only 5.3 percent of net domestic product. That was the lowest rate of all OECD countries. In 2008 Germany had saved €277bn in all sectors (private households, businesses and government); that much money was available for net investments, but in fact only €111bn was invested. The lion’s share of the savings, €166bn, flowed as capital exports abroad, far too frequently via the dubious businesses of the state banks, for which apparently no risk was great enough. The result of the capital exports, i.e. the transfer of the rights to utilise economic goods, was that from 1995 to 2008 Germany, after Italy, had the lowest growth rate of all EU countries. http://www.finfacts.ie/irishfinancenews/article_1019874.shtml On average, from 1995 to 2008 no less than 76% of aggregate German savings (private, governmental and corporate) were invested abroad, while only 24% found their way into the domestic economy. P.S yields now @ 9.3%! @ ED, I’ve been watching them aswell. They’ve been falling like a stone since 12pm. As you say they have dropped a whole percentage point in under a week. German yields are rising but only by a few basis points. The only media mention I see of bond yields today is Portugal’s bond issue. No sign yet of the drop in Irish bond prices. Maybe later. @ Seamus FYI Honohan FT article released at 11:33! http://www.ft.com/cms/s/0/c5d711bc-602f-11e0-abba-00144feab49a.html#axzz1IjA9JIh8 Talks about the potential to link sovereign debt repayments to GNP growth… Sounds like excellent initiative to me. The amount we pay back on our debt is linked to the performance economy. Therefore lessening the stunting nature of large scale debt payback. Can’t see the dreaded Germans going for anything other than FISCAL RESPONSIBILITY though! Also seen a few new buy rating notes on Irish debt from institutional brokerages over the last few days…. @ ED The article may be a factor. Not sure. The buy ratings are out a day or two. I would guess, though, that volumes are very light and that it is small retail rather than large institutional investors that are getting active. Still, it is much better than seeing yields moving in the other direction. @Seamus Coffey Phew – for a moment there I thought you were going to say – We have turned the corner! Going in ‘the right direction’ is a much more conservatively measured turn of phrase … Of course, the particular stones in Cork were never too bothered with the vertical nature of the universal ‘g’ … @ED Nothing scientific – purely intuitive … and this market isn’t even ‘real’ … @Michael Hennigan Rem that Germany managed to cope with re-unification … and grow … Interesting article: “German banks also have an unusual reliance on hybrid capital: the oddly named “silent participations” (stille Einlagen), which global regulators will no longer consider as up to scratch.” There must be a lot behind that sentence that would belong to a story of how Wall St sold the pup of mortgage subprime CDO’s and derivatives in under the counter deals to europe and the rest of the world. But don’t expect transparency in being able to look for reliable information on what those exposures are: “Altogether, €7,600bn of German banking assets are supported by less than €350bn of equity and reserves, according to DIW, a Berlin think-tank. Franz-Christof Zeitler, deputy president of the Bundesbank,” So presumably any form of stress testing of German banks exposed in this way would see them sink without trace, but no, this is what Germany does: “What Berlin has done is to develop one of Europe’s first bank restructuring acts, approved in recent months along lines proposed for all of Europe by the European Commission. The law is intended to create the conditions for failing banks to be reorganised without spooking markets, “bailing in” creditors by enforcing debt-to-equity swaps if needed, and winding down the businesses.” So we’ve been sold a pup regarding ECB demands that debt-to-equity are off the table for us, one law for Germany, another for us! “The other set of banks badly hit were property and public sector lenders such as Hypo Real Estate” Posters should read the work of Kathleen Barrington to gain a view of the finer nuances involved in the above sentence. In particular the story of Depfa, ‘Irish pigsty’ and HRE subsidiaries down at our IFSC. Of particular interest is the involvement of Sean Fitzpatrick in revolving door loans with German banks and Anglo’s relationship with these subsidiaries down at the IFSC. Which also brings into focus our low corporation tax and how German banks got on board the IFSC subsidiary opportunities. Kathleen Barrington explores http://bit.ly/eA1E0x http://bit.ly/eHmfdu The