did germany learn enough from the scandinavian financial ... · 10-09-14 dorothea schäfer 5 german...

10-09-14 Dorothea Schäfer 1

Did Germany learn enough from theScandinavian financial crisis twentyyears ago?

Jönköping International Business School20. Mai 2010

Dorothea Schäfer


Outline

• Reminder: enfolding of today‘s financial crisisand how it affected Germany

• Important steps in the crisis management in Germany

• Crises management in Sweden in the early90s – central ingredient AMCs

• Bad bank model of DIW Berlin • The German government‘s bad bank model• Conclusion: Answer to question


Crisis: Prelude• Jumping interest rates in the USA

2004: 1% und 2007: 5,25 %

• US-house prices started to fall in the midst of 2006

• Prior to that: – steady increase in property prices– stark extension of banks‘ balance sheets all over the

world


Extension of banks‘ balance sheets: UK banks (multiple 2001-2008 ≈ 3)

Bank of England (2008), Financial Stability Report, Oktober 2008


German banks‘ balance sheets Multiple of 10 biggest =1.63, Average growth rate 13 %

0

500

1000

1500

2000

2500

Deu

tsch

e Ba

nk

Hyp

oVer

eins

bank

-HRE

Dre

sdne

r Ba

nkCom

mer

zban

k

DZ

Bank

Land

esb.

Bade

n-W

Bay

er. La

ndes

bank

KfW

Wes

tLB

Euro

hypo

2003

2008

Billions Euro

2,74

1,83

1,64

1,39 1,35

Multiple of BIP 2003-II til 2008-II = 1.12, Average growth ‹ 2.3 %


Hedge Funds – Increase in Assets


Crisis prelude

• Defaults in Subprime Mortgages increased sharply

– Triggers expired (no amortization and interest rates for the initial period)

– Restructuring of mortgages did not occur in sufficient amount and fast enough (although expected)

– Burden of households due to variable interest rates increased sharply

– Rolling over became difficult: banks stopped to grant loans collateralized by expected increases in house prices


Subprime mortgages distributed around the world

• Via financial engineering: securitization (boom year 2006)

Mortgages– collected

– bundled– tranched

– given a rating

– sold

Special purpose vehicles (conduits) of banks

Hedge funds


Off balance sheet vehicles

Financial structure• Short-term loans and debt

– maturity of only a few month– assumed advantage: low short-term interest

rates

• Necessary: repeated roll over

repeated risk: crisis at maturity


6/07- Acute Crisis: Wave 1• Bear Stearns closed two Hedgefonds:

invested in mezzanine CDOs• Massive downgrading of CDOs startet• Roll over of short-term financing stopped• Default risk of SPVs• Parent banks: needed to take over the SPV-financing

• First victims: German banks IKB and Sachsen Landesbankneeded help Invested also in mezzanine CDOs via SPVEventually ceased to exist


Powder keg: mezzanine CDOs

Stage 1: MBS Stage 2: CDO

Entire range of ratings again

Equity trancheremains withoriginator (in

theory)

Remains with originator

Assets of MBS: indiv.

Mortgages

Liabilities: Securities of

different ratings, Either sold to the markets orused to build a

CDO

Downgrading to Junk in 2007

within 6 month


12/07- Acute Crisis: Wave 2• Hedge funds, banks, insurance companies

needed huge amounts of liquidity– Margin calls of prime brokers– Investors: steadily increasing redemption of

shares

• Need to sell liquid assets • Asset prices went down

– Stock prices, in particular those of banks


International Stocks

Indices

0

2000

4000

6000

8000

10000

12000

14000

16000

Jan

.07

Mä

r.0

7

Ma

i.0

7

Jul.

07

Se

p.0

7

No

v.0

7

Jan

.08

Mä

r.0

8

Ma

i.0

8

Jul.

08

Se

p.0

8

No

v.0

8

Jan

.09

Mä

r.0

9

Ma

i.0

9

Ind

ex

Po

ints

DAX

DOW

S&P 500

FTSE100

CAC40

SMI


German Banks and Insurance Company (Xetra)

Stocks of German Banks and Insurance Company

0

20

40

60

80

100

120

140

160

180

200

Jan

.07

Mä

r.0

7

Ma

i.0

7

Jul.

07

Se

p.0

7

No

v.0

7

Jan

.08

Mä

r.0

8

Ma

i.0

8

Jul.

