Bank rescue? Advice to Greece: Follow the Germans

Germans like building cars, putting their towels on European sun-lounges, and winning the World Cup. That seems to be the three comparative advantages, upon which Germany built its reputation as the strong man of Europe. Until the 17 hour marathon negotiations last week-end, of course, when the Germans took that title a little bit too literally. They showed that they are pretty adept at financial waterboarding too, a crown previously held exclusively by the IMF.

What else are the Germans good at? Selling drugs in supermarkets maybe, a crucial component, the Troika thinks, in helping Greece repay the 320bn of debt? Far from it, drugs like aspirin and paracetamol are about 5 times more expensive in a German pharmacy than in a UK supermarket. And you are not allowed to buy drugs in a supermarket in Germany. It is against the law. You do, however, get friendly pharmacists, and glossy TV guides and health magazines at German pharmacies, for free.

How about liberalized markets, companies like Uber and Amazon, the rent extractors of the internet, must be laughing in Germany, the neo-liberal paradise. If only Greece was like Germany in that regard – and liberalised, maybe Greece would have 6% unemployed, instead of 26%, seems to be the IMF’s thinking!

Not quite, despite its German looking name Uber is strictly verboten in Germany, as it would undermine the regulated taxi market; and Amazon, although it does a good trade in Germany, has no competitive price advantage over a book store, as there is a fixed price book agreement. So no liberalised market for books. Thus thankfully, even in little towns you still have independent book shops, which in other countries, which do not have fixed-price agreements, have long since disappeared.

Could it be, perhaps, that the IMF with its liberalized markets and bizarre ideas of supply side reforms is suggesting the wrong thing?

And could it be, that the idea of putting 25bn into Greek private sector banks to add to their capital base (the only new money available in the “alleged 86bn bail-out“) is also the wrong thing as far as bank rescue is concerned?

Rather than doing that, it seems that with bank-rescue, as with pharmacies and book-shops, it would be wise to follow the Germans:

Option (1) Follow German actions: Create a Bad Bank

Option (2) Follow German words of wisdom: Use Quantitative Easing for what it was intended for – Purchase of Bad Debt

Option (3) Follow German writings: Continue to provide liquidity, even if insolvent

So let us examine the first option:

Option (1) Create A Bad Bank: Hypo Real Estate and its Bad Bank FMS Wertmanagement

The biggest and most expensive financial bank disaster ever in Germany is Hypo Real Estate, a bank which got badly caught in the financial tsunami of 2008, leading to massive losses and bad debts. In 2008 Hypo Real Estate was a bank with consolidated assets of 420bn Euro. Because it was unable to find lenders to refinance itself during 2008, (it had borrowed short term, but lent long term, but looked also extremely weak) it had to look for state help. Following the collapse of Lehman Brothers the German state had to support the balance sheet of Hypo Real Estate with ultimately a 10bn capital injection to allow it to continue trading. It also needed further guarantees of 120bn from the German government so that lenders would fund it. In 2009 it was taken over by the German government. In the beginning of 2008 shares had traded at 30 Euro, but when Germany nationalised the bank, it got a majority shareholding by offering to buy at just over 1 Euro a share.

When all dodgy loans were finally totted up in 2010 it came to a cool 173bn in bad debt. The biggest losses of any bank due to the financial crisis in Germany. And, incidently, more that the hole in Lehman’s balance sheet which started the melt-down.

173bn which would have to be written off, which would of course not only have sunk the Hypo Real Estate, but a good selection of other banks which lent to it. The whole German banking system would have been in peril. A disaster.

(That 173bn is about half the size of the total debt of the Greek government, one little bank, which I previously never heard of before it went bust, makes bad loans, of that magnitude. That makes the bankers to Greece look like paragons of financial virtue, comparitively. Or, looking at it another way, of the 420bn in total assets for Hypo Real Estate 173bn were bad loans – some record, surely!)

Finally, in 2010 Germany split the bank into two, moving all the bad assets into a bad bank, and leaving all the good assets in a good bank. In fact it used the 6-step clean up routine, which can be used for virtually any bank in trouble.

(1) nationalise,
(2) create bad bank (bad loans),
(3) create good bank (good loans),
(4) administer bad bank,
(5) privatise good bank,
(6) count money

So what is the result, and what has happened since 2010?

Bad Bank:

When the bad bank, FMS Wertmanagement, was formed in 2010 it obtained all 173bn of the bad debts from Hypo Real Estate as assets. Over the last 4 years it has reduced the assets previously counted as bad debts from 173bn to 108bn. These 65bn bad debts, in fact, did not turn out to be bad debts at all. FMS is a corporation owned by the German government. That ultimate guarantee allows the bank to issue bonds to finance its assets. And it can issue bonds at 0% interest, in fact slightly negative interest rates.

