German Chancellor Angela Merkel cautioned in an online video broadcast Saturday November 28 that credit conditions in Germany remain critical. Merkel advised that she would be meeting with representatives of financial institutions, trade unions and academia on Wednesday, December 2 to discuss ways in which Germany can avoid a credit crunch that could potentially stifle Germany’s nascent economic recovery. Finance Minister Wolfgang Schaeuble, Vice Chancellor Guido Westerwelle and Economy Minister Rainer Bruederle will be in attendance.
Berlin is very concerned about the availability of credit for it is a necessary condition for both the resumption of growth and a sustainable economic recovery. The inability of corporations and households to obtain financing would spell disaster for Germany’s growth and already tenuous employment situation, both of which are currently propped up by temporary measures.
Since the financial crisis intensified last autumn, Berlin has sought to shepherd the German economy and its banking system through the worst of the financial crisis by letting automatic stabilizers work and by discretionary fiscal measures. To support households and enterprises, Berlin has begun implementing its 81 billion euro ($120.3 billion) stimulus package, which aimed to boost infrastructure investment and subsidize short-shift workers’ wages and new car purchases. These measures have been largely successfully and helped to boost Germany’s GDP in the third quarter.
Berlin sought to shore up confidence in the banking sector in October 2008 by establishing the Financial Market Stabilization Fund (SoFFin), which may guarantee up to 400 billion euros of newly issued bank debt and has an additional 80 billion euros earmarked for capital injections and asset purchases. In May 2009, Berlin backed an impaired asset relief scheme that would allow private banks to swap their toxic assets for long-term bonds issued by a government-guaranteed “bad bank.” While Berlin’s efforts have helped to assuage the near term threat of a total banking meltdown, the flow of credit to the household and corporate sector remains tight— Munich-based Ifo institute reported that credit conditions index decreased to X in November from Y in October.
One of the major factors explaining the continued credit tightness is the fact that German banks’ balance sheets— especially those of the Landesbanken, regional banks partly owned by the various German states— are still contaminated by the large stock of toxic assets accumulated during the 2001-2008 credit boom. Germany’s banks have not been participating in the asset relief program because it’s voluntary and banks believe its terms as relatively unattractive— the fact that the first and only bank (WestLB, a very large and most troubled Landesbank) agreed just last week to participate since the program’s introduction nearly 6 months ago seems to confirm this. There is also the concern that participating would stigmatize the participating banks.
German banks wrote off at least 1301 billion euros in 2007 and 2008, and this year have written off at least 77 billion euros. Last week, the Bundesbank, Germany’s central bank, warned that it expects German banks to write-down an additional 60 to 90 billion euros in 2010 depending on the recovery. However, these write-downs, though massive, would be but a dent in the toxic assets problem facing Germany’s banking sector, which the IMF estimates that the Landesbanks’ toxic asset holdings are anywhere between 350 billion and 500 billion euro, and that total holdings could be X.
It’s therefore easy to see why Merkel and Berlin is concerned about a credit crunch in 2010. Instead of jettisoning the bad assets and starting over with a clean balance sheet, banks are just deleveraging further, preferring to whittle away the bad assets still festering on their balance sheets with incremental write-downs. This is problematic because absorbing losses erodes a bank’s capital and therefore restricts lending, which economic activity requires and can therefore lead to yet more banking losses— completing a vicious, self-reinforcing circle.