"The blow came from the USA," he said, "and Germany served as a shock absorber."

TO BE NOTED: From Spiegel:

'WORST DEPRESSION' SINCE 1930S
Optimism Dips As Economic Downward Spiral Continues

The German economy is sinking precipitously as a result of the global economic crisis, creating the worst downturn since the Great Depression. Politicians and labor leaders are concerned about social unrest, but the government remains firm in its conviction that its not time yet for a third stimulus package.

It's been a bad week for German Chancellor Angela Merkel. At the start of the week, she tried to cheer up her compatriots, saying the economy showed signs it may be bottoming out. Since then, though, it's been one negative economic development after the next.

The German economy is in a nose dive and is already in its worst slump in almost 80 years. Indeed Hans-Werner Sinn, the head of the respected Munich-based Ifo Institute economic think tank, is describing the current crisis as the "worst depression" since the global economic downturn of the 1930s.

REUTERS

Germany's leading economic institutes are predicting a gloomy 2009, with GDP shrinking by 6 percent.

On Thursday, Germany's leading economic think tanks concurred in a report that the economy would likely shrink in 2009 by 6 percent of gross domestic product. The International Monetary Fund is estimating a downturn of 5.6 percent. Officially the government in Berlin has forecast a decline of 2.5 percent, but next Wednesday it is expected to revise that figure downward.

However Sinn also praised the German government for its work in combatting the crisis so far, describing it to the Frankfurter Rundschau newspaper as a "major stabilizing factor." He said with its first two economic stimulus packages, the German government had created hundreds of millions of euros in demand in global markets. "The blow came from the USA," he said, "and Germany served as a shock absorber." It has been a stimulus program for the entire world, he said, noting the strong number of imports coming into a country traditionally known for its exports.

Is Social Unrest at the Door?

With the situation looking dire, on Thursday the center-left Social Democrats' candidate for the largely symbolic office of German president, Gesine Schwan, warned that social unrest, some of which has already been seen in other parts of Europe, could soon be lurking around the corner in Germany. "I can imagine that in two to three months the people's anger could increase markedly," Schwan told the Münchener Merkur newspaper. If people have no hope for an improved situation, she warned, it could get explosive. Michael Sommer, the head of DGB, one of the country's leading labor unions, also warned of unrest.

With no end in sight for the crisis, it's getting increasingly difficult for the German government to buoy spirits.

On Wednesday, Merkel called together 30 top politicians, executives, union leaders and industry officials to discuss the dramatic developments. Little of the optimism Merkel expressed at the beginning of the week remained and she was reserved in her comments. Merkel spoke of a "serious economic collapse," and Finance Minister Peer Steinbrück described an undamped downward dynamic. For his part, German Economics Minister Karl-Theodor zu Guttenberg prophesized a "very, very difficult year." The politician -- who belongs to Bavaria's conservative Christian Social Union, which is part of the government as the sister party to Merkel's Christian Democrats -- said that when he revises the government's forecast next week, it will be "considerably worse" than it was in January. Back then, the Economics Ministry predicted a drop in gross domestic product of 2.25 percent.

Against that backdrop, German unions are demanding a third economic stimulus package. It's a move the federal government has so far refused, saying it wants to let the first measures, with a volume of €80 billion, take effect first. Finance Minister Peer Steinbrück described union demands for an additional €100 billion spending package as "counterproductive."

Trade unions are critical of the government's wait-and-see attitude. "We need policies that tackle the problem head on and extensive job guarantees for employers," DGB union chief Michael Sommer told the weekly newspaper Die Zeit. In light of the depth of the crisis, he said, the government needed to improve its stimulus efforts.

Wolfgang Franz, the head of the panel of prominent economists who advise the German government, told the Mannheimer Morgen newspaper that the first two stimulus packages, particularly the second, must be allowed to gain traction. He added that the crisis-precipitated drop in energy and food prices, with a volume of around €30 billion a year, could have an impact similar to a third economic stimulus package.

Economists Call for Stimulus Discretion

Germany's top economists say the federal deficit is growing precipitously and that new stimulus programs should be rejected unless all the efforts up until now to spur the euro zone economy fail. At that point, they argue, additional finance policy measures should be negotiated at the European level.

