In Search of the Visible Hand - By Spiegel Staff
Posted by ProjectC
<blockquote>"Long lines of nervous customers waiting to withdraw their savings -- the images of 1931 have been burned into Germany's collective memory. They have become symbolic for the world economic crisis that began in 1929, plunged millions of people into unemployment and poverty and eventually led to the Nazis' rise to power in 1933.
...
Instead of billions or even hundreds of billions, the losses stemming from the financial crisis could now number in the trillions. Mountains of public debt could limit the ability of governments to act for years, if not decades. In the United States, an additional digit had to be added to the national debt meter in New York so that it could display a number in the double-digit trillions.
...
The program, if ultimately approved, would resemble in some respects the measures taken by the government of Chancellor Heinrich Brüning in 1931. But the similarities don't end there. Then, as now, it all began with a speculative bubble. In the 1920s, investors gambled with debt-financed stocks, and in the 2000s it was credit derivatives. Then, as now, politicians initially underestimated the extent of the crisis, and their reactions came too late and lacked coordination. In both cases, there were bankers whose actions were excessively risky and who exerted far too much control, then covered up the entire disaster and eventually proved incapable of taking concerted action to solve the problem.
An era came to an end in 2008. It was the age of unbridled capitalism, which, stemming from the United States and driven by uninhibited financial markets, fundamentally changed the global economy. It was an era that considered debt healthy and pronounced all risks manageable, and now threatens to choke on those same debts and risks -- and drag the world economy down with it.
...
Both Kauder and Struck have clearly suffered in recent years, suffered at the hands of bankers who considered themselves the world's true masters and treated politicians as poor relatives -- limited, weak-spirited, uncool and a barrier on the obstacle course to the big money. Those days are gone, say both politicians. The bankers are finished. Rumor has it that one of them, one of the key figures, has even called for the nationalization of Hypo Real Estate (HRE). Nationalization, of course, means politicians assuming power.
...
The man in charge of Germany's purse strings, normally so eager to convey the impression of cool rationality, has been waffling of late. In a speech on the budget four weeks ago, Steinbrück praised the resilience of the German economy. "There is no reason to be painting scenarios of doom," he said, adding that the problem stems in large part from America. One week later, in his government statement on the crisis in the financial markets, the finance minister suffered a serious attack of hubris combined with schadenfreude and dogmatism. Steinbrück predicted the end of London and New York as the world's dominant financial markets.
...
"Bank bonds are no longer marketable at this time, not for any bank," said the chairman of a large German bank. At some point, every financial institution finds itself up against a wall, he adds, and sometimes this can happen within days. It took many decades, according to this executive, to develop a truly international financial system, "and now everything is collapsing in the space of four weeks," he says, shaking his head.
...
Insiders say that OMTOS was once "a highly regulated world." Before the financial crisis, banks would pick up their money once a week. As a rule, they had until 9:30 a.m. every Tuesday morning to enter into the system the amount of money they intended to borrow and the interest rate they were willing to pay for it. In those days, banks that gambled with the system by entering a rate that was too low could end up empty-handed -- an outcome far from disastrous.
Today all of that has changed. The OMTOS auctions are the lifeblood of every German bank. Almost every day, the banks use the system to acquire money at auction from the ECB. In some cases they are bidding astronomical interest rates to do so.
Their very survival is at stake, as it was last Wednesday, when the ECB was auctioning off loans worth €50 billion ($68 billion) for a six-month term. Because the banks must keep an especially large amount of liquidity available over the Christmas holidays, a panic apparently set in on that day's auction. The 181 banks bidding for the loan, anxious to secure liquidity until next year, submitted bids totally €114 billion ($154 billion). Some bankers offered to pay rates of more than 6.1 percent to avoid going home empty-handed. This is more than two percentage points higher than the official prime rate -- signaling a total state of emergency.
For months, banks have been hording the money they borrow because their competitors are no longer lending to them, out of the fear that their borrowers could become bankrupt. "The global interbank market is virtually closed," says Michael Hartnett, a strategist with Merrill Lynch, the investment bank that Bank of America recently acquired.
...
The credit industry, along with its aloof executive elite, will also have to pay a price for government intervention. The government will do what it can to reduce the excesses that have become a hallmark of the banking sector, particularly when it comes to risk and astronomical salaries. "That is the price we must pay," said one of the bankers, with uncharacteristic tolerance.
A similar situation occurred in the summer of 1931, when some of Germany's major banks became acutely strapped for funds. The government of the German Reich acquired share packages from the banks in return for injections of fresh capital. In the end, the government owned 30 percent of Deutsche Bank and 70 percent of Commerz- und Privatbank. In the case of Dresdner Bank, which had merged with Danat Bank, the government acquired fully 91 percent of shares. The government had virtually socialized all major German consumer banks, at least for a few years. By 1936, the banks were sufficiently solvent once again to be able to buy back the shares from the government.
The government had to pay close to one billion reichsmarks to clean up the banks' balance sheets: about 150 million to acquire bank stock, 250 million for cash and 400 million in loans. The amount was less than 2 percent of the 1931 national income of 57.5 billion reichsmarks. In other words, the government's stake was manageable.
The upshot of the 1931 bailout program was that two large consumer banks collapsed and almost all executives lost their jobs. But the measure ensured that a meltdown was avoided, and citizens slowly regained confidence, at least in the financial system, though not in the political system. "None of the depositors in the major Berlin banks lost a single reichsmark," says Isabel Schnabel, an economic and expert on financial crises at the University of Mainz."</blockquote>
THE BLACK AUTUMN
In Search of the Visible Hand
By SPIEGEL Staff (Beat Balzli, Jan Fleischhauer, Frank Hornig, Alexander Jung, Armin Mahler, Christoph Pauly, Christian Reiermann, Wolfgang Reuter and Michael Sauga.)
10/13/2008
Source (Mish: Brave New World To "Preserve" Free Markets)
There is an air of desparation in European capitals and in the United States as politicians try to stop the global financial meltdown. The crisis has grown into a major test for the government of Angela Merkel. On Monday, Berlin signed off on a major bailout package.
It was only a short note posted on the bank's doors, but everyone knew what it meant: "All payment transactions are suspended until further notice."
It was the morning of July 13, 1931, a Monday, and long lines immediately began forming in front of the branches of Darmstädter und Nationalbank (or Danat Bank). Nobody had ever expected this to happen: Germany's second-largest bank was insolvent. The news spread like wildfire, triggering widespread panic.
Soon customers were storming Berlin's other banks -- Deutsche Bank, Commerzbank, Dresdner Bank and savings banks -- to retrieve their savings. By noon, the banks were no longer able to withstand the swelling masses and branch managers ordered the doors locked. More police officers were sent into the streets to "immediately stifle any attempts to take advantage of the current situation by inciting the masses."
By evening, the entire financial system of the German Reich had ground to a halt. Germany was experiencing its Black Monday, part of the most turbulent days in its economic history.
Long lines of nervous customers waiting to withdraw their savings -- the images of 1931 have been burned into Germany's collective memory. They have become symbolic for the world economic crisis that began in 1929, plunged millions of people into unemployment and poverty and eventually led to the Nazis' rise to power in 1933.
Indeed, these images were what prompted German Chancellor Angela Merkel and a visibly distressed Finance Minister Peer Steinbrück to step in front of the cameras on the Sunday before last in the atrium of the Chancellery in Berlin. But their statement, reassuring citizens that the government would back their savings, was so poorly worded that the German government press office was forced to issue a subsequent statement to clarify what the chancellor had said.
After this memorable appearance, anyone who had still seriously questioned the gravity of the situation was quickly disabused of such notions. Although there were no long lines at bank counters the next day, Merkel's €1 trillion ($1.35 trillion) bailout promise failed to improve the situation. Armored car companies had to add extra shifts to keep the cash machines filled, €500 ($675) bills have never been in this much demand and anyone interested in buying gold bullion or coins can expect to wait up to three weeks for delivery.
Only 29 percent of Germans believe that Merkel would be able to live up to her promise if push were to come to shove, while 66 percent believe she would not. Only 28 percent are confident in the German government's handling of the crisis, while 53 percent say that it worries them.
At this point, who can stop the crisis? Can it even be stopped?
Its destructive force is growing from one week to the next, as governments are forced to prop up banks on the verge of collapse. The entire country of Iceland could face bankruptcy.
Instead of billions or even hundreds of billions, the losses stemming from the financial crisis could now number in the trillions. Mountains of public debt could limit the ability of governments to act for years, if not decades. In the United States, an additional digit had to be added to the national debt meter in New York so that it could display a number in the double-digit trillions.
Nevertheless, the panic had been limited to those individuals acting behind the scenes, the bankers and politicians who were becoming increasingly aware of the true scope of the disaster. At least until last week, when panic reached the stock markets.