08

Se

p.0

8

No

v.0

8

Jan

.09

Mä

r.0

9

Ma

i.0

9

Eu

ro

Allianz

Commerzbank

Deutsche Bank

Postbank

HRE


Acute Crisis: Wave 2• Money market dried up

– Banks in deep need for liquidity because of SPVs– Fear of lenders to lose money because of banks’ high

default risk (counterparty risk)

• Liquidity became extremely scarce

• Next victim: Bear Stearns to JP Morgan• Surprisingly: no intensification


Acute Crisis: Wave 3

• Fannie Mae und Freddie Mac: nationalized• Investment banks: massive liquidity drain• Short sales: speculation for massive price drops• September 15:

Lehman Brothers filed for chapter 11


Monthly Returns of Hedge Funds: Big Dip

HFN Aggregate Average Return per Month

-6,0%

-5,0%

-4,0%

-3,0%

-2,0%

-1,0%

0,0%

1,0%

2,0%

3,0%

4,0%

Se

p.0

7

Ok

t.0

7

No

v.0

7

De

z.0

7

Jan

.08

Fe

b.0

8

Mä

r.0

8

Ap

r.0

8

Ma

i.0

8

Jun

.08

Jul.

08

Au

g.0

8

Se

p.0

8

Ok

t.0

8

No

v.0

8

De

z.0

8

Jan

.09

Fe

b.0

9

Mä

r.0

9

HFN Aggregate Average 2,7% 0,7% -1,9% 1,8% -0,6% -2,0% -0,8% -5,3% -5,2% -1,4% 1,0% -1,0% 1,5%

Sep.0

7

Dez.0

7

Mär.

08

Mai.

08

Jun.0

8

Jul.0

8

Aug.0

8

Sep.0

8

Okt.0

8

Nov.0

8

Dez.0

8

Feb.0

9

Mär.

09


Money Market came to a holdDeposit facility ECB

0

50000

100000

150000

200000

250000

300000

350000Ja

n.0

8

Fe

b.0

8

Mä

r.0

8

Ap

r.0

8

Ma

i.0

8

Jun

.08

Jul.

08

Au

g.0

8

Se

p.0

8

Ok

t.0

8

No

v.0

8

De

z.0

8

Jan

.09

Fe

b.0

9

Mä

r.0

9

Ap

r.0

9

Ma

i.0

9

Mil

lio

ns

of

Eu

ro

Rescue Packages worldwide


Rescue Packages Germany• October 5: Bank deposits guaranteed• October 17: 480 billion Euro package

• Foundation of SoFFin (Financial Market Stabilization Fund)

• Guarantees for refinancing in the moneymarket (400 billion Euro)

• Fund for recapitalization and buying troubled assets (80 billion Euro)


Major developments in crisis management

Germany• Major bail outs of 4 German Landesbanken

• Equity Donations: 18 Billion Euro

• Guarantees: 60 Billion Euro

• Major bail outs of Commerzbank/Dresdner: 18.2 Billion Euro


Major developments in crisis management

Germany• June 2009: nationalization of Hypo Real

Estate (HRE) Squeeze out of minority shareholders

• July 2009: German Bad Bank(s) law cameinto effect

• May 2010: West LB started Bad Bank (SoFFin)


Core Capital Ratio - Selected Banks

Minimal CCR

0,0%

2,0%

4,0%

6,0%

8,0%

10,0%

12,0%

14,0%

16,0%

31.12.2006 8,9% 6,7% 5,5% 7,0% 12,2% 13,9% 7,5% 8,6%

Q1 2009 10,2% 6,8% 7,2% 6,3% 10,5% 14,1% 9,9% 11,8%

Deutsche

Bank

Commerzba

nkPostbank HRE UBS Credit Suisse RBS CitiGroup

fairly low compared to others


EU:Aid7%

0,00%

2,00%

4,00%

6,00%

8,00%

10,00%

12,00%

31.12.2006 7,70% 6,90% 6,80% 7,20% 7,20% 8,10% 7,70%

Q1 2009 9,60% 8,70% 6,80% 7,76% 6,90% 5,90% 8,10%

BayernLB Helaba HSH Nord LBB LBBW WestLB Nord LB

Core Capital Ratio - German Landesbanken

Losses in 2009 (announced): At least 4 Billions of Eu ro again

ailing Landesbank 4


Fear: Further deterioration of the capital situation

• Reference Sweden (crisis at the beginning of the 90s)

Losses due to failed loans of 12% of GDP

This share applied to Germany:

about 300 billion Euros (Germany)

• Total equity of the German banks: approximately 415 billioneuro (ECB)

• Write-offs till May 2009: 94 billion U.S. dollars (Bloomberg)


Consequences of Detoriation of Equity Basis

• Decrease in lending (not enough equity forbacking up lending according to Basel II)

• „Gambling for resurrection“ (typical behavior forover-indebted US-banks during S&L-crisis)

• Closure


Possible solution: Bad Bank

• buys (takes over) problematic loans

• manages these assets

• sells the assets later (or holds them untilmaturity)


Previous Bad Banks

• Nordic banking crisis - Sweden :

• Securum - troubled assets of Nordbanken: 3000 (Real estate)

loans of 1274 ailing borrowers,

67 billion SEK = 20 % of Nordbanken‘s assets

• Retriva - assets of ailing Gota (Bank)

39 billion SEK = 45 % of Gota‘s assets

• S&L crisis in the US : Resolution Trust Corporation (RTC)

1989 - 1995: 747 bankrupt thrifts (394 billion $)