In the opinion of the economists, the two stimulus programs already passed with investment projects, the sinking of taxes and the reduction of social security payments are already measures taken that could lead to mid-term growth. They said it was reasonable to use deficit spending to finance those measures. At the same time, they criticized Berlin's much-vaunted scrapping premium to spur new-car sales, saying it would only promote short-term spending. They also called on the European Central Bank to lower its key interest rate to 0.5 percent from the current 1.25 percent.

Government officials have been reserved in their predictions. Economics Minister Guttenberg said it's possible the economy could bottom out by winter. But the corner still might not be turned even then, he said. Both Guttenberg and Steinbrück warned that economic predictions have become less reliable in the current climate. Steinbrück said he believed the dark forecasts of economists had been partly responsible in the past for making the economic climate even worse.

Steinbrück said the crisis remained primarily a banking crisis. Inter-bank loans, the mutual extension of credit, still aren't working as it should because of a lack of trust, he said, explaining that the situation is making it very difficult for businesses to get refinancing. Nevertheless, in macroeconomic terms, he said there was no credit crunch.

In two weeks, the German government is expected to present its plans for creating so-called bad banks in order to free financial institutions of their toxic assets, which are threatening existing capital as well as the supply of loans to the business world. If trust still cannot be restored after the creation of the bad banks, and if the two economic stimulus packages already approved do not produce the desired effect, calls for a third package will likely increase."

must let the state supply the required capital and become a partner. I call this the stuffing-of-the-goose strategy.

TO BE NOTED: From Vox:

"Stuffing the goose strategy

Hans-Werner Sinn 4 April 2009

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Banks’ balance sheets need to be fixed, but they cannot be allowed to shrink themselves back to health – instead of accepting government money – because that would severely harm the economy. This column proposes that any bank that cannot privately find at least 4% equity capital and a tier-one ratio of 8% must let the state supply the required capital and become a partner.

The US banking system is bankrupt and to be rescued with state money. Western Europe’s banks are limping. In Eastern Europe, a time bomb is ticking. And all this just because banks, hedge funds, special purpose vehicles, investment funds and real-estate financers were allowed to conduct their business with only tiny amounts of equity capital. Without equity, there is no liability, and without liability, people gamble. They hunt for risks wherever they can find them because they can privatise profits and socialise the losses. Now the jungle is burning, and no one knows how to put out the fire.

Even Chicago-school economists must understand that markets can only function within a strong regulatory framework. This applies especially to financial markets, where the losses can exceed capital reserves many times over. Strict banking regulation acts as a barrier against opportunism. Only strict regulations can create the confidence in the markets that capitalism needs to continue to increase the prosperity of the masses. America needs Walter Eucken, the father of ordoliberalism.

Governments must control the banks during the cure

But before Eucken lands in America, Keynes must save the banks and the economy. To do this, the state needs to have ownership rights in the afflicted banks. The banks cannot be allowed to shrink themselves back to health (rather than accepting money from the state) because the economy would shrink to death.

My proposal is that any bank that does not find enough capital from the market to shore up its balance sheet with at least 4% equity capital and a tier-one ratio of 8% (core capital relative to risk weighted assets), on average for the past three years, must let the state supply the required capital and become a partner. I call this the stuffing-of-the-goose strategy.

Long-term and short-run goals coincide here, because only with fresh capital will the banks begin to trust each other again. As things now stand, the capital can only come from the state, there is no alternative to partial nationalisation. Partial nationalisation is not expropriation but a forced issue of new shares to increase the bank’s capital. There is no objection to the old stockholders remaining on board. But the bank must sell the state so many new shares, at prevailing market rates, until the required equity ratios are reached. The old shareholders should not have the right to block this if the conditions do not suit them. What their investment is still worth will be seen in the stock market and not in the balance sheet. And before the state is awarded its share, the new stocks should be offered on the stock market at the planned price. Then no one can claim to have been treated unfairly.

Governments make poor bankers

Of course, banks should not become government agencies. The state has deeper pockets, to be sure, but it is a bad banker. The private legal form must be maintained because the state will have to sell back its shares when the crisis is over, hopefully at some profit.