Stock prices plunged worldwide. The week began with a Black Monday, and conditions hardly improved in the following days. Never had so much market capital been wiped out in the US, Germany and Japan in such a short amount of time -- more than $3 trillion (€2.22 trillion) within a few days.
Congressional approval for the $700 billion (€520 billion) bailout plan for US banks didn't help. Neither did the European Union announcement of its own guarantee to ensure the survival of major banks, nor did the concerted interest rate reduction made by leading central banks, including the American Federal Reserve Bank and the European Central Bank (ECB).
Market players seem to have lost confidence in the ability of politicians and bankers to solve the fundamental problems on the financial markets. Moreover, they have apparently realized that the financial crisis will affect the real economy far more seriously than was previously thought possible.
At the end of this turbulent week, the banks' problems, which Merkel had sought to alleviate with her government guarantee, had grown instead of shrunk. The chancellor was faced, once again, with the same question that had been hotly discussed on the previous weekend and, at first, answered in the negative: Will the state have to nationalize the banks, at least in part? Will it have to guarantee all deposits and not just those of private citizens, as Merkel had promised?
After prolonged hesitation, Merkel and Steinbrück have now answered that same question in the affirmative. A major European bailout plan has been unveiled, a coordinated concept to rescue the banks and secure the credit supply. It is intended to leave room for national variations, but it will also include a measure that the Germans had fiercely opposed for days: the partial nationalization of private banks.
European governments intend to implement the plan quickly. The heads of government in the euro zone, the 15 countries where Europe's common currency is used, hammered out the details at a summit meeting in Paris on Sunday. On Monday, the German government introduced the plan and the necessary legislation will be pushed through in fast forward this week. Within a week, the two houses of the German parliament -- the Bundestag and the Bundesrat -- and the president are to approve a rescue plan that is substantially larger than previous bailout attempts. The cabinet in Berlin established a bailout fund worth a total of some €500 billion ($680 billion), Merkel announced on Monday.
The program, if ultimately approved, would resemble in some respects the measures taken by the government of Chancellor Heinrich Brüning in 1931. But the similarities don't end there. Then, as now, it all began with a speculative bubble. In the 1920s, investors gambled with debt-financed stocks, and in the 2000s it was credit derivatives. Then, as now, politicians initially underestimated the extent of the crisis, and their reactions came too late and lacked coordination. In both cases, there were bankers whose actions were excessively risky and who exerted far too much control, then covered up the entire disaster and eventually proved incapable of taking concerted action to solve the problem.
An era came to an end in 2008. It was the age of unbridled capitalism, which, stemming from the United States and driven by uninhibited financial markets, fundamentally changed the global economy. It was an era that considered debt healthy and pronounced all risks manageable, and now threatens to choke on those same debts and risks -- and drag the world economy down with it.
The crisis is eating into the foundation of the financial system with terrifying speed, jeopardizing the real economy's money supply in the process. German investors are pulling out of their money market funds, because they are not covered by Merkel's guarantee. But these funds invest in corporate bonds, thereby supplying capital to German corporations.
Now that the market threatens to collapse, even those who for years preached that the market would regulate itself are now calling for government intervention. But their appeals are coming from behind closed doors, because hardly a corporate executive or banker is willing to comment publicly these days. The country's economic elite has gone into hiding.
With the economy no longer capable of helping itself, the state can do nothing but intervene. Governments are now needed more than ever, acting individually or, preferably, in unison. They must overcome the most fundamental of all crises, because it has infected the entire financial system within the global economy.
For Angela Merkel, the crisis is also a golden opportunity to demonstrate leadership, decisiveness and drive. But such a crisis is also a trial by fire for a chancellor, a time when she is the center of attention and is given the chance to prove herself.
Such a time came on Tuesday of last week. Merkel is standing at the podium in the Reichstag building, where the German Bundestag meets, to deliver a hastily scheduled statement from her administration. She begins to speak. She talks about trust and the need to regain it, and yet she is unable to find convincing words and memorable phrases.
Once again, Germany is left without inspiring rhetoric, even as it faces its most severe economic crisis since the end of World War II. Merkel is apparently unwilling and unable to deliver those words. Instead, Germans are left largely on their own in their search for direction in this time of need.
And what of politics at large? What is the mood in Berlin's government offices? The mood, as it happens, is split between depression and hope. There are worries, even fears, that things could get much worse, even leading to a major crash. No one knows where the bottom is, the absolute lowest point where this crisis could land. At least a bottom, wherever it may be, would constitute a terminal point, a place where rebuilding could begin. But there is still no bottom in sight. The markets could easily continue to fall.
This does not mean that deep depression is the order of the day in Berlin. Whenever one world falls apart, a new one rises up to take its place, and some, including the two parliamentary leaders of the parties that make up Berlin's Grand Coalition, Volker Kauder of the Christian Democrats (CDU) and Peter Struck of the Social Democrats (SPD), see this new world as an opportunity for a renaissance in German politics.
Both Kauder and Struck have clearly suffered in recent years, suffered at the hands of bankers who considered themselves the world's true masters and treated politicians as poor relatives -- limited, weak-spirited, uncool and a barrier on the obstacle course to the big money. Those days are gone, say both politicians. The bankers are finished. Rumor has it that one of them, one of the key figures, has even called for the nationalization of Hypo Real Estate (HRE). Nationalization, of course, means politicians assuming power.
In the great maelstrom of globalization, politicians seemed powerless and at the mercy of others. Today they are the last leaders left standing.
Kauder and Struck can also feel vindicated by the fact that Anglo-Saxon capitalism was seen as a model for the rest of the world until recently, because it promised more wealth to the industrious. But it was the recklessness, the sheer savageness of this model that caused the crisis. Now German politicians can hope to shed their dull and tedious reputation worldwide, because what they have at home is the alternative to Anglo-Saxon turbo-capitalism, even as neglected as it has been: the social market economy, guided by the principles of consideration, scruples and compromise.
But this renaissance of German politics will only transpire if the political elite can regain public confidence. And although the rhetoric coming from the German government so far has failed in this respect, the mudslinging and bickering has at least disappeared for a few days.
Indeed, Merkel and Finance Minister Steinbrück are united as never before these days. Merkel says she relies on Steinbrück's expert financial sector knowledge, while Steinbrück has repeatedly praised her crisis management. He says he needs her to handle the "big guys," the talks with French President Nicolas Sarkozy and US President George W. Bush.
Merkel and Steinbrück are not the only ones getting along so well these days. An unprecedented sense of unity prevailed in a meeting last Sunday of the Coalition Committee, a group of top politicians from both parties in the governing coalition. Contentious issues were resolved in no time. SPD parliamentary leader Struck said that, given the situation, politicians could not afford to become caught up in the details, and that everyone felt that the government, with its broad power base from Germany's two biggest political parties, is the right alliance for a major crisis.
But by the next day, Monday of last week, Germany's politicians were at it again, unable to agree on reforming the country's inheritance tax, a disagreement that continued through Thursday. And the question of whether the German military should be deployed domestically was also up for discussion.
The great danger, now, is that politicians will look for ways to profit from the crisis. Some have already made the first steps in this direction. "The crisis in the financial markets marks the end of the dance around the Golden Calf of the neoliberalism of Friedrich Merz and his CDU/CSU and the FDP of Guido Westerwelle," Environment Minister Sigmar Gabriel told Financial Times Deutschland. Gabriel said that his advice to his own party, the SPD, was to turn the crisis into a campaign issue. Merkel and Steinbrück were horrified when they read the news on their mobile phones.
These politicians do have one foe in common. His name is Oskar Lafontaine, leader of the far-left Left Party, and he now hopes to transform widespread dissatisfaction and fear into votes. The best antidote to Lafontaine's effort would be smart crisis management.
But the German government's crisis management has been under a dark cloud from the very beginning. It is characterized by hesitation, miscalculation and abrupt changes of direction. Since the failure of US investment bank Lehman Brothers, it has seemed that the roles of Chancellor Merkel and Finance Minister Steinbrück in addressing the crisis have been more passive than active.
The man in charge of Germany's purse strings, normally so eager to convey the impression of cool rationality, has been waffling of late. In a speech on the budget four weeks ago, Steinbrück praised the resilience of the German economy. "There is no reason to be painting scenarios of doom," he said, adding that the problem stems in large part from America. One week later, in his government statement on the crisis in the financial markets, the finance minister suffered a serious attack of hubris combined with schadenfreude and dogmatism. Steinbrück predicted the end of London and New York as the world's dominant financial markets.
The crisis reached Germany a short time later. The second-largest German mortgage financier, Hypo Real Estate (HRE), had made mistakes. At HRE, the disaster began earlier than had been disclosed until then. At the beginning of the year, DEPFA Bank, an Irish subsidiary of HRE, had been given the opportunity to secure their refinancing for at least two years. But the bankers in Dublin were unwilling to pay the price.