sensitivities around Depfa, the low corporation tax model of German bank subsidiaries operating out of IFSC, raise questions about the real state of our GDP; how our domestic economy has been broken by the Irish financial services industry, in the service of dodgy and criminal banks eg Anglo operating unregulated in Ireland. Re ““What Berlin has done is to develop one of Europe’s first bank restructuring acts, approved in recent months along lines proposed for all of Europe by the European Commission. The law is intended to create the conditions for failing banks to be reorganised without spooking markets, “bailing in” creditors by enforcing debt-to-equity swaps if needed, and winding down the businesses.” don’t ask why our ‘gombeens’ did not create such a law here!!! Commerzbank to Repay $20.4 Billion of German Bailout http://dealbook.nytimes.com/2011/04/06/commerzbank-to-repay-20-4-billion-of-german-bailout/?ref=global-home ‘silent participations’ may be added to the lexicon … @ MH-F Many thanks for the data. It is an extraordinary story in many ways. It shows that the Germans are better at making cars than international finance. Herewith a link to the IT that should not go unnoticed. http://www.irishtimes.com/newspaper/finance/2011/0406/1224294011184.html Why the bafflement? As Ciarán O’Hagan remarked on another thread some time ago, countries do not go bankrupt in the manner of companies. They continue to exist and to need a banking sector. Investors in New York seem more on the ball on this point than those on this side of the water. The sudden turn in Irish bond spreads and the increased inflow of funds to the two banking “pillars” may be a confirmation of the point I was making some days ago on the likely general policy thrust of euorarea heavyweights. But one swallow does not a summer make. Arthur Beesley was reporting at midday (Newstalk) that the French were still sticking to their position on corporation tax. No joy, therefore, on that front until the June European Council. @DOCM ‘..increased inflow’? or ‘decreased outflow’? U Spinning? @ ED What happening? 9.2? Are we still fecked or less fecked? Calm down (no more coffey (sic) for you today) and give us some more information. 🙂 @DOCM key stone @ martindgl Thanks. You are quite right. It is, I suppose, appropriate that the key element of the design on euronotes is that of (stone) bridges. @Joseph Ryan “I don’t understand how how they will be able to meet Basel 111 with an extra €50 billion, unless more than the €350 billion reserves above are taken into account as “reserves”.” No, I don’t understand either, unless bank bonds are not being considered as risky assets with a weighting… @all My monthly Minsky moment goes to Portugal: German Banks are ‘Takers’ Working Paper No. 664, March 2011 Can Portugal Escape Stagnation without Opting Out from the Eurozone? Pedro Leao and Alfonso Palacio-Vera The sovereign debt crisis of eurozone countries such as Portugal has highlighted rising heterogeneity, macroeconomic imbalances, and high levels of private and public sector indebtedness. There is no clear pattern of economic integration among eurozone countries, say the authors. Peripheral eurozone countries have financed their large current account deficits by increasing their indebtedness vis-à-vis core countries—Germany in particular. According to the authors, Portugal, Greece, and Spain face a decade of economic stagnation and high unemployment. In the absence of institutional reform, Portugal’s best way forward is to exit the eurozone. http://www.levyinstitute.org/pubs/wp_664.pdf @ED What are volumes like? Could Frankfurt be behind this? @all Read above linked paper for good overview on Portugal …. http://www.irishtimes.com/newspaper/breaking/2011/0406/breaking6.html Portugal seeks assistance … @DOCM Who you spinnin for? @all Europeans Two leading German commentators have accused the Berlin government of being disingenuous about the role of German banks in helping to drive the Irish financial crisis. German philosopher Jürgen Habermas and former foreign minister Joschka Fischer said the EU is facing “creeping death” unless Germany seizes the euro zone crisis as a chance for final European integration. http://www.irishtimes.com/newspaper/frontpage/2011/0407/1224294101508.html @ Jürgen Habermas & Joschka Fischer [& all Europeans] Germany should admit its part in causing European crises, says former minister http://www.irishtimes.com/newspaper/world/2011/0407/1224294096707.html Mr Joschka Fischer said Berlin was being disingenuous in factoring out the culpability of German banks – particularly state-owned institutions – in the Irish financial crisis. “We are