The bad bank, however, is a bad idea. It only makes sense if the state pays more for assets than the market is willing, but then the state would be giving away taxpayers’ money. To prevent taxpayers from being cheated, nationalisation must precede the creation of a bad bank. That was the Swedish remedy, and it worked. President Obama’s plan also amounts to giving money to the stockholders. The $1 trillion that is to be paid as a “scrapping” bonus for toxic assets is about as high as the capital reserves of the entire US banking system. Hedge funds will receive a sizeable portion. No wonder the stock market rallied. Wall Street has managed to prevail again.

After the banks are saved

When the banks are saved, Eucken can take over. The most important ordoliberal rule would be to require considerably higher capital reserves. This ought to be the key strategy for the recovery of the banks, because it would increase the liability of the stockholders. Higher capital reserve requirements help better cushion shocks and induce a more cautious approach to risk-taking. They would also bring about a change in management compensation systems.

Basel II also needs to be overhauled. Today the banks’ assets are reduced computationally to a fraction of the balance sheet total, and the core capital ratio leads us to believe that the equity-asset ratio is up to five times larger than it actually is. This institutional monkey business has to stop. Basel III must mandate fair weights for risk-weighted assets that make the banks’ risk-weighted assets on average as large as the balance-sheet total. Only then will we again have a sound banking system. And we need not fear that capital will be lacking if more capital reserves must be held. The savings in an economy are always sufficient to finance investments, whether they are transferred to the firms in the form of owner’s equity or loan capital.

The need for international harmonisation

All of the regulations for the new banking system must be harmonised internationally, because otherwise countries will relax their regulations to undercut each other. Without harmonisation, there would again be a race to the bottom for where banks decide to do business. Then we would be right back where we started.

In Europe, the ECB must take over banking supervision. In Germany, BaFin, the Federal Financial Supervisory Authority, must be subject to the Bundesbank and not the Finance Ministry. This is the only alternative. The necessary international umbrella organisation can be formed by the IMF or the UN. This is a solution that the Anglo-Americans should also be able to accept at the World Financial Summit, since both organisations are headquartered in America.

Editor-in-Chief’s note: This was first published in German as “Stragegie der Stopfgans” , WirtschaftsWoche, No.14, 30 March 2009, p. 40. Reposted with permission."

"Dissembling, I have concluded, is hard-wired into the banks’ DNA."

From Alphaville:

"Nationalisation linkfest Posted by Sam Jones on Jan 20 11:48. 6 comments.

To nationalise or not to nationalise?

The UK government has shown its hand. TARP II is underway in the US.

If the latest gamut of policy responses don’t work - and there’s plenty who say they won’t - then nationalisation of banks is very much the only option left. More…

To nationalise or not to nationalise?

The UK government has shown its hand. TARP II is underway in the US.

If the latest gamut of policy responses don’t work - and there’s plenty who say they won’t - then nationalisation of banks is very much the only option left.

With that in mind, FT Alphaville has rounded up a selection of the pro-nationalisation views currently on offer . ( AM I LISTED? )

Kicking things off is Paul Krugman, who says nationalisation is preferable to a zombie banking collapse:
…many influential people, including Federal Reserve officials, bank regulators, and, possibly, members of the incoming Obama administration, have become devotees of a new kind of voodoo: the belief that by performing elaborate financial rituals we can keep dead banks walking… Unfortunately, the price of this retreat into superstition may be high. I hope I’m wrong, but I suspect that taxpayers are about to get another raw deal - and that we’re about to get another financial rescue plan that fails to do the job.

Exactly what Krugman means when he refers to voodoo accounting at the banks is fleshed out by analysts at RBS - according to whom, the UK’s banks are “technically insolvent”. (via The Independent, via Naked Capitalism):

Analysts working for RBS, one of several British banks to have received emergency funding from the UK Government last year, told the City that “the domestic UK banks are technically insolvent on a fully marked-to-market basis”.

The warning does not mean British banks are about to go bust, because the assessment is purely theoretical, and RBS said the position was “not unusual at this stage in the economic cycle”.

Technical insolvency is not necessarily grounds for nationalisation and as the analysts note, is not wholly unusual in a downturn. Then again, we nationalised Northern Rock. Edmund Conway, the Telegraph’s economics editor says there’s little difference in some sense between the Rock and RBS:
Pragmatically speaking, there is little to separate RBS and Northern Rock in terms of their asset books or control structures, nor indeed their absolute reliance on the Government for support. Should the stream of losses continue at even a fraction of this rate, the company looks a banker to return to the Government for further capital injections and, ultimately, nationalisation.