The German parent company eventually imposed a limit on new business on its Irish subsidiary, but the managers in Ireland ignored the directive. By early summer, it was clear to executives that the outcome would be dire.
Representatives of the banking industry, bank regulators and the German central bank, the Bundesbank, met to discuss bailout options. Steinbrück forbade his deputy, Jörg Asmussen, from attending the meeting, fearing that the government could end up paying dearly if the Finance Ministry became involved too soon.
In the end, Asmussen did attend the meeting, at the insistence of the Bundesbank and BaFin, the German banking industry regulator. A guarantee, half-government and half-private, was quickly put together for HRE. But it became clear within a few days that this would not be sufficient. BaFin, which is part of Steinbrück's Finance Ministry, had been unable to provide solid figures on the financial situation.
A new bailout program became necessary by the weekend before last. While it was underway, Merkel and Steinbrück announced that the government would guarantee savings deposits. Only a day earlier, at a special EU summit in Paris, the chancellor had severely criticized a similar measure proposed by the Irish government.
The next day, an exhausted Steinbrück stumbled into his next embarrassing moment during a radio interview. Bailout programs based on the HRE model would no longer be possible in the future, he said. Insisting that "singular solutions" are not the solution, he announced that he had a Plan B. Steinbrück's spokesman qualified his statements on the very same day, and on the next day, a Tuesday, the minister admitted sheepishly to the SPD's parliamentary group: "There is no Plan B."
There are also no signs of the rest of Europe taking anything resembling a clear, coordinated approach. On the contrary, the mood is one of hopeless confusion -- and relentless competition.
The reasoning behind the often uncoordinated, individual measures is simple: He who bails out the quickest wins the most.
The Irish, for example, after dramatic losses on the Dublin Stock Exchange on Monday, Sept. 22, when the ISEQ Index fell 13 percent, put together a comprehensive bailout package. The island nation guaranteed the deposits of citizens, businesses and financial institutions. The government guarantees amounts to €400 billion ($540 billion), which is twice the country's gross domestic product. But the protective shield, which expires in two years, is restricted to Irish banks.
The German government's guarantee applies to deposits of Germans and foreigners, which prompted heavy criticism from Austrian Chancellor Alfred Gusenbauer, who fears the measure could encourage Germans using his country as a tax haven to retrieve their deposits. It could become lucrative, for the first time, for Austrians to open accounts in Germany, and invest their money with the Germans. In response, Gusenbauer promptly announced a plan to increase the amount of Austria's deposit insurance limit from the current level of €20,000 ($27,000). Austria now fully guarantees private deposits.
Other governments also saw themselves forced to take action. Greece decided to raise its deposit insurance limit to €100,000 ($135,000), and Spain plans to take a similar step. Sweden has already doubled its limit to €51,000 ($69,000). Great Britain initially raised the government guarantee for savings deposits from £35,000 ($60,000) to £50,000 ($85,000). Despite the measure, some of the major British banks lost half of their market value in recent days, prompting Chancellor of the Exchequer Alistair Darling to add new measures last Wednesday.
Darling announced that the Bank of England has provided £200 billion ($340 billion) in loans for the country's financial sector, as well as equity capital injections of up to £50 billion ($85 billion) for some of the country's largest financial institutions. In return, the government will receive shares in these banks. In a third step, the British government will provide a guarantee for new loans to banks worth up to £250 billion ($425 billion).
On Thursday of last week, Italy introduced a similar plan of action. In Denmark, banks and the government agreed to pay, over the course of the next two years, almost €5 billion ($6.75 billion) into a fund intended to protect ailing banks from collapse.
The financial crisis threatened to throw the European Union back into a political situation characterized by territorialism and infighting. The Europeans have long addressed the global crisis with the tools of the nation-state. Initially, at least, they were unable to agree to a coordinated approach, and all efforts to do so failed.
The Europeans' more recent efforts to address the crisis jointly came to an inglorious head three weeks ago. It began when a supposedly French plan for a general European bailout package became known. France, which currently holds the rotating EU Council presidency, wanted to collect €300 billion ($405 billion) from the member states to save the banks, a move that would have resembled the Americans' $700 billion (€518 billion) bailout package.
But the French concept was quickly met with a wave of indignation. Steinbrück's office noted that "the German government is completely opposed to this plan."
Germany's share of the proposed rescue fund would have amounted to €75 billion ($101 billion), or more than 3 percent of German GDP. The plan included no mechanisms to monitor the use of this enormous sum, an omission that triggered Steinbrück's disapproval. Besides, his experts feared that a European fund would be too unwieldy in an emergency.
But French President Nicolas Sarkozy and Finance Minister Christine Lagarde also bear a share of the blame for the failure of their plan. They were too quick to unveil the project and its questionable financing. After encountering opposition in Berlin, the idea didn't stand a chance of convincing the ECOFIN Council, the finance and economics ministers of the 27 EU member states, in Luxembourg.
Now the European governments want to give the joint approach one more try. Faced with a continuing decline on the stock markets and a dismal situation in the interbank money market, they realized that their disorderly pettiness was more than just unproductive. It was becoming increasingly clear that continuing along the same path would only exacerbate the crisis.
French President Nicolas Sarkozy, who currently holds the rotating presidency of the EU Council, invited the heads of state and government of the euro zone nations to attend yet another meeting to discuss the crisis on Sunday evening. It was time, Sarkozy argued, that the common currency zone adopt a uniform approach. The goal was to put together a joint bailout package for the euro zone.
The bundle of measures that the British government had introduced a few days earlier, which included the injection of government capital into the banks, served as a model for the group of 15 leading politicians meeting in Paris. Another issue up for debate was whether governments should continue to provide guarantees for ailing financial institutions, as well as additional liquidity injections. Each country, the 15 leaders agreed, would proceed with its own measures, but all measures would be coordinated within the euro zone.
All of these actions serve a single, overriding purpose: to dispel fear. Fear has replaced greed, which dominated the financial sector worldwide until only a few months ago, as the prevailing sentiment. Without renewed mutual confidence among banks, analysts in the European capitals concluded, a new creditworthiness within the banking industry could not develop.
European Central Bank President Jean-Claude Trichet and Bundesbank President Axel Weber have long called for a government capital injection for the German banking sector. The central bankers have argued that a strong signal from the government was needed to end the crisis. If market participants no longer felt confident in each other, they added, the state, as the only remaining institution capable of taking action, would have to intervene.
Of course, such large-scale government intervention into the economy is difficult to justify -- in normal times, that is. But those days are now long gone. If no one trusts anyone else, it is up to the government to create confidence. The government, after all, has an immeasurable advantage over all other players: its virtually unlimited resources.
In such a far-reaching economic crisis, just as in times of war or natural disasters, the government is not obliged to keep track of every euro it spends. This is a disadvantage during normal times, because it tempts governments to incur debt. But it is the only way out in times of crisis.
This explains why even the most ardent supporters of the market economy rarely object to government intervention during emergency situations. A market that no longer exists is incapable of solving problems, and governments must step in. This pragmatism is in part a lesson learned from the world economic crisis of the early 1930s. At that time, the banks collapsed first, because no one stepped in, followed by businesses, because they were no longer able to borrow money. The ultimate consequence was an army of the unemployed numbering in the millions.
This time around, the worst-cast scenario is to be avoided. The state must step in, and it makes perfect sense for it to ask for shares in the banks in return. Why should it give away the money? The public is not responsible for the financial institutions' problems, and thus it can expect to receive something in return for bailing them out. Sometimes such assistance can even pay off. In the early 1990s, the Swedish government reorganized the country's banking sector by assuming debt, issuing guarantees and acquiring stakes in banks. Once the crisis was overcome, the government sold its shares at a profit.
That outcome is still a long way off for Europe. For the time being, European lawmakers face a host of questions: Who decides which banks are saved and which ones are allowed to go under? How much will the bailout programs cost? How do governments ensure that their bailouts do not completely distort competition in the lending industry?
The scope of the problem reminds many an expert at Berlin's Finance Ministry of the questions that arose during the collapse of the former East Germany and the ensuing process of German reunification. "It is quite possible," says one of them, "that we will need an organization like the Banken-Treuhand (German Bank Trust) to process and manage the new government shareholdings."
It is a radical plan with considerable risks. For instance, it is already clear that it will cost the German government a sum numbering in the double-digit billions, and that it will foil Steinbrück's long-held aim of balancing the German budget by 2011.
It is hardly surprising that the German government ended up using the British example as a model. If Merkel and Steinbrück had stuck to their guns, they would have placed the domestic banking industry in an untenable situation. In recent days, German capital has already begun migrating to the more generously secured banks in Ireland and Great Britain.
