“While in principle these state-owned wholesale banks are an excellent idea, their history has been marred by corruption, sleaze, and clientelism by Germany´s parasitic political parties” This is a typical example of the endemic corruption that exists in Germany.
Elmar Müller is a former bank executive, who served more than 20 years in various management positions, inter alia for Landesbanks. Today he is active as an investor in the capital market and in start-up financing
In Britain progressive economists are holding up Germany’s Landesbanks as a model to be emulated. While in principle these state-owned wholesale banks are an excellent idea, their history has been marred by corruption, sleaze, and clientelism by Germany´s parasitic political parties. For this reason many had to be liquidated or sold, while others incurred huge losses at the expense of the taxpayer. The latest basket-case, HSH Nordbank, will probably be privatised this year leaving the taxpayers of the two federal states of Hamburg and Schleswig-Holstein with losses of about sixteen billion euros.
Origin and purpose of the Landesbanks
In Germany’s social market economy, “Landesbanks” are the traditional form of banking at the interface between the public and private sectors. They emerged in the mid-1950s when federal states in what was then West Germany began issuing bonds and wanted independent syndicate leaders to place these with private investors. Because the federal states quickly became permanent issuers, and the Federal Republic of Germany followed them from 1962, the Landesbanks grew over the years to become the largest securities issuers in Germany. The basic infrastructure and economic policy of the German “economic miracle” in its historical form would not have been possible without them. They established a body of national debt at the level of the municipalities, states and the federal government.
The classical legal form for this was (and still is to some extent) the “institution of public law”. The public law regulations of unlimited state support (“Anstaltslast”) and guarantee obligation (Gewährträgerhaftung) were associated with this – a legal construct which was the equivalent of a 100% state guarantee for all these banks’ liabilities. The Landesbanks were thus able to refinance themselves very cheaply. This fundamental advantage over the private banks helped the Landesbanks to expand rapidly, in particular with the syndication of loans and bonds for the many savings banks under public law supported by municipalities (Sparkassen), whose equity capital was generally not sufficient to settle larger transactions themselves. The municipal lending and mortgage lending business, which the Landesbanks refinanced through Pfandbriefe (these provide investors with a pool of assets in the event of insolvency), or municipal bonds, also became highly significant. Because of this business, the capital requirements of the Landesbanks grew steadily.
Until 1993, this growth, which was increasingly financed by public borrowing, remained robust. Then, following a complaint by private banks, the EU Competition Commission for the first time classified an equity capital increase by Westdeutsche Landesbank (which has since disappeared) as distorting competition. Eight years later, in July 2001, after much back and forth, the rearguard action by the Landesbanks and German politicians against the EU was finally lost. As a result of the “Brussels Concordance” between the EU Commission and the German Federal Government, the owners of the public banks were no longer allowed to assume unlimited liability for the liabilities of their institutions. The “guarantor’s liability” only continued to exist for liabilities previously entered into and – for transitional purposes – for those entered into until 2005 and with a term of less than 10 years. This spelled death by instalments for the Landesbanks business model, as the state guarantee dwindled to zero by 2015.
To take advantage of their state guarantee while it still existed, the Landesbanks expanded their refinancing operations in 2004 and 2005 far beyond their needs at the time. This excessive liquidity was initially only invested in low-margin interbank business, but later increasingly in real estate development and corporate customer business. These tended to be high-risk borrowers seeking lower interest rates. The quality of the loan portfolio deteriorated rapidly, while the balance sheet total – which unfortunately all too often serves as the sole criterion for ranking the major banks – continued to grow. Apart from the top three commercial banks, the biggest banks in Germany were now Landesbanks.
Various efforts at consolidation were planned to save costs and create scale, but these often failed because of diverging interests and petty jealousies between the federal states. Although some mergers took place, such as the merger of the Landesbanks of Schleswig-Holstein and Hamburg in 2002 to form HSH Nordbank, or the takeover of Landesbank Rheinland-Pfalz in 2004 by Landesbank Baden-Württemberg (LBBW), this was not enough to absorb the structural distortions in the sector.
The flaw in the business model was further exposed after 2007 by the subprime crisis. In principle, this was more or less the same for all banks, but the Landesbanks had invested their liquid funds far more than most in structured products, above all in the US. Other risk markets of choice were asset-backed securities from supposedly high-growth euro-zone countries, especially Spain and Ireland, the EU’s internal tax haven for the restructuring and repackaging of US securities. All these markets, including highly specialised financing such as shipping loans, promised high returns – before the dream became a nightmare.