Looking at the picture more broadly, the LSE’s Willem Buiter argues that bailouts simply don’t work : in fact, they actually incentivise banks to stop lending:
But I believe that costly partial state ownership and the fear of future state ownership (partial or complete) are themselves discouraging banks from lending… If a bank has no option but to take the government’s money, it will try to repay it as soon as possible - to get the government out of its hair. Such a bank will therefore be reluctant to take any risk, including the risk of lending to the non-financial private sector. Such a bank will hoard liquidity (sometimes in the form of deposits/reserves with the central bank) to regain its independence from the government. Still independent banks will hoard liquidity to stay out of the clutches of the government.

And Hans-Werner Sinn, Ifo president provides some concrete German examples to back-up Buiter’s points:

Faced with the choice of reducing business or seeking to return to previous volumes by accepting government equity, bank executives will opt for the first alternative in order to avoid cutting their own salaries.

With such arguments against bailouts in mind, nationalisation is probably, then, the lesser of two evils, Felix Salmon suggests over at Portfolio.com:

Given how messy all of these alternatives are, why not simply go down the nationalization route? It’s transparent and easy to understand: if a bank is insolvent (and the FDIC is good at making those determinations), then simply nationalize it. That’s what the Swedes did, and that’s what we should do too.

Steve Waldman at interfluidity fleshes out the Swedish model: which involved nationalising the two nations largest troubled banks and then, reprivatising them later:

The state took full ownership and control over Nordbanken in 1992, actively cleaned it up, and eventually reprivatized it. During the crisis, Nordbanken purchased Gota, effectively nationalizing the smaller bank. It is true that only these two banks were nationalized, and a Swedish government description of the crisis is careful to note that, as a matter of policy “the state would not endeavour to become an owner of banks or other institutions.” But Nordbanken alone had an asset base of 23% of GDP. To put that in perspective, in US terms that’s almost as large as Citi and Bank of America.

And for a more first-hand exposition of the Swedish experience of bank nationalisation, it’s worth consulting this 1997 Jackson Hole speech by Urban Bäckström, former governor of the Swedish central banks. The crucial thing seems to be that banks were forced to present a full account of expected losses and writedowns:

This clarifies the extent of the problems and the support that is required. Provided the authorities and the banks make it credible that no additional problems have been concealed, this procedure also promotes confidence.

Joshua Rosner of Graham Fischer says that like Sweden, the best bet for the US (and the UK) would then too be for banks to be forced to writedown all their suspect assets and then have equity bought by the government. Writedowns and then nationalisation.
Faced with a similar crisis in the 1990s, Sweden forced banks to write down bad loans, then the government injected liquidity into the system and profited from the upside after taking equity stakes in the banks.

Interesting that Brown is calling for banks to “come clean” then.

Which brings us perhaps to the current UK situation. And whether, as says the Economist we’re on a course of “creeping nationalisation” anyway :

Despite repeated government claims it is not interested in running banks, creeping nationalisation may be on the way:

There is little in the new package to give banks the incentive to put their profit motive aside and help to reflate the economy. RBS and Lloyds have some private shareholders who could sue if they suspected their interests were being abused… Unhappily, the government’s new measures do not dispel the uncertainty that continues to weigh on banks’ balance sheets.

The government … has chosen a slow and complex route.

A “slow and complex route” that the Economist’s Free Exchange blog is meanwhile, quite explictly no fan of:

Time to quit mucking around and make with the nationalisations.

Finally, if it’s coming, then make sure it’s done properly says John Hempton at Bronte Capital in his blog post Nationalisation after due process:
What I want is extreme government action (nationalisation) but with a process to ensure that existing property rights are honoured. I want the benefits of nationalisation (that it works) without the costs (that it is seen to be arbitrary to capital providers).

Update: For further reference, FT.com now has a very interesting video of PE chief Guy Hands’ thoughts on nationalisation and Phillip Stephens’ op-ed (”Shoot the bankers, nationalise the banks”) is an excellent read:

Dissembling, I have concluded, is hard-wired into the banks’ DNA."

A very useful brief.