Banks were threatening to run out of cash. And as desperation grew at the headquarters of major banks in Frankfurt, so did resentment against Merkel and Steinbrück.
"Bank bonds are no longer marketable at this time, not for any bank," said the chairman of a large German bank. At some point, every financial institution finds itself up against a wall, he adds, and sometimes this can happen within days. It took many decades, according to this executive, to develop a truly international financial system, "and now everything is collapsing in the space of four weeks," he says, shaking his head.
The only sources of fresh funds are the central banks, and private banks are now surrounding them like thirsty animals around a watering hole. In return for collateral, the banks can obtain currency -- euros, dollars, Swiss francs -- from their respective central banks.
To keep the economy supplied with capital, the central banks have loosened their interpretation of the concept of collateral. Since last week the US Federal Reserve Bank has been accepting as collateral short-term bonds, known as commercial paper, a form of security that the banks, when dealing with each other, would not touch.
But central banks like the ECB are not simply pumping liquidity into the banks' vaults free of charge. Instead, banks can obtain liquidity in the form of loans through an auctioning system known as OMTOS. Operated in Germany by the Bundesbank, the system can be likened to an eBay for fresh money.
Insiders say that OMTOS was once "a highly regulated world." Before the financial crisis, banks would pick up their money once a week. As a rule, they had until 9:30 a.m. every Tuesday morning to enter into the system the amount of money they intended to borrow and the interest rate they were willing to pay for it. In those days, banks that gambled with the system by entering a rate that was too low could end up empty-handed -- an outcome far from disastrous.
Today all of that has changed. The OMTOS auctions are the lifeblood of every German bank. Almost every day, the banks use the system to acquire money at auction from the ECB. In some cases they are bidding astronomical interest rates to do so.
Their very survival is at stake, as it was last Wednesday, when the ECB was auctioning off loans worth €50 billion ($68 billion) for a six-month term. Because the banks must keep an especially large amount of liquidity available over the Christmas holidays, a panic apparently set in on that day's auction. The 181 banks bidding for the loan, anxious to secure liquidity until next year, submitted bids totally €114 billion ($154 billion). Some bankers offered to pay rates of more than 6.1 percent to avoid going home empty-handed. This is more than two percentage points higher than the official prime rate -- signaling a total state of emergency.
For months, banks have been hording the money they borrow because their competitors are no longer lending to them, out of the fear that their borrowers could become bankrupt. "The global interbank market is virtually closed," says Michael Hartnett, a strategist with Merrill Lynch, the investment bank that Bank of America recently acquired.
In fact, the crisis of confidence among banks has only worsened, making it more difficult for banks to refinance themselves. In normal times, banks have an easier time of obtaining cash when their customers' deposit are insufficient -- through overnight loans from competitors, short-term loans and central bank funds.
But nothing is normal anymore today, especially now that many savers are taking the money out of their accounts and depositing it with the state-owned savings banks, under the assumption that their money is safer there. In recent weeks, Hamburger Sparkasse received €500 million ($675 million) in new customer deposits. It is abnormal to see so many citizens hording cash. Safe deposit boxes have become a hot commodity. Securlog, the market leader in the German money transport business, has been completing "special orders on a regular basis" in the past few days, says Georg Kierdorf, the head of the company. Kierdorf also notes that automatic teller machines have had to be filled with cash significantly more frequently. Machines in downtown areas, in particular, are registering higher turnover.
But an even greater problem for banks is the flight out of money market funds. In late August, these funds contained total assets worth more than €100 billion ($135 billion). They were praised as a way of securing decent yields and safely investing funds for the short term, and many also invested heavily in bank bonds. Now many funds are losing value. The Gerling Money Saving Fund, for example, lost 8 percent of its value within one month.
Investors are already reacting. In early October, €700 million ($945 million) was apparently withdrawn from Union Investment's Uni Opti 4 fund. The cooperative central banks DZ and WGZ helped by providing a €1 billion ($1.35 billion) credit line, so that the outflow of funds could be processed in an orderly fashion.
Yields are likely to continue to decline, because fund managers, know that their liquidity has been depleted, are forced to sell the money market funds' investments at low prices. In the wake of this sell-off, other major investors will have to sell bank bonds, because their prices are plunging.
By promising that savings deposits are safe, Chancellor Merkel only increased the pressure on the system, because money market funds are not provided with a government guarantee. "They're behaving erratically," says a banker, referring to the fund companies. Billions of euros have already migrated from the funds into safe savings deposits. In the United States, it was an exodus from the money market funds that forced the government in Washington to devise its $700 billion bailout plan. Within a few days, for example, so much money was withdrawn from the Putnam Prime Money Market Fund, with total assets of $12.3 billion, that fund management decided to liquidate the entire fund.
It is no surprise, then, that banking executives last week became increasingly insistent on the development of a large-scale solution. When asked at the end of last week how much the bailout would cost, one of them responded: "Don't be too modest," adding that it is too late for modesty. The €400 billion ($540 billion) the Irish and the £500 billion ($850 billion) the British are prepared to spend to save their banks are a good benchmark, the banking executive said.
Now the bankers have apparently prevailed. With its bailout package, the government in Berlin hopes to return to the bankers what they have lost in recent weeks: trust, liquidity and equity.
The credit industry, along with its aloof executive elite, will also have to pay a price for government intervention. The government will do what it can to reduce the excesses that have become a hallmark of the banking sector, particularly when it comes to risk and astronomical salaries. "That is the price we must pay," said one of the bankers, with uncharacteristic tolerance.
A similar situation occurred in the summer of 1931, when some of Germany's major banks became acutely strapped for funds. The government of the German Reich acquired share packages from the banks in return for injections of fresh capital. In the end, the government owned 30 percent of Deutsche Bank and 70 percent of Commerz- und Privatbank. In the case of Dresdner Bank, which had merged with Danat Bank, the government acquired fully 91 percent of shares. The government had virtually socialized all major German consumer banks, at least for a few years. By 1936, the banks were sufficiently solvent once again to be able to buy back the shares from the government.
The government had to pay close to one billion reichsmarks to clean up the banks' balance sheets: about 150 million to acquire bank stock, 250 million for cash and 400 million in loans. The amount was less than 2 percent of the 1931 national income of 57.5 billion reichsmarks. In other words, the government's stake was manageable.
The upshot of the 1931 bailout program was that two large consumer banks collapsed and almost all executives lost their jobs. But the measure ensured that a meltdown was avoided, and citizens slowly regained confidence, at least in the financial system, though not in the political system. "None of the depositors in the major Berlin banks lost a single reichsmark," says Isabel Schnabel, an economic and expert on financial crises at the University of Mainz.
Is history repeating itself today? Even in the United States, the home of unfettered capitalism, something that was unthinkable until very recently is up for debate: direct government participation in the ailing banks. Until now, attention in the United States was focused on the banks' toxic mortgage products. The government will buy up the junk securities, the banks will be rid of their ballast, money and credit will be flowing freely once again and the market will return to their normal mode of operations. This was the US government's optimistic scenario until not too long ago.
But since the end of last week, it has been clear that this approach isn't enough. US Treasury Secretary Henry Paulson now wants to inject capital directly into the banks, thereby strengthening their balance sheets. This, according to Paulson, is the only way to reestablish trust in the capital markets. Banks that participate in the program would be required to surrender shares to the government in return.
The partial nationalization of the next financial institutions is expected to take place by the end of October. "We will take decisive action and use all available tools," says Paulson, adding that this would include "direct strengthening of the banks' capital base."
For some time, investors like George Soros, and leading US economists, have been calling for the United States to follow the example set during the Swedish banking crisis and partially nationalize the American banking system. But this was difficult to reconcile with the market ideology of President George W. Bush and his fellow Republicans.
For two weeks, members of the US Congress waged a bitter debate over whether buying out Wall Street is morally justifiable. When they eventually approved the $700 billion (€945 billion) bailout package, known as the Emergency Economic Stabilization Act, only very few of the politicians realized that the law would now give Paulson the authority to acquire direct stakes in the banks.
Economists consider the step, based on the British model, to be the better solution.
"But the equity issue was critical," writes Princeton economist -- and 2008 winner of the Nobel prize for economics -- Paul Krugman, "and may now be the thing that turns a useless plan into something that really does a lot of good." "This is the only solution that can prevent a meltdown of the financial system," says Nouriel Roubini of New York University.
What an end to Anglo-American financial capitalism that would be. It would mark the beginning of a new economic age, an age characterized by more government and less market, and less growth, but also fewer risks.
A similar system was put into place after the world economic and banking crisis of the last century. It lasted until the lessons from the crisis had been forgotten. And until profit seeking had replaced caution once again.