currently going about sinking 50 years of European history,” said Prof Jürgen Habermas at a Berlin event organised by the European Council on Foreign Relations. Habermas: “Awareness of a historical-moral obligation was the source (in the EU) of German restraint and readiness to adopt the position of others and to defuse conflicts through advance payments,” he said. Pointing to the recently agreed EU austerity measures, he said: “The economic package … was put together with so little sensitivity by the economic model student that neigbours no longer talk of not wanting a Brussels political model imposed on them rather a German political model.” Fischer: “In the backrooms in Dublin it was our (state-owned) Landesbanks earning all the money to the delight of our state governments of all political persuasions. No one tells the people here that part,” he said. “I don’t see in this a master plan, but a bit of the reality is being kept from view. Ireland could have gotten away well if Brian Cowen had said, ‘we will save Irish banks but English Banks and German banks are not our problem’.” Economics professor Henrik Enderlein went further, saying Dr Merkel’s government was “hushing up on purpose” German involvement. “It’s clear German state-owned banks are a key issue in the (Irish) problem,” he said. “But if this got out into the open we’d have a problem with five state governors and if the German federal system needed to become part of solving European difficulties, then we would have a real problem.” @ David O’Donnell Economics professor Henrik Enderlein: “It’s clear German state-owned banks are a key issue in the (Irish) problem,” he said. A comforting morsel? But he is surely confusing the IFSC with the domestic banking system? Not so comforting, Prof. Sinn: “Optimists believe that the new rescue operations are aimed only at protecting old claims now at risk and for this reason the costs that Germany will have to bear will not increase further. But this hope is too good to be true. The more money that flows, the longer the heavily indebted countries will live beyond their means, the longer the trade gaps will be maintained, and the higher the eventual losses. Throwing good money after bad has never been a very good idea. The more that goes out, the less comes back.” @hoganmahew, Paul H, DOCM The prescription drug analogy captures the concept that whereas the system as a whole may be able to withstand a shock, there may be some individual institutions that get sick and die. However the analogy doesn’t really capture the concept that banks are ultimately intermediaries. To take another example, suppose there are some airlines that have excess capacity and decide to “loan” their unused aircraft to a leasing company, for a fee (let’s call these the ‘originating’ airlines). Now instead of one leasing company there is a network of leasing companies that can sublease these aircraft amongst each other (e.g. to different territories, or with different wholesale/retail business models or ones that specialize in cargo planes or whatever). Ultimately there are other airlines that don’t have enough planes and they “borrow” planes from the leasing companies (let’s call these the the ‘consuming’ airlines). When the consuming airlines are done with the planes they return them to the leasing companies, who in turn return them to the originating airlines. Now this all works well until some of the consuming airlines crash the planes and can’t return them. If 1000 planes were submitted into the leasing system, and 10 crashed, then at the end there are 990 planes left. Informing the leasing company that you’ve crashed your plane doesn’t cause other planes to crash – the loss will have to work its way through the mesh of subleases, but ultimately there are 10 planes missing from the originating airlines fleet, not some multiple of 10. This is what I mean when I don’t see the “multiplier” effect. The process of each sub-leaser informing its ‘parent’ leaser that there has been a loss is qualitatively different from a plane crash – it is the the process by which the loss is transmitted through the system to the originating airlines. With a contagion/chain reaction model the number of lost planes at the end would be some multiple of 10, since each crash would trigger another. Now if the leasing companies decide to stop doing business with each other for a while, as they don’t know how many planes have crashed or where the next crash might occur, then a trusted neutral “lease exchange” company could fill the gap for a while (acting as an intermediary between all the leasing companies). However again this does not cause any more plane