February 13, 2008
The mysterious political economy of the IKB bailout
If ever a bank was sufficiently systemically insignificant and small enough to fail by any metric except for the political embarrassment metric, it is surely IKB, the German small and medium enterprise lending bank that got itself exposed fatally to the US subprime crisis through a conduit (wholly owned off-balance sheet entity) devoted to speculative ventures involving instruments it did not understand.
Yet after two bail outs by its shareholders (which provided funds or guarantees for just over €6 bn), we now have the German Federal Government about to inject €1bn out of a third rescue attempt total of €1.5bn. The earlier rescue attempts were largely public sector bail outs in any case. The largest shareholder of IKB is KfW, a state-owned development bank which holds 38% of the shares of IKB.
I can think of no better way of encouraging more appropriate future behaviour towards risk by German banks than letting IKB go into insolvency now. The institution gambled recklessly and irresponsibly. It lost. Liquidation and sale of its assets would be the market-conform reward for its failures.
We are not dealing here with an institution facing a liquidity crunch. This is no Northern Rock which invested reasonably sensibly but got caught in a funding crunch when global wholesale markets froze in August 2007 as a result of circumstances beyond its control. This is an institution which, through its out-of-sight-and-out-of-mind conduit, invested badly and paid the price. It deserves to fail. And it is in the interest of future sound banking in Germany that it be allowed to fail. Contagion effects are extremely unlikely, as it is plain as a pikestaff that it is insolvency because of bad investment decisions rather than illiquidity because of disorderly financial markets or other irrational herding behaviour that is causing the downfall of this minor German bank.
The €1.5bn stumped up in this third rescue attempt is in any case unlikely to be enough to recapitalise IKB in a sustainable way. If this misguided half-rescue goes ahead, it will have to be followed up shortly by a further larger injection of funds (public or private but government-cajoled) within a couple of months at most.
Peer Steinbrück, the German Federal finance minister, talks a pretty good game about market discipline. The proposed bail-out of IKB is a form of socialism for the rich and well-connected that should appeal neither to market disciplinarians nor to the left wing of the SPD. So what is driving the politics of this bail out? Surely it could not be fear of political embarrassment? Let’s hope that the European Commission will view a politically motivated rescue of IKB for what it is: an illegal use of state aid.
“The proposed bail-out of IKB is a form of socialism for the rich and well-connected…”
Posted by: Michael | February 14th, 2008 at 10:59 am | Report this commentExactly! Unfortunately this is the German way. When push comes to shove the establishment closes ranks. After all, there are reputations at stake, not to mention juicy pensions and non- exec jobs for the boys. After his justifiably scathing condemnation of the mediocrity and sheer incompetence of German Bank Managers,of which there are far too many, Steinbrück appears to have been quietly spoken to by the powers that be and told to not to rock the boat.
The concept of sound banking, as generally understood, doesn’t exist in Germany. Where would KfW be without state banking? Insolvent. Where would the Landesbanks be without public ownership? Insolvent. The entire banking system is corrupted by state support. IKB is just one small part of the picture.
Posted by: pepik | February 14th, 2008 at 1:10 pm | Report this commentAnd so…. Northern Rock??
Posted by: Alfonso | February 14th, 2008 at 2:38 pm | Report this commentHindsight is 20/20. A lot of people got punked by sub-prime mortgages.
“I can think of no better way of encouraging more appropriate future behaviour towards risk by German banks than letting IKB go into insolvency now.”
I agree that letting IKB go into insolvency would make German banks more cautious. There’s a fine line between caution and too much caution. The problem is you might make German banks too tight. Perhaps they were at a reasonable level of tightness but just got duped like everyone else in sub-prime mortgage lending. In that case letting them fall would not be the right move. Think of all the productive loans that would not be given out because of the induced fear of being blind-sided.
I see your point if you think that IKB’s actions are generally viewed as reckless. In psychology it’s called the Hedonic Treadmill (fancy for slippery slope). If other banks see the bank as acting recklessly and it gets bailed out, then it will make other banks think that they will also get bailed out if they act recklessly, which will cause more bad loans. I think the trick is to not be too heavy-handed or too forgiving.