BY BEAT BALZLI, JAN FLEISCHHAUER, FRANK HORNIG, ALEXANDER JUNG, ARMIN MAHLER, CHRISTOPH PAULY, CHRISTIAN REIERMANN, WOLFGANG REUTER AND MICHAEL SAUGA
Translated from the German by Christopher Sultan
...
Instead of billions or even hundreds of billions, the losses stemming from the financial crisis could now number in the trillions. Mountains of public debt could limit the ability of governments to act for years, if not decades. In the United States, an additional digit had to be added to the national debt meter in New York so that it could display a number in the double-digit trillions.
...
The program, if ultimately approved, would resemble in some respects the measures taken by the government of Chancellor Heinrich Brüning in 1931. But the similarities don't end there. Then, as now, it all began with a speculative bubble. In the 1920s, investors gambled with debt-financed stocks, and in the 2000s it was credit derivatives. Then, as now, politicians initially underestimated the extent of the crisis, and their reactions came too late and lacked coordination. In both cases, there were bankers whose actions were excessively risky and who exerted far too much control, then covered up the entire disaster and eventually proved incapable of taking concerted action to solve the problem.
An era came to an end in 2008. It was the age of unbridled capitalism, which, stemming from the United States and driven by uninhibited financial markets, fundamentally changed the global economy. It was an era that considered debt healthy and pronounced all risks manageable, and now threatens to choke on those same debts and risks -- and drag the world economy down with it.
...
Both Kauder and Struck have clearly suffered in recent years, suffered at the hands of bankers who considered themselves the world's true masters and treated politicians as poor relatives -- limited, weak-spirited, uncool and a barrier on the obstacle course to the big money. Those days are gone, say both politicians. The bankers are finished. Rumor has it that one of them, one of the key figures, has even called for the nationalization of Hypo Real Estate (HRE). Nationalization, of course, means politicians assuming power.
...
The man in charge of Germany's purse strings, normally so eager to convey the impression of cool rationality, has been waffling of late. In a speech on the budget four weeks ago, Steinbrück praised the resilience of the German economy. "There is no reason to be painting scenarios of doom," he said, adding that the problem stems in large part from America. One week later, in his government statement on the crisis in the financial markets, the finance minister suffered a serious attack of hubris combined with schadenfreude and dogmatism. Steinbrück predicted the end of London and New York as the world's dominant financial markets.
...
"Bank bonds are no longer marketable at this time, not for any bank," said the chairman of a large German bank. At some point, every financial institution finds itself up against a wall, he adds, and sometimes this can happen within days. It took many decades, according to this executive, to develop a truly international financial system, "and now everything is collapsing in the space of four weeks," he says, shaking his head.
...
Insiders say that OMTOS was once "a highly regulated world." Before the financial crisis, banks would pick up their money once a week. As a rule, they had until 9:30 a.m. every Tuesday morning to enter into the system the amount of money they intended to borrow and the interest rate they were willing to pay for it. In those days, banks that gambled with the system by entering a rate that was too low could end up empty-handed -- an outcome far from disastrous.
Today all of that has changed. The OMTOS auctions are the lifeblood of every German bank. Almost every day, the banks use the system to acquire money at auction from the ECB. In some cases they are bidding astronomical interest rates to do so.
Their very survival is at stake, as it was last Wednesday, when the ECB was auctioning off loans worth €50 billion ($68 billion) for a six-month term. Because the banks must keep an especially large amount of liquidity available over the Christmas holidays, a panic apparently set in on that day's auction. The 181 banks bidding for the loan, anxious to secure liquidity until next year, submitted bids totally €114 billion ($154 billion). Some bankers offered to pay rates of more than 6.1 percent to avoid going home empty-handed. This is more than two percentage points higher than the official prime rate -- signaling a total state of emergency.
For months, banks have been hording the money they borrow because their competitors are no longer lending to them, out of the fear that their borrowers could become bankrupt. "The global interbank market is virtually closed," says Michael Hartnett, a strategist with Merrill Lynch, the investment bank that Bank of America recently acquired.
...
The credit industry, along with its aloof executive elite, will also have to pay a price for government intervention. The government will do what it can to reduce the excesses that have become a hallmark of the banking sector, particularly when it comes to risk and astronomical salaries. "That is the price we must pay," said one of the bankers, with uncharacteristic tolerance.
A similar situation occurred in the summer of 1931, when some of Germany's major banks became acutely strapped for funds. The government of the German Reich acquired share packages from the banks in return for injections of fresh capital. In the end, the government owned 30 percent of Deutsche Bank and 70 percent of Commerz- und Privatbank. In the case of Dresdner Bank, which had merged with Danat Bank, the government acquired fully 91 percent of shares. The government had virtually socialized all major German consumer banks, at least for a few years. By 1936, the banks were sufficiently solvent once again to be able to buy back the shares from the government.
The government had to pay close to one billion reichsmarks to clean up the banks' balance sheets: about 150 million to acquire bank stock, 250 million for cash and 400 million in loans. The amount was less than 2 percent of the 1931 national income of 57.5 billion reichsmarks. In other words, the government's stake was manageable.
The upshot of the 1931 bailout program was that two large consumer banks collapsed and almost all executives lost their jobs. But the measure ensured that a meltdown was avoided, and citizens slowly regained confidence, at least in the financial system, though not in the political system. "None of the depositors in the major Berlin banks lost a single reichsmark," says Isabel Schnabel, an economic and expert on financial crises at the University of Mainz."</blockquote>
THE BLACK AUTUMN
In Search of the Visible Hand
By SPIEGEL Staff (Beat Balzli, Jan Fleischhauer, Frank Hornig, Alexander Jung, Armin Mahler, Christoph Pauly, Christian Reiermann, Wolfgang Reuter and Michael Sauga.)
10/13/2008
Source (Mish: Brave New World To "Preserve" Free Markets)
There is an air of desparation in European capitals and in the United States as politicians try to stop the global financial meltdown. The crisis has grown into a major test for the government of Angela Merkel. On Monday, Berlin signed off on a major bailout package.
It was only a short note posted on the bank's doors, but everyone knew what it meant: "All payment transactions are suspended until further notice."
It was the morning of July 13, 1931, a Monday, and long lines immediately began forming in front of the branches of Darmstädter und Nationalbank (or Danat Bank). Nobody had ever expected this to happen: Germany's second-largest bank was insolvent. The news spread like wildfire, triggering widespread panic.
Soon customers were storming Berlin's other banks -- Deutsche Bank, Commerzbank, Dresdner Bank and savings banks -- to retrieve their savings. By noon, the banks were no longer able to withstand the swelling masses and branch managers ordered the doors locked. More police officers were sent into the streets to "immediately stifle any attempts to take advantage of the current situation by inciting the masses."
By evening, the entire financial system of the German Reich had ground to a halt. Germany was experiencing its Black Monday, part of the most turbulent days in its economic history.
Long lines of nervous customers waiting to withdraw their savings -- the images of 1931 have been burned into Germany's collective memory. They have become symbolic for the world economic crisis that began in 1929, plunged millions of people into unemployment and poverty and eventually led to the Nazis' rise to power in 1933.
Indeed, these images were what prompted German Chancellor Angela Merkel and a visibly distressed Finance Minister Peer Steinbrück to step in front of the cameras on the Sunday before last in the atrium of the Chancellery in Berlin. But their statement, reassuring citizens that the government would back their savings, was so poorly worded that the German government press office was forced to issue a subsequent statement to clarify what the chancellor had said.
After this memorable appearance, anyone who had still seriously questioned the gravity of the situation was quickly disabused of such notions. Although there were no long lines at bank counters the next day, Merkel's €1 trillion ($1.35 trillion) bailout promise failed to improve the situation. Armored car companies had to add extra shifts to keep the cash machines filled, €500 ($675) bills have never been in this much demand and anyone interested in buying gold bullion or coins can expect to wait up to three weeks for delivery.
Only 29 percent of Germans believe that Merkel would be able to live up to her promise if push were to come to shove, while 66 percent believe she would not. Only 28 percent are confident in the German government's handling of the crisis, while 53 percent say that it worries them.
At this point, who can stop the crisis? Can it even be stopped?
Its destructive force is growing from one week to the next, as governments are forced to prop up banks on the verge of collapse. The entire country of Iceland could face bankruptcy.
Instead of billions or even hundreds of billions, the losses stemming from the financial crisis could now number in the trillions. Mountains of public debt could limit the ability of governments to act for years, if not decades. In the United States, an additional digit had to be added to the national debt meter in New York so that it could display a number in the double-digit trillions.
Nevertheless, the panic had been limited to those individuals acting behind the scenes, the bankers and politicians who were becoming increasingly aware of the true scope of the disaster. At least until last week, when panic reached the stock markets.
Stock prices plunged worldwide. The week began with a Black Monday, and conditions hardly improved in the following days. Never had so much market capital been wiped out in the US, Germany and Japan in such a short amount of time -- more than $3 trillion (€2.22 trillion) within a few days.