crashes. So bank to the banking system – the ECB’s job (as this trusted neutral exchange company) should be to ensure the orderly transferral of losses through the system from the consuming parties to the originating parties. Instead it has effectively decided to force uninvolved motorists to buy new planes to replace the crashed ones. Bryan G. Your analogy is how the credit union system works. Note that not a single penny has been needed for the credit unions. The analogy fails when it is compared to banking which has reserves that are a fraction of its lending. In that situation when a loan (consumer) fails there is only a fraction of the originating deposit available to meet it.. And we are where we are. @Michael Hennigan A welcome ‘morsel’ – and ‘realism’ from well informed Germans is even more welcome. Germany, and imho Europe’s, leading philosopher and public intellectual and ex-Foreign minister are heavy-weights; Enderlein is now on my ‘get to know’ list ……. On ‘national’ (excluding IFSC) there was/is large percentage of German bondholders ……… who are 100% protected by Irish citizen-serfs: and this is being hidden in public political discourse in Germany – Sinn is one the leading spinners wearing the German Gansey …. and imho very pro Dr Merkel ……… For European solution we need European Allies: Jürgen Habermas would be, has been, my number 1 pick for quite some time. Need a reading list? And I might add that Axel Weber’s dissenting opinion in Berlin last Thurs was also a very welcome ‘morsel’. Have come across an Irish Times editorial of August 24 2006 which rather arrogantly suggests that the Germans at that time should have adopted the IRISH economic model This type of smug and naive lecture did not of course endear us to our Eurofriends This from a newspaper and economy whose economic model was totally dependent on the property circus! michael http://dublinopinion.com/2010/08/17/geraldine-kennedy-2006-germany-must-follow-irelands-lead-for-the-student-has-now-become-the-master/ @Conor O’Brien I think that the point I was trying to malke applies to fractional reserve banking also. It was not about avoiding losses, but about how those losses are distributed and whether there is a multiplier when a given loss is injected into the system. If a 10bn loss is injected into the system, then this will eat up capital in the first bank in the chain. If there was only 5bn in capital in the first bank, then the remaining 5bn losses should be imposed on the bondholders who lent to that bank. These bondholders could be non-banks in which case the chain stops, or another bank, in which case the chain iterates. At the end, 10bn of losses are distributed throughout the system, through some combination of wiping out bank capital and creditor funds. This is a redistribution of losses, so the system as a whole takes a hit by the size of the original loss that was injected into the system. The contagion metaphor with warnings of ‘meltdown’ and ‘collapse’, as I understand it, goes beyond simple linear loss allocation and implies that the losses feed on themselves and amplify through some feedback loops, with the result that total losses are greater than those injected in, though maybe I’m reading too much into this. It appears that both the present and previous government proposed that the unguaranteed seniors be hit, I would guess to the level of €10bn or so. Would €10bn of losses cause the collapse of the banking system or Euro? No, since this amount is a tiny percentage of total assets. “Contagion” is just another word for “distribution of losses as they should occur in a functional capitalist economy”. @ Bryan G I follow what you’re saying, but I thought that the ‘contagion’ argument was a bit more like this. A non-bank individual (Roman Abramovitch say), or wealth management agency decides to buy senior bonds in a large, reputable bank. The Irish government, now being the major shareholder in its own banks, decides to force losses on senior bonholders in those banks, so as to share out the losses that the banks have taken. Across Europe and the world, wealthy individuals and fund-mangers, etc wake up and say, hang on, we thought, rightly or wrongly, those bonds were as safe as, uh, houses, and now we find they are not. Let us now either (a) bid for bonds at a higher interest for our money, or (b) invest in gold (or take your pick). The bit I don’t get is that if the ECB are saying that (pre-ESM), all senior bank bond-holders in systemic banks (don’t know how this is defined), must always 100% be paid back in full, even by the state, then why do they get a variable rate of interest for the bonds? After all, the higher rate