German Bad Bank Plan

[Skip to the end]

(email exchange)

The ‘short cut’ would be to allow banks to mark to model aggressively and then write off the losses over 20 years so the losses don’t alter capital ratios.

And while it does drive down their ‘economic net worth’ and reveals ‘actual shareholder equity’ immediately, as long as they can fund themselves with insured deposits and central bank funding operations, they are not affected.

They may even be allowed to pay dividends based on reported (though arguably overstated) earnings.

And they can still raise new capital if the new investors can get in at levels that give sufficient returns on investment.

Also, as is the case in the various US plans, the price the assets are sold at is critical.

The government does not want to overpay and subsidize bank shareholders, and there is no advantage for a bank to sell too low.

This plan also adds to the ‘financial stress’ of the German national government and weakens its creditworthiness as their economy continues to deteriorate and deficit funding needs grow.

While more support from the ECB has been discussed, it is not a certainty.

>   On Wed, May 13, 2009 at 7:07 AM, wrote:
>   Original Message 5/13 7:02:27
>   The German government today approved a “bad bank” plan to take
>   toxic assets off the balance sheet of banks. The plan will likely be
>   passed by parliament within six weeks.
>   The key idea of the plan is to give banks up to 20 years to cover their
>   losses from toxic structured assets without putting much taxpayer >   money at risk.
>   Judging by the initial draft, the key elements of the plan are:
>   Banks can deposit toxic structured assets at 90% of the book
>   value in an in-house special purpose vehicle (“bad bank”).
>   In return, the banks receive bonds that are guaranteed by the
>   government’s bank support agency (SoFFin) against a fee. The
>   banks thus swap bad assets against good assets.
>   Independent auditors will determine the “true” value of the toxic
>   structured assets.
>   The banks than have up to 20 years to build up reserves in equal
>   annual instalments to cover the difference between the face value
>   (minus the 10% haircut) and the “true” value. In the end, the banks
>   will also have to make up for any difference between the “supposed
>   ”true” value of the toxic assets and the amount that their “bad
>   banks” realise upon winding down the bad assets.
>   The problems of the Landesbanken, which go well beyond toxic structured
>   assets, will be dealt with by a separate procedure to be unveiled within a
>   few weeks.
>   We haven’t seen all details of the law yet, and it may well be changed
>   in parliament.
>   For banks, participation in the scheme is voluntary. The basic idea, namely
>   to ease bank balance sheets constraints up-front and to give them up to 20
>   years time to build up reserves against losses from toxic structured assets,
>   looks sound. As usual, the devil could be in the detail. So far, German banks
>   have accepted government support only late and reluctantly because they
>   consider the conditions attached as too harsh. If few banks participate, the
>   ”bad bank” plan may not much impact on lending behaviour of banks.