Congressional approval for the $700 billion (€520 billion) bailout plan for US banks didn't help. Neither did the European Union announcement of its own guarantee to ensure the survival of major banks, nor did the concerted interest rate reduction made by leading central banks, including the American Federal Reserve Bank and the European Central Bank (ECB).
Market players seem to have lost confidence in the ability of politicians and bankers to solve the fundamental problems on the financial markets. Moreover, they have apparently realized that the financial crisis will affect the real economy far more seriously than was previously thought possible.
At the end of this turbulent week, the banks' problems, which Merkel had sought to alleviate with her government guarantee, had grown instead of shrunk. The chancellor was faced, once again, with the same question that had been hotly discussed on the previous weekend and, at first, answered in the negative: Will the state have to nationalize the banks, at least in part? Will it have to guarantee all deposits and not just those of private citizens, as Merkel had promised?
After prolonged hesitation, Merkel and Steinbrück have now answered that same question in the affirmative. A major European bailout plan has been unveiled, a coordinated concept to rescue the banks and secure the credit supply. It is intended to leave room for national variations, but it will also include a measure that the Germans had fiercely opposed for days: the partial nationalization of private banks.
European governments intend to implement the plan quickly. The heads of government in the euro zone, the 15 countries where Europe's common currency is used, hammered out the details at a summit meeting in Paris on Sunday. On Monday, the German government introduced the plan and the necessary legislation will be pushed through in fast forward this week. Within a week, the two houses of the German parliament -- the Bundestag and the Bundesrat -- and the president are to approve a rescue plan that is substantially larger than previous bailout attempts. The cabinet in Berlin established a bailout fund worth a total of some €500 billion ($680 billion), Merkel announced on Monday.
The program, if ultimately approved, would resemble in some respects the measures taken by the government of Chancellor Heinrich Brüning in 1931. But the similarities don't end there. Then, as now, it all began with a speculative bubble. In the 1920s, investors gambled with debt-financed stocks, and in the 2000s it was credit derivatives. Then, as now, politicians initially underestimated the extent of the crisis, and their reactions came too late and lacked coordination. In both cases, there were bankers whose actions were excessively risky and who exerted far too much control, then covered up the entire disaster and eventually proved incapable of taking concerted action to solve the problem.
An era came to an end in 2008. It was the age of unbridled capitalism, which, stemming from the United States and driven by uninhibited financial markets, fundamentally changed the global economy. It was an era that considered debt healthy and pronounced all risks manageable, and now threatens to choke on those same debts and risks -- and drag the world economy down with it.
The crisis is eating into the foundation of the financial system with terrifying speed, jeopardizing the real economy's money supply in the process. German investors are pulling out of their money market funds, because they are not covered by Merkel's guarantee. But these funds invest in corporate bonds, thereby supplying capital to German corporations.
Now that the market threatens to collapse, even those who for years preached that the market would regulate itself are now calling for government intervention. But their appeals are coming from behind closed doors, because hardly a corporate executive or banker is willing to comment publicly these days. The country's economic elite has gone into hiding.
With the economy no longer capable of helping itself, the state can do nothing but intervene. Governments are now needed more than ever, acting individually or, preferably, in unison. They must overcome the most fundamental of all crises, because it has infected the entire financial system within the global economy.
For Angela Merkel, the crisis is also a golden opportunity to demonstrate leadership, decisiveness and drive. But such a crisis is also a trial by fire for a chancellor, a time when she is the center of attention and is given the chance to prove herself.
Such a time came on Tuesday of last week. Merkel is standing at the podium in the Reichstag building, where the German Bundestag meets, to deliver a hastily scheduled statement from her administration. She begins to speak. She talks about trust and the need to regain it, and yet she is unable to find convincing words and memorable phrases.
Once again, Germany is left without inspiring rhetoric, even as it faces its most severe economic crisis since the end of World War II. Merkel is apparently unwilling and unable to deliver those words. Instead, Germans are left largely on their own in their search for direction in this time of need.
And what of politics at large? What is the mood in Berlin's government offices? The mood, as it happens, is split between depression and hope. There are worries, even fears, that things could get much worse, even leading to a major crash. No one knows where the bottom is, the absolute lowest point where this crisis could land. At least a bottom, wherever it may be, would constitute a terminal point, a place where rebuilding could begin. But there is still no bottom in sight. The markets could easily continue to fall.
This does not mean that deep depression is the order of the day in Berlin. Whenever one world falls apart, a new one rises up to take its place, and some, including the two parliamentary leaders of the parties that make up Berlin's Grand Coalition, Volker Kauder of the Christian Democrats (CDU) and Peter Struck of the Social Democrats (SPD), see this new world as an opportunity for a renaissance in German politics.
Both Kauder and Struck have clearly suffered in recent years, suffered at the hands of bankers who considered themselves the world's true masters and treated politicians as poor relatives -- limited, weak-spirited, uncool and a barrier on the obstacle course to the big money. Those days are gone, say both politicians. The bankers are finished. Rumor has it that one of them, one of the key figures, has even called for the nationalization of Hypo Real Estate (HRE). Nationalization, of course, means politicians assuming power.
In the great maelstrom of globalization, politicians seemed powerless and at the mercy of others. Today they are the last leaders left standing.
Kauder and Struck can also feel vindicated by the fact that Anglo-Saxon capitalism was seen as a model for the rest of the world until recently, because it promised more wealth to the industrious. But it was the recklessness, the sheer savageness of this model that caused the crisis. Now German politicians can hope to shed their dull and tedious reputation worldwide, because what they have at home is the alternative to Anglo-Saxon turbo-capitalism, even as neglected as it has been: the social market economy, guided by the principles of consideration, scruples and compromise.
But this renaissance of German politics will only transpire if the political elite can regain public confidence. And although the rhetoric coming from the German government so far has failed in this respect, the mudslinging and bickering has at least disappeared for a few days.
Indeed, Merkel and Finance Minister Steinbrück are united as never before these days. Merkel says she relies on Steinbrück's expert financial sector knowledge, while Steinbrück has repeatedly praised her crisis management. He says he needs her to handle the "big guys," the talks with French President Nicolas Sarkozy and US President George W. Bush.
Merkel and Steinbrück are not the only ones getting along so well these days. An unprecedented sense of unity prevailed in a meeting last Sunday of the Coalition Committee, a group of top politicians from both parties in the governing coalition. Contentious issues were resolved in no time. SPD parliamentary leader Struck said that, given the situation, politicians could not afford to become caught up in the details, and that everyone felt that the government, with its broad power base from Germany's two biggest political parties, is the right alliance for a major crisis.
But by the next day, Monday of last week, Germany's politicians were at it again, unable to agree on reforming the country's inheritance tax, a disagreement that continued through Thursday. And the question of whether the German military should be deployed domestically was also up for discussion.
The great danger, now, is that politicians will look for ways to profit from the crisis. Some have already made the first steps in this direction. "The crisis in the financial markets marks the end of the dance around the Golden Calf of the neoliberalism of Friedrich Merz and his CDU/CSU and the FDP of Guido Westerwelle," Environment Minister Sigmar Gabriel told Financial Times Deutschland. Gabriel said that his advice to his own party, the SPD, was to turn the crisis into a campaign issue. Merkel and Steinbrück were horrified when they read the news on their mobile phones.
These politicians do have one foe in common. His name is Oskar Lafontaine, leader of the far-left Left Party, and he now hopes to transform widespread dissatisfaction and fear into votes. The best antidote to Lafontaine's effort would be smart crisis management.
But the German government's crisis management has been under a dark cloud from the very beginning. It is characterized by hesitation, miscalculation and abrupt changes of direction. Since the failure of US investment bank Lehman Brothers, it has seemed that the roles of Chancellor Merkel and Finance Minister Steinbrück in addressing the crisis have been more passive than active.
The man in charge of Germany's purse strings, normally so eager to convey the impression of cool rationality, has been waffling of late. In a speech on the budget four weeks ago, Steinbrück praised the resilience of the German economy. "There is no reason to be painting scenarios of doom," he said, adding that the problem stems in large part from America. One week later, in his government statement on the crisis in the financial markets, the finance minister suffered a serious attack of hubris combined with schadenfreude and dogmatism. Steinbrück predicted the end of London and New York as the world's dominant financial markets.
The crisis reached Germany a short time later. The second-largest German mortgage financier, Hypo Real Estate (HRE), had made mistakes. At HRE, the disaster began earlier than had been disclosed until then. At the beginning of the year, DEPFA Bank, an Irish subsidiary of HRE, had been given the opportunity to secure their refinancing for at least two years. But the bankers in Dublin were unwilling to pay the price.