Good Bank:

The remainder of Hypo Real Estate became the good bank in 2010. That good bank has now 76bn of consolidated assets. Its only trading subsidiary, Deutsche Pfandbriefbank was finally listed last week (15th July 2015) on the Frankfurt Stock Exchange, valuing the bank at Euro 1.5bn. Which the ultimate shareholder, the German state, can now pocket and count as profits.

This was the biggest new listing on the Frankfurt Stock exchanges so far this year.

What can Greece learn from the sorry tale of Hypo Real Estate?

(a) The sooner Bad Banks are established, the better.

Before the bad bank was established, Germany had to support the bank with 10bn Euro of additional capital. This money has now been lost by the German state, even though the sale of of the main arm of its still active subsidiary, Deutsche Pfandbriefbank, last week meant the inflow of eventually 1.5bn Euro.

If Germany had established the Bad Bank earlier, it might have avoided the 10bn capital injection which came largely between 2008 and 2010.

(b) A Bad Bank concentrates on getting money back only, and can borrow cheaply

Getting money back over the long term is a long and messy business for the Bad Bank, but its only business purpose. It will try to wind the bank down over the next few years. Concentrating on just getting the money back, selling assets, and restructuring deals is much better performed in a bank set up just for that purpose. The main aim of a normal, good bank is of course to lend as much as possible. To try to recoup as much as possible and shrink the balance sheet is the exact opposite.

It therefore makes sense to have a separate bad bank in this respect. The ultimate ownership of the German state and low interest rates make a resolution of these bad debts more likely and allow cheap re-financing in the market.

It remains to be seen whether FMS can get all its money back. That is of course highly unlikely that 108bn of bad debt remaining will, in the end, all turn out to be “good debt”. In fact, the longer a debt sits on the balance sheet of FMS, the more likely is it, that it will never be repaid. So the taxpayer, in the end will have to pay for some of the bad debt.

(c) Bad banks increase debt/GDP ratio of a country,

Because of its full government guarantee, the bad debt of the bad bank FMS is fully included in the state debts of the government of Germany.

So about 1 Euro in 20 of German government debt is due to the irresponsible lending policy of one bank alone, Hypo Real Estate! Or as Germany repays its total state debt from taxes, (Germany has a budget surplus), one twentieth of the tax money allocated to repayment is to pay for the Hypo Real Estate disaster.

What does that mean for Greece? if perhaps a quarter of Greek bank loans (100bn) in the end turns out be be bad, the total debt to GDP ratio of Greece could increase to over 230% from about 180% now, if that bad debt were to be resolved through a bad bank.

(d) The good bank can survive, and the good bank’s solvency will be assured

Once a bad bank is proposed, all lending even slightly doubtful will end up in the bad bank.

That means that the Good Bank will now undoubtedly be solvent!

The good bank is then able to continue to lend new money to businesses, trade profitably, and could eventually be sold off.

(e) Hypo real Estate was always insolvent, Greek banks are not.

At no stage did the Bundesbank seem to help Hypo Real Estate as a lender of last resort, having obviously decided in 2008 that it was not just a liquidity problem, but a solvency one. The German Central Bank, the Bundesbank, did only play a supporting role in the restructuring. The German Banking Supervisor, Soffin, had to put in 10bn of extra capital, provide the government guarantees, arrange all the rescue and re-structuring, and set-up the Bad Bank.

Greek banks are not insolvent, however, liquidity is currently provided by the ECB via the Greek Central Bank for the Greek banks, financing about a third of its assets. 120bn of the Greek banks liabilities are financed via Target2 payment system, and sit as liabilities in Greek banks’ balance sheets. Arguably, therefore, the Greek banking system, which in total has assets of 400bn (about the same as Hypo Real Estate had in 2008 ! ) will be in a better position than Hypo Real Estate was.

So in summary – to follow Option (1) and set up a bad bank – the following points are important to remember:

If Greece were to follow German in setting up a bad bank immediately, to resolve all its bad debts in the long term, the consequences would be:

Avoidance of capital injections now, the 25bn of new bank capital injections, part of the “86bn bail-out”, would not be necessary!

The remaining good banks would then be solvent

Cash in-flow from selling the good banks would arrive when good banks are sold

Bad banks have then only one purpose. getting money back from bad debts in Greece, and are able to wait long term for asset prices to increase.

Bad Banks increase government debt and result in increases in debt/GDP ratio – a recognition of the fact that the government (especially before a fully functioning banking union is in place next year) will ultimately be responsible for the debt of its banks.

So, if Greece was to follow what Germans did with Hypo Real Estate, the bad bank would be the solution to follow.