Developments leading to Securum and Retriva

Domestic credit growth

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

35%

40%

1981 1984 1987 1990 1993 1996

Sweden

Finland

• High growth of credit and low savings rate of private households• Foreign currency loans of private households and enterprises


00,10,20,30,40,50,60,70,80,9

1

1985 1988 1991 1994 1997

SwedenFinland

Private Credit by Deposit Money Banks/GDP


• Real estate and stock market boom

• When both booms came to an end: foreign capitalstartet to leave

• Devaluation of domestic currency, increased interestrates

• Overindebtedness of households and enterprises

• Increased credit defaults deterioration of bankcapital

Events leading to Securum and Retriva


Credit default in Finland and Sweden (percent of total credit stock)

Sweden

Finland

Source: Vesa Vihriälä.


BIP development in Sweden and Finland: Dip into negative territory

Sweden

Finland


Crisis Management in Sweden

• Guarantee for all deposits• Foundation of Bank Support Authority• Principle: only strong banks should survive

– either banks get strong themselves– or they get strong with help of government

(shareholders loose everything)– bad assets have to be separated from good ones

(AMC)

• Recapitalisation was necessary for allmost all banks butonly Nordbanken and Gota asked for government capital


Cost to taxpayers

• Sweden - Securum & Retriva : 0 (through privatization proceeds and capital gainsfrom state participation in Nordea)

• USA - RTC: $ 76 billion (S & L crisis, a total of 124 billion)


Prerequisite for success of a bad bank (Loss minimizing )

• Low purchasing price of troubled assets• Active management is possible (e.g. investment to upgrade quality

or fungibility of houses/flats, renegotiation with borrowers) • Specialized expertise for managing defaulted/distressed assets• Time (or funding) to avoid fire sales • Clear governance structures (independence from conflict of

interests)

Largely met with Securum and Retriva in Sweden


Bad bank plan for Germany proposed by DIW BerlinPublished: Schäfer, D. und K. F. Zimmermann (2009): Bad Bank(s) and

Recapitalization of the Banking Sector, Intereconomics. Review of European Economic Policy, 44, (4), 215–225.

Objectives• transparent taking off of problem assets from banks’ balance

sheets• Give the good bank a promising restart• Minimize costs for taxpayers• Do not create disincentives

• Limit hold-up problem• Keep for shareholders and management the perspective of

losses


Bad bank plan (cont.)

Cornerstones• Depreciation on the basis of the current selling price

No market: zero price and complete write off• Government recapitalizes the good bank

Becomes shareholder, in extreme cases takes over completely

• Government capitalizes bad bank and assumes management of troubled assets (external expertise).



Cornerstones (cont.)• Surplus, if any, after deducting the maintenance costs

of bad bank goes back to the banking sector (shareholders)

• Plan is mandatory for systemically important banks• Credible perspective for re-privatization of the good

bank has to be fixedBad bank and nationalization are complements (two

sides of one and the same coin)



Ailing Landesbanken - Huge systemic risk in Germany (IMF)

• Same procedure: – depreciation of toxic assets, – toxic assets to a central bad bank, – Recapitalisation of good Landesbanks by the

government (possibly in conjunction with saving banks) contingent to a merger



Benefits • Transparency: Clear separation of taxpayers’

risks (bad bank) and chances (participation in good bank)

• Limits the hold-up problem: taxpayers exposure to immediately due financial obligations is limited and risk of losses is shifted to the banks



Benefits (cont.)• maintains the disciplining effect of losses for

shareholders and management • “low-risk”-investments for taxpayers in good banks after

outsourcing toxic assets to the bank bank - that is, DIW-plan minimizes the risk to taxpayers

Disadvantage• Immediately necessary: high volumes of public funds for

acquisition of shares (recapitalization of banks)


Reality: Germany’s Bad Bank Law• Three alternatives:

– SPVs for private banks

• SPV gets toxic assets (90 percent value)

• SPV gives bank bonds with governmental guarantee

• Difference between fundamental value and book value paid

from dividends over 20 years

• Rest remains with government

– Federal resolution agencies with SoFFin

– Resolution agencies of “Länder” for their Landesbanken


Bad Bank Law Germany • Application for establishing a bad bank is voluntary

• Almost no depreciation occurs no reduction of equity capital

• Hold up problem is still built in

• No (truly) fresh capital: new lending needs to be financed with debt

– increasing balance sheets

– increasing leverage

• Federal states can avoid mergers of Landesbanken


Conclusion: Germany did not learn enough from the Scandinavian experience

• Importance of clearing up bank balance sheets quickly and in a transparent way was largely ignored

• Taxpayers money is more at risk: investment largely in the bad bank but not in the good bank: takeover of troubled assets almost without write downs

• Chance to initiate and enforce necessary mergers (of ailing Landesbanken) has not been taken (no principle: only strong banks should survive)

did germany learn enough from the scandinavian financial ... · 10-09-14 dorothea schäfer 5 german...

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