The German parent company eventually imposed a limit on new business on its Irish subsidiary, but the managers in Ireland ignored the directive. By early summer, it was clear to executives that the outcome would be dire.
Representatives of the banking industry, bank regulators and the German central bank, the Bundesbank, met to discuss bailout options. Steinbrück forbade his deputy, Jörg Asmussen, from attending the meeting, fearing that the government could end up paying dearly if the Finance Ministry became involved too soon.
In the end, Asmussen did attend the meeting, at the insistence of the Bundesbank and BaFin, the German banking industry regulator. A guarantee, half-government and half-private, was quickly put together for HRE. But it became clear within a few days that this would not be sufficient. BaFin, which is part of Steinbrück's Finance Ministry, had been unable to provide solid figures on the financial situation.
A new bailout program became necessary by the weekend before last. While it was underway, Merkel and Steinbrück announced that the government would guarantee savings deposits. Only a day earlier, at a special EU summit in Paris, the chancellor had severely criticized a similar measure proposed by the Irish government.
The next day, an exhausted Steinbrück stumbled into his next embarrassing moment during a radio interview. Bailout programs based on the HRE model would no longer be possible in the future, he said. Insisting that "singular solutions" are not the solution, he announced that he had a Plan B. Steinbrück's spokesman qualified his statements on the very same day, and on the next day, a Tuesday, the minister admitted sheepishly to the SPD's parliamentary group: "There is no Plan B."
There are also no signs of the rest of Europe taking anything resembling a clear, coordinated approach. On the contrary, the mood is one of hopeless confusion -- and relentless competition.
The reasoning behind the often uncoordinated, individual measures is simple: He who bails out the quickest wins the most.
The Irish, for example, after dramatic losses on the Dublin Stock Exchange on Monday, Sept. 22, when the ISEQ Index fell 13 percent, put together a comprehensive bailout package. The island nation guaranteed the deposits of citizens, businesses and financial institutions. The government guarantees amounts to €400 billion ($540 billion), which is twice the country's gross domestic product. But the protective shield, which expires in two years, is restricted to Irish banks.
The German government's guarantee applies to deposits of Germans and foreigners, which prompted heavy criticism from Austrian Chancellor Alfred Gusenbauer, who fears the measure could encourage Germans using his country as a tax haven to retrieve their deposits. It could become lucrative, for the first time, for Austrians to open accounts in Germany, and invest their money with the Germans. In response, Gusenbauer promptly announced a plan to increase the amount of Austria's deposit insurance limit from the current level of €20,000 ($27,000). Austria now fully guarantees private deposits.
Other governments also saw themselves forced to take action. Greece decided to raise its deposit insurance limit to €100,000 ($135,000), and Spain plans to take a similar step. Sweden has already doubled its limit to €51,000 ($69,000). Great Britain initially raised the government guarantee for savings deposits from £35,000 ($60,000) to £50,000 ($85,000). Despite the measure, some of the major British banks lost half of their market value in recent days, prompting Chancellor of the Exchequer Alistair Darling to add new measures last Wednesday.
Darling announced that the Bank of England has provided £200 billion ($340 billion) in loans for the country's financial sector, as well as equity capital injections of up to £50 billion ($85 billion) for some of the country's largest financial institutions. In return, the government will receive shares in these banks. In a third step, the British government will provide a guarantee for new loans to banks worth up to £250 billion ($425 billion).
On Thursday of last week, Italy introduced a similar plan of action. In Denmark, banks and the government agreed to pay, over the course of the next two years, almost €5 billion ($6.75 billion) into a fund intended to protect ailing banks from collapse.
The financial crisis threatened to throw the European Union back into a political situation characterized by territorialism and infighting. The Europeans have long addressed the global crisis with the tools of the nation-state. Initially, at least, they were unable to agree to a coordinated approach, and all efforts to do so failed.
The Europeans' more recent efforts to address the crisis jointly came to an inglorious head three weeks ago. It began when a supposedly French plan for a general European bailout package became known. France, which currently holds the rotating EU Council presidency, wanted to collect €300 billion ($405 billion) from the member states to save the banks, a move that would have resembled the Americans' $700 billion (€518 billion) bailout package.
But the French concept was quickly met with a wave of indignation. Steinbrück's office noted that "the German government is completely opposed to this plan."
Germany's share of the proposed rescue fund would have amounted to €75 billion ($101 billion), or more than 3 percent of German GDP. The plan included no mechanisms to monitor the use of this enormous sum, an omission that triggered Steinbrück's disapproval. Besides, his experts feared that a European fund would be too unwieldy in an emergency.
But French President Nicolas Sarkozy and Finance Minister Christine Lagarde also bear a share of the blame for the failure of their plan. They were too quick to unveil the project and its questionable financing. After encountering opposition in Berlin, the idea didn't stand a chance of convincing the ECOFIN Council, the finance and economics ministers of the 27 EU member states, in Luxembourg.
Now the European governments want to give the joint approach one more try. Faced with a continuing decline on the stock markets and a dismal situation in the interbank money market, they realized that their disorderly pettiness was more than just unproductive. It was becoming increasingly clear that continuing along the same path would only exacerbate the crisis.
French President Nicolas Sarkozy, who currently holds the rotating presidency of the EU Council, invited the heads of state and government of the euro zone nations to attend yet another meeting to discuss the crisis on Sunday evening. It was time, Sarkozy argued, that the common currency zone adopt a uniform approach. The goal was to put together a joint bailout package for the euro zone.
The bundle of measures that the British government had introduced a few days earlier, which included the injection of government capital into the banks, served as a model for the group of 15 leading politicians meeting in Paris. Another issue up for debate was whether governments should continue to provide guarantees for ailing financial institutions, as well as additional liquidity injections. Each country, the 15 leaders agreed, would proceed with its own measures, but all measures would be coordinated within the euro zone.
All of these actions serve a single, overriding purpose: to dispel fear. Fear has replaced greed, which dominated the financial sector worldwide until only a few months ago, as the prevailing sentiment. Without renewed mutual confidence among banks, analysts in the European capitals concluded, a new creditworthiness within the banking industry could not develop.
European Central Bank President Jean-Claude Trichet and Bundesbank President Axel Weber have long called for a government capital injection for the German banking sector. The central bankers have argued that a strong signal from the government was needed to end the crisis. If market participants no longer felt confident in each other, they added, the state, as the only remaining institution capable of taking action, would have to intervene.
Of course, such large-scale government intervention into the economy is difficult to justify -- in normal times, that is. But those days are now long gone. If no one trusts anyone else, it is up to the government to create confidence. The government, after all, has an immeasurable advantage over all other players: its virtually unlimited resources.
In such a far-reaching economic crisis, just as in times of war or natural disasters, the government is not obliged to keep track of every euro it spends. This is a disadvantage during normal times, because it tempts governments to incur debt. But it is the only way out in times of crisis.
This explains why even the most ardent supporters of the market economy rarely object to government intervention during emergency situations. A market that no longer exists is incapable of solving problems, and governments must step in. This pragmatism is in part a lesson learned from the world economic crisis of the early 1930s. At that time, the banks collapsed first, because no one stepped in, followed by businesses, because they were no longer able to borrow money. The ultimate consequence was an army of the unemployed numbering in the millions.
This time around, the worst-cast scenario is to be avoided. The state must step in, and it makes perfect sense for it to ask for shares in the banks in return. Why should it give away the money? The public is not responsible for the financial institutions' problems, and thus it can expect to receive something in return for bailing them out. Sometimes such assistance can even pay off. In the early 1990s, the Swedish government reorganized the country's banking sector by assuming debt, issuing guarantees and acquiring stakes in banks. Once the crisis was overcome, the government sold its shares at a profit.
That outcome is still a long way off for Europe. For the time being, European lawmakers face a host of questions: Who decides which banks are saved and which ones are allowed to go under? How much will the bailout programs cost? How do governments ensure that their bailouts do not completely distort competition in the lending industry?
The scope of the problem reminds many an expert at Berlin's Finance Ministry of the questions that arose during the collapse of the former East Germany and the ensuing process of German reunification. "It is quite possible," says one of them, "that we will need an organization like the Banken-Treuhand (German Bank Trust) to process and manage the new government shareholdings."
It is a radical plan with considerable risks. For instance, it is already clear that it will cost the German government a sum numbering in the double-digit billions, and that it will foil Steinbrück's long-held aim of balancing the German budget by 2011.
It is hardly surprising that the German government ended up using the British example as a model. If Merkel and Steinbrück had stuck to their guns, they would have placed the domestic banking industry in an untenable situation. In recent days, German capital has already begun migrating to the more generously secured banks in Ireland and Great Britain.
Banks were threatening to run out of cash. And as desperation grew at the headquarters of major banks in Frankfurt, so did resentment against Merkel and Steinbrück.