It would be the only option if central bank lending was not available, as it did not seem to be for Hypo Real Estate.

But, if the Greek banks are solvent, or even border-line solvent, there are other options available:

Option (2) Follow German words of wisdom: Use Quantitative Easing for what it was intended for – Purchase of Bad Debt

Option (3) Follow German writings: Continue to provide liquidity, even if solvency is in doubt

Option (2) Follow German words of wisdom: Use Quantitative Easing for what it was intended for – Purchase of Bad Debt

Richard Werner, Banking and Finance Professor at Southampton University, and the person who invented the term quantitative easing says here what it really should mean, helping banks back on its feet. He is being interviewed for the RT program Boom Bust

(Please fast forward to go to minute 18:00 to 21:00)

Just in case the video will not work, the gist of Prof. Werner’s argument is this: the ECB shoud just buy up non-performing assets of banks at face value and thereby give the banks the liquidity and solvency they need. That would allow the banks to lend. Also, Professor Werner argues, why should the taxpayer pay for it, the taxpayer did not create those bad debts? The argument is, before the crisis hit, it was the ECB’s fault, allowing credit creation, year on year of 25% to 40% growth. So the ECB should deal with the mess that it has created.

Also, it would allow countries to move away from the fiscal rectitude they have had to endure, due to the banking problems in their countries, which have made the problem in the peripherie countries worse.

So really what Prof Werner is saying that the ECB should pay to solve any bad debt issues.

Option (3) Follow German writings: Continue to provide liquidity, even if solvency is in doubt

For the last option on how to deal with bad debts, let us read the words of Prof Martin Hellwig, the co-author of the most eminently sensible suggestion on how to avoid future banking crisis. (The idea is that banks should in future have a much stronger capital base, so shareholders should put up 30% of their own money to lend, across the board, rather than just effectively 3%).

In the article for the German blog Oekonomenstimme, he talks about the role of the ECB during the bank closures in Greece (my translation):

The real question must be  how the ECB behaves. Jens Weidmann [Head of the German Bundesbank] and Hans-Werner Sinn [prominent German economist] have long been demanding to end the emergency loans for Greek banks . Why has the ECB now frozen the emergency loans (ELA) to the Greek banking system and not completely cancelled them ?

However, already the freezing of emergency loans is questionable. According to the European Treaty, the ECB has the task of “promoting the smooth operation of payment systems” and it has to do so in all member states, also in Greece . The freezing of emergency loans had resulted in the closure of the Greek banks and massive restrictions their banks’ payment system . This is incompatible with the contractual obligations of the ECB.

Hellwig continues:

Emergency loans in case of a run on the banks belong to the core tasks of a central bank . Banks finance themselves through short- and medium-term customer deposits , and assign these funds to long-term loans . If depositors come to panic and withdraw their deposits, the banks are defenseless. In such a situation, either the central bank helps, or a crisis will develop that will badly affect the economy as a whole.

And finally, Hellwig addresses the issue of solvency:

According to the rules of the ECB only solvent banks can get loans from the central bank. By applying that rule the central bank can protect itself from losses. But would it not have been better in 1931, had the Reichsbank [the German Central Bank at the time] continued to give credit to the commercial banks, even the apparently insolvent Danatbank [the first German bank to become insolvent, triggering further insolvencies in the German banking system]? The costs of the crisis for Germany were so great that the answer should be easy to this question. In those days, however, the Reichsbank did not have a choice but had to end its support because it did not have sufficient gold and foreign exchange reserves to provide adequate cover for its liquidity support.

The rule to lend money only to solvent banks, comes from the time when the central banks had to be ready to redeem their paper money for gold or foreign exchange. Concern for their gold and foreign exchange and the fear of a run caused the Reichsbank to take special care. This caution prevented an adequate monetary policy in the Great Depression.

Now, we have pure paper money, without any obligation to redeem. Central banks can support the monetary system and the banking system without worrying about their own ability to act. Should the EU Treaty, setting out the responsibility for the functioning of payment systems, not take precedence over an internal rule of the ECB, which dates back to the time of the gold standard and is not covered by the treaty?

So, yet another professor who thinks that ultimately it is the ECB’s job to take on potential losses, to protect a functioning payment system.

So the three German solutions to bank restructuring are:

(1) a long term work out solution, a bad bank, which tries to get money back in the long term

(2) a buying up of bad loans by the ECB

(3) continued liquidity support by ECB, to ensure functioning payment system, even in the case of insolvent banks, as broken payment system is worse outcome for economy.

Greece should pick and choose from the 3 options.