Posted by: Mark Bulmer | February 14th, 2008 at 3:01 pm | Report this commentHindsight is 20/20. Now you KNOW who was lying in order to steal. But in the end, who suffers? The thief, or the victim [public]? The thieves even lie about the sub-prime mortgages. It isn’t the first-level mortgage going bad; it the 10th, 15th or 20th mortgage that was sold on top of the 1st sub-prime mortgage. Only they didn’t call them “mortgages.” They had fancier names; which is lying just the same. Sometimes the Dragon Wins.
Posted by: Edward Ulysses Cate | February 14th, 2008 at 4:36 pm | Report this commentThe IKB’s main bizz is with German KMUs (small and medium size companies) so there are good reasons why it should not be sold off or allowed to go bust. Its main shareholder is the KfW (Kreditanstalt für Wiederaufbau) formed post WW2 to assist in financing Germany’s recovery. The KfW is stretched financially right now but could raise more cash to aid IKB by selling off some more of the Deutsche Post shares which it still holds (KfW is a much-used parking place for shares (which the German govt still owns) of some privatised state entities. However, this is probably not a good time to sell DP shares, esp. if the German govt itself will put up the cash needed right now (and no doubt get it back later on from KfW??).
Posted by: fh | February 14th, 2008 at 9:40 pm | Report this comment“The IKB’s main bizz is with German KMUs (small and medium size companies) so there are good reasons why it should not be sold off or allowed to go bust.”
Posted by: Michael | February 15th, 2008 at 11:05 am | Report this commentA complete non sequitur in my opinion. Are KMUs holy entities that need nurturing? The fact of the matter is that peddling loans at, or below cost, to the German “Mittelstand” is a pretty crappy business model. Which why IKB got involved with structured credit in the first place.
I heard that in this sub-prime mortgage-lending fiasco the bank that gave the initial loan didn’t even check to see if the person borrowing had the means to make the payments. The bank knew it would pass off the loan to someone else so it didn’t really worry about important things like the income of the person borrowing. Is that pretty much what happened? And what was IKB doing, buying up the mortgages somewhere down the line expecting huge interest payments only to have the borrowers go bankrupt?
Posted by: Mark Bulmer | February 15th, 2008 at 4:12 pm | Report this commentIf that’s the case, then wouldn’t the “thieves” be the bank that gave the initial loan and the ones who bought it and sold it at the beginning of the chain guaranteeing that the borrowers were good to pay the loan? What do you financial gurus think?
Posted by: Mark Bulmer | February 15th, 2008 at 4:19 pm | Report this commentKMUs are the acorns from which great oaks grow…. unless pigs get to gobble them up
and so they do need protection and nurturing. Unfortunately in the case of IKB the “parents” did not exercise sufficient supervision. I do remember a comment - was it from Steinbrück? - that one reason (and there are many of course) for state support was the excellent customer base that IKB has.
As the state still owns large chunks of privatisations, another event today was the resignation of Zumwinkel, Deutsche Post’s
Posted by: fh | February 15th, 2008 at 4:39 pm | Report this commentCEO (alleged tax avoidance), but a few hours later, DPost had announced a new CEO (Frank Appel) and now there is speculation that after the excitement in the Dax of the last weeks, DP may not sell its holding in the Postbank after all!! German pols are learning by doing, creating a great new German Banking industry, putting a pair of pieces together carefully then having second thoughts. One has to realize that the permutations are almost infinite.
“I do remember a comment - was it from Steinbrück? - that one reason (and there are many of course) for state support was the excellent customer base that IKB has.”
Again, a non sequitur. If IKB has such a peachy customer roster, then why isn’t there a private bidder in sight?
The fact is, as someone here remarked, there is no concept of prudent banking engrained in German banks. After the war banks existed to serve the needs of industry and the reconstruction of the country, and where wholly, or partially in the case of IKB, under state control. Their legacy persists in the curious nature of entities such as IKB AND KfW. Who the hell needs them anyway?
I wholly agree with Wofgang Münchau’s sentiments uttered today. It is sickening to see IKB going cap in hand to the government after having screwed up. I happen to know some of the managers involved in IKB’s demise. I personally wouldn’t trust them to manage booze up in a brewery! However, rest assured, they all have juicy pensions and non-exec directorships to while away their time when not playing high handicap Golf in Mallorca. The same can’t be said for their underlings at IKB. They’ll be out of a job.
Posted by: Michaeö | February 18th, 2008 at 12:07 pm | Report this comment