"Bank bonds are no longer marketable at this time, not for any bank," said the chairman of a large German bank. At some point, every financial institution finds itself up against a wall, he adds, and sometimes this can happen within days. It took many decades, according to this executive, to develop a truly international financial system, "and now everything is collapsing in the space of four weeks," he says, shaking his head.
The only sources of fresh funds are the central banks, and private banks are now surrounding them like thirsty animals around a watering hole. In return for collateral, the banks can obtain currency -- euros, dollars, Swiss francs -- from their respective central banks.
To keep the economy supplied with capital, the central banks have loosened their interpretation of the concept of collateral. Since last week the US Federal Reserve Bank has been accepting as collateral short-term bonds, known as commercial paper, a form of security that the banks, when dealing with each other, would not touch.
But central banks like the ECB are not simply pumping liquidity into the banks' vaults free of charge. Instead, banks can obtain liquidity in the form of loans through an auctioning system known as OMTOS. Operated in Germany by the Bundesbank, the system can be likened to an eBay for fresh money.
Insiders say that OMTOS was once "a highly regulated world." Before the financial crisis, banks would pick up their money once a week. As a rule, they had until 9:30 a.m. every Tuesday morning to enter into the system the amount of money they intended to borrow and the interest rate they were willing to pay for it. In those days, banks that gambled with the system by entering a rate that was too low could end up empty-handed -- an outcome far from disastrous.
Today all of that has changed. The OMTOS auctions are the lifeblood of every German bank. Almost every day, the banks use the system to acquire money at auction from the ECB. In some cases they are bidding astronomical interest rates to do so.
Their very survival is at stake, as it was last Wednesday, when the ECB was auctioning off loans worth €50 billion ($68 billion) for a six-month term. Because the banks must keep an especially large amount of liquidity available over the Christmas holidays, a panic apparently set in on that day's auction. The 181 banks bidding for the loan, anxious to secure liquidity until next year, submitted bids totally €114 billion ($154 billion). Some bankers offered to pay rates of more than 6.1 percent to avoid going home empty-handed. This is more than two percentage points higher than the official prime rate -- signaling a total state of emergency.
For months, banks have been hording the money they borrow because their competitors are no longer lending to them, out of the fear that their borrowers could become bankrupt. "The global interbank market is virtually closed," says Michael Hartnett, a strategist with Merrill Lynch, the investment bank that Bank of America recently acquired.
In fact, the crisis of confidence among banks has only worsened, making it more difficult for banks to refinance themselves. In normal times, banks have an easier time of obtaining cash when their customers' deposit are insufficient -- through overnight loans from competitors, short-term loans and central bank funds.
But nothing is normal anymore today, especially now that many savers are taking the money out of their accounts and depositing it with the state-owned savings banks, under the assumption that their money is safer there. In recent weeks, Hamburger Sparkasse received €500 million ($675 million) in new customer deposits. It is abnormal to see so many citizens hording cash. Safe deposit boxes have become a hot commodity. Securlog, the market leader in the German money transport business, has been completing "special orders on a regular basis" in the past few days, says Georg Kierdorf, the head of the company. Kierdorf also notes that automatic teller machines have had to be filled with cash significantly more frequently. Machines in downtown areas, in particular, are registering higher turnover.
But an even greater problem for banks is the flight out of money market funds. In late August, these funds contained total assets worth more than €100 billion ($135 billion). They were praised as a way of securing decent yields and safely investing funds for the short term, and many also invested heavily in bank bonds. Now many funds are losing value. The Gerling Money Saving Fund, for example, lost 8 percent of its value within one month.
Investors are already reacting. In early October, €700 million ($945 million) was apparently withdrawn from Union Investment's Uni Opti 4 fund. The cooperative central banks DZ and WGZ helped by providing a €1 billion ($1.35 billion) credit line, so that the outflow of funds could be processed in an orderly fashion.
Yields are likely to continue to decline, because fund managers, know that their liquidity has been depleted, are forced to sell the money market funds' investments at low prices. In the wake of this sell-off, other major investors will have to sell bank bonds, because their prices are plunging.
By promising that savings deposits are safe, Chancellor Merkel only increased the pressure on the system, because money market funds are not provided with a government guarantee. "They're behaving erratically," says a banker, referring to the fund companies. Billions of euros have already migrated from the funds into safe savings deposits. In the United States, it was an exodus from the money market funds that forced the government in Washington to devise its $700 billion bailout plan. Within a few days, for example, so much money was withdrawn from the Putnam Prime Money Market Fund, with total assets of $12.3 billion, that fund management decided to liquidate the entire fund.
It is no surprise, then, that banking executives last week became increasingly insistent on the development of a large-scale solution. When asked at the end of last week how much the bailout would cost, one of them responded: "Don't be too modest," adding that it is too late for modesty. The €400 billion ($540 billion) the Irish and the £500 billion ($850 billion) the British are prepared to spend to save their banks are a good benchmark, the banking executive said.
Now the bankers have apparently prevailed. With its bailout package, the government in Berlin hopes to return to the bankers what they have lost in recent weeks: trust, liquidity and equity.
The credit industry, along with its aloof executive elite, will also have to pay a price for government intervention. The government will do what it can to reduce the excesses that have become a hallmark of the banking sector, particularly when it comes to risk and astronomical salaries. "That is the price we must pay," said one of the bankers, with uncharacteristic tolerance.
A similar situation occurred in the summer of 1931, when some of Germany's major banks became acutely strapped for funds. The government of the German Reich acquired share packages from the banks in return for injections of fresh capital. In the end, the government owned 30 percent of Deutsche Bank and 70 percent of Commerz- und Privatbank. In the case of Dresdner Bank, which had merged with Danat Bank, the government acquired fully 91 percent of shares. The government had virtually socialized all major German consumer banks, at least for a few years. By 1936, the banks were sufficiently solvent once again to be able to buy back the shares from the government.
The government had to pay close to one billion reichsmarks to clean up the banks' balance sheets: about 150 million to acquire bank stock, 250 million for cash and 400 million in loans. The amount was less than 2 percent of the 1931 national income of 57.5 billion reichsmarks. In other words, the government's stake was manageable.
The upshot of the 1931 bailout program was that two large consumer banks collapsed and almost all executives lost their jobs. But the measure ensured that a meltdown was avoided, and citizens slowly regained confidence, at least in the financial system, though not in the political system. "None of the depositors in the major Berlin banks lost a single reichsmark," says Isabel Schnabel, an economic and expert on financial crises at the University of Mainz.
Is history repeating itself today? Even in the United States, the home of unfettered capitalism, something that was unthinkable until very recently is up for debate: direct government participation in the ailing banks. Until now, attention in the United States was focused on the banks' toxic mortgage products. The government will buy up the junk securities, the banks will be rid of their ballast, money and credit will be flowing freely once again and the market will return to their normal mode of operations. This was the US government's optimistic scenario until not too long ago.
But since the end of last week, it has been clear that this approach isn't enough. US Treasury Secretary Henry Paulson now wants to inject capital directly into the banks, thereby strengthening their balance sheets. This, according to Paulson, is the only way to reestablish trust in the capital markets. Banks that participate in the program would be required to surrender shares to the government in return.
The partial nationalization of the next financial institutions is expected to take place by the end of October. "We will take decisive action and use all available tools," says Paulson, adding that this would include "direct strengthening of the banks' capital base."
For some time, investors like George Soros, and leading US economists, have been calling for the United States to follow the example set during the Swedish banking crisis and partially nationalize the American banking system. But this was difficult to reconcile with the market ideology of President George W. Bush and his fellow Republicans.
For two weeks, members of the US Congress waged a bitter debate over whether buying out Wall Street is morally justifiable. When they eventually approved the $700 billion (€945 billion) bailout package, known as the Emergency Economic Stabilization Act, only very few of the politicians realized that the law would now give Paulson the authority to acquire direct stakes in the banks.
Economists consider the step, based on the British model, to be the better solution.
"But the equity issue was critical," writes Princeton economist -- and 2008 winner of the Nobel prize for economics -- Paul Krugman, "and may now be the thing that turns a useless plan into something that really does a lot of good." "This is the only solution that can prevent a meltdown of the financial system," says Nouriel Roubini of New York University.
What an end to Anglo-American financial capitalism that would be. It would mark the beginning of a new economic age, an age characterized by more government and less market, and less growth, but also fewer risks.
A similar system was put into place after the world economic and banking crisis of the last century. It lasted until the lessons from the crisis had been forgotten. And until profit seeking had replaced caution once again.
BY BEAT BALZLI, JAN FLEISCHHAUER, FRANK HORNIG, ALEXANDER JUNG, ARMIN MAHLER, CHRISTOPH PAULY, CHRISTIAN REIERMANN, WOLFGANG REUTER AND MICHAEL SAUGA
Translated from the German by Christopher Sultan