They are, of course, not on offer as part of the bail-out. The Troika has other ideas:

It is not entirely clear, how the 25bn is to be used, but in this detailed report we get an idea. It is the view what could happen from Silvia Merler, an economist working for the Brueghel think-tank.


a) Greek depositors are to pay, every deposit of over 100,000 Euro will be reduced to increase the capital base of the banks. A depositor bail-in

b) then, the Greek taxpayer becomes liable, with a further 25bn injection into Greek banks

Now, clearly, this idea of using depositors, and hair-cuts on their deposits, to recapitalise banks has been used in Cyprus, and has arguably led to the bank run which we have seen in Greece in the last few months.

It would be a sure-fire way to ensure that Italians and the Spanish will now also move their money from accounts in their respective countries, to Germany and Switzerland. As Italy and Spain might be next. A more stupid idea could not be proposed, it will lead eventually to the undermining of trust in the whole banking system. But it seems that is what the EU is aiming for.

In order to avoid further debt, Greeks now have to refuse the 25bn new loans offered to them for bank restructuring as part of the “alleged 86bn bail out” and aim to use the lower cost options set out above. That would make the “alleged 86bn bail out”, of course, entirely redundant. As the only new money would have been the 25bn.

So the moral of the tale: sometimes it pays to listen to the Germans, not always, but where they have a comparative advantage it might pay dividends. In ideas for bank restructure, they seem to have such an advantage.

Banking restructure, a comparative advantage by the Germans, which seems to be as solid as in football.

Greece should remember what happened last time their national football team was led by a German football coach. Otto Rehhagel led the Greek team to a famous victory in the European Championships in 2004.

Is it now time that German proposals will save the Greek banking sector?


2 thoughts on “Bank rescue? Advice to Greece: Follow the Germans

  1. “The correct announcement of the ECB should be that it will provide all the necessary liquidity to the Greek banks. Such an announcement will pacify depositors. Knowing that the banks have sufficient cash to pay them out they will stop running to the bank. Like the OMT, such an announcement will stop the banking crisis without the ECB actually having to provide much liquidity to the Greek banks.

    These are first principles of how a central bank should deal with a banking crisis. I would be very surprised if the very intelligent men (and one woman) in Frankfurt did not know these first principles. This leads me to conclude that the ECB has other objectives than stabilizing the Greek banking system. These objectives are political. The ECB continues to put pressure on the Greek government to behave well. The price of this behavior by the ECB is paid by millions of Greeks.”




    The European Central Bank welcomed Greece’s draft legislation to bring its bank-resolution rules into line with European Union law, while warning some provisions could harm the independence of the local monetary authority.

    “The ECB welcomes the draft law, as it strengthens the tools and procedures available to the Bank of Greece to carry out effective preventive, early intervention and effective resolution measures,” the Frankfurt-based institution said in a legal opinion posted on its website.

    The ECB didn’t offer a view as to whether the bill “effectively discharges the obligations of the Greek state to implement the Bank Recovery and Resolution Directive in Greek law.”

    Transposing the EU’s rules on how to save or shutter an ailing bank was required by euro-area leaders as a condition of further financial aid for Greece. The European rules, fully effective as of Jan. 1, 2016, seek to prevent governments from footing the bill for bank failures.

    The ECB said that as the Bank of Greece is already the country’s supervisory and resolution authority, transposing the BRRD law doesn’t represent a major shift in its responsibilities. That said, provisions in the law could still hamper its operational independence, according to the opinion.

    “By requiring the Finance Ministry’s prior consent for all decisions pertaining to the sale of a business, the setting up of a bridge bank, asset separation, bail-in, write down or conversion, regardless of whether they have a direct fiscal impact or systemic implication, the draft law seems to go beyond” the BRRD text, the ECB said.

    ‘Fiscal impact’

    This raises the possibility that the Finance Ministry could be considered a second resolution authority alongside the Bank of Greece, the ECB said.

    “The consulting authority is invited to consider whether the Finance Ministry’s prior consent should be more appropriately limited to those cases in which the resolution measures have a direct fiscal impact or systemic implications,” according to the opinion.

    The ECB also expressed concerns that the personal liability clauses affecting senior staff of the Bank of Greece in the text may not be proportionate. The final law should also make clear that under no circumstances can the central bank assume financial liabilities for the entities being wound down.

    Greek lenders are in line to receive as much as 25 billion euros ($27 billion) in fresh capital from the euro area as part of the bailout framework proposed this month. Given that the bail-in provisions of European law are only in force from January, any bank wind-downs in the meantime may take place under existing legislation.

    The ECB’s supervisory arm will decide on the precise amount needed and will also conduct a stress test of bank balance sheets. The law is scheduled to be debated in the Greek parliament on July 22, with a vote expected after midnight Athens time.



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