of interest on the bank bonds in the first place is pricing in some sort of risk factor isn’t it? But there is no risk factor. Tell me if I’m barking up the wrong tree. @Bryan G I don’t think the airplane analogy stacks up. The problem is not that one plane crashes, but that in crashing it makes all the other planes worth less but at the same time the originating airlines get to charge more for them (price of bank bonds go down, therefore yield for lending banks goes up – borrowing banks have to pay more for funding, which bleeds into consumers who take loans from the borrowing banks paying more for their loans or some of the borrowing banks going bust). If the overall risk premium for unsecured senior debt goes up, so does the yield; if it is differentiated on bank financial strength ratings (for example), this will be unevenly spread, so the weaker banks will pretty much immediately be cut out of the funding markets. The German banks appear to have a huge reliance on this form of funding. I don’t know about the French banks, but I wouldn’t be surprised. @Gavin Kostick “The bit I don’t get is that if the ECB are saying that (pre-ESM), all senior bank bond-holders in systemic banks (don’t know how this is defined), must always 100% be paid back in full, even by the state, then why do they get a variable rate of interest for the bonds? After all, the higher rate of interest on the bank bonds in the first place is pricing in some sort of risk factor isn’t it? But there is no risk factor.” Absolutely that is a problem. There is a risk premium built in, it just isn’t big enough for the losses that are likely. The ECB, as you rightly point out, is talking out of both sides of its posterior. @Henrik Enderlein Welcome to European Reality on its western fringes …. let’s have a pint sometime …. http://www.henrik-enderlein.de/ More on Commerzbank http://www.spiegel.de/international/business/0,1518,755646,00.html#ref=nlint Many governors are having trouble parting ways with institutions with which “they can move a few millions with a phone call, without having to ask their parliaments,” says economist Martin Hellwig of the Max Planck Institute. In 2010 Peter Müller (CDU), the governor of the western German state of Saarland, even bought back the majority of shares in his state’s Landesbank, SaarLB, which had once been sold to its Bavarian counterpart, BayernLB. & a bit more on savings banks and state banks … ‘Meanwhile, the savings bank associations and their president, Heinrich Haasis, are primarily concerned with getting off as cheaply as possible. As part owners, the savings banks are partly liable for the mistakes of the state-owned banks. Dirk Schiereck, a finance professor who specializes in banks, believes that the savings banks have a special obligation, because they did not prevent the state-owned banks from making faulty investments “and therefore failed miserably as owners.” So far, however, the savings banks, with the support of politicians, have repeatedly managed to pass on most of the bailout costs to taxpayers.’ http://www.spiegel.de/international/business/0,1518,750982,00.html @hoganmahew, Gavin Kostick OK I think I’m starting to get it – rather than solely focusing on loan losses and their propagation through the system with their impact on solvency/capital, it is necessary to look at funding costs and their impact on liquidity, and which in turn could lead to solvency problems. If there’s a bank run on one bank (whether for wholesale or retail funding) then other banks with the same characteristics could also be subject to the same sort of bank run, regardless of whether there are direct counterparty exposures between them. @Bryan G Yep. It’s a design flaw, rather than pilot error… Calling bank bonds as solid as sovereign bonds (which the system appears to) means that if it turns out they are not, it affects all bank bonds. It is like saying that wings don’t work anymore in windy weather. It affects not just the wings of the plane that crashed, but all other wings. There’s a similar problem with secured bonds. If they are defaulted on and the lender gets the security, they will want to sell it. It is worth more unsold than sold (firesale problems, structural problems with the concentration of assets in a particular market – eurozone secured bonds are not geographically dispersed like US ones were, even in the US the general property price collapse rendered the geographic dispersal unhelpful). So, given the certainty of losses in the event of forced sales, this would mean a writedown (increase in risk) of the value of all secured bonds whether sold or not. VaR has a lot to answer for… Comments are closed.