The role of politics in the Landesbanks
“The devil take the hindmost.” This truism applied to numerous assets, held by Landesbanks in the subprime crisis and the subsequent euro crisis, which could no longer be adequately resold. The need to write off losses in structured real estate and special loan portfolios was compounded by the collapse of proprietary trading income from bond portfolios and asset/liability management of interest-rate structures. They were victims of the low interest-rate policy applied by the US Federal Reserve and European Central Bank to combat the crisis.
How could the Landesbanks have got themselves into this ghastly position? It was not just bad luck, as many of the Landesbanks’ senior managers claimed during later investigations, often in a court of law. Anyone who had been involved with the Landesbanks during the times of crisis could clearly see that their risk management in virtually all fields (corporate credit, pricing, interest-rate, currency and country risks) fell far below professional standards. The reason for this was the lack of professionalism on the part of management, who believed they understood risk. As they then discovered, they had no idea.
“Banking is people”. The Landesbanks were dominated by representatives of their public owners, seconded by virtue of their public office, often with the prospect of a tasty extra income. As a rule, the supervisory boards were staffed according to the weighting of parties in state parliaments, and the management boards according to the preferences of these supervisory boards. Many Landesbank managers had only ever worked in public-sector companies, their careers being shaped more by political opportunities and personal relationships than by professional competence. While compliance regulations were enforced quite rigidly in the private banking sector, in the public banking sector, because of the interference of political parties, they were often ignored.
The story of Landesbank Sachsen (Sachsen LB), founded in 1992 by the State of Saxony and the regional savings bank holding company, “Sachsen-Finanzgruppe”, illustrates how politicians bankrupted their own bank. At the time, the bank´s mandate, to promote Saxony’s economy and the savings banks (Sparkassen), was laid down by law. From the outset, the then Finance Minister Georg Milbradt was chairman of a board of directors which, among many other things, decided in 1999 to establish an Irish subsidiary, Sachsen LB Europe. From 2001 onwards, the bank in search of easy profits expanded it foreign business, supported by this subsidiary. At that time, the board of directors was headed by Thomas de Maizière, who later became Federal Minister of Defence.
The bank’s management triggered one scandal after the other. Some of them: The CEO leases a Mercedes 600 with an extra trailer coupling at the bank’s expense in order to pursue his water sports hobby. The bank promotes his girlfriend, a simple bank employee, to personnel manager of the bank. The staff accuses the bank management of using private detectives to spy on employees. Milbradt invests his own capital in a closed fund for the construction of the Landesbank’s administrative building. This cost him his position as Saxony´s prime minister, in April 2008.
Instead of financing small regional businesses as it should have done, Sachsen LB was doing 80 percent of its business abroad. In the meantime, because of the abolition of its state guarantee its refinancing costs rose and rating agencies downgraded its credit. In June 2005, the state treasury had to add 300 million euros to the bank’s equity capital. In August 2007, following the replacement of the members of the managing board – combined with high severance payments – a collapse of the bank was imminent. Among other things, the Irish subsidiary had given unlimited guarantees to its special-purpose company Ormond Quay, including 17 billion euros invested in the US property market. Shortly thereafter Sachsen LB was sold to Landesbank Baden-Württemberg to avoid bankruptcy, with Saxony assuming a state guarantee of 2.75 billion euros. Already more than half has been paid out and the sum is rising.
WestLB, the Landesbank of Germany´s most populous state, North Rhine – Westphalia and a bastion of exceptionally well paid jobs for the Social Democratic Party, was soon to follow. In the summer of 2007, WestLB’s managing board spoke of write-downs in double-digit millions, in November of an unavoidable annual loss, and in January 2008 the bank needed a capital injection of two billion euros. A few weeks later the owners, the state of North Rhine-Westphalia and the savings banks associations there, had to increase their risk coverage to five billion euros under pressure from the financial supervisory authorities in order to be able to transfer risk assets of initially 23 billion euros to a “bad bank”. In 2012, the bank was at the end of its tether. The remaining 200 billion assets were added to the liquidation portfolio. Today, the bank hopes to be completely liquidated by the middle of the 2020s.
In autumn 2007, the Bavarian finance minister for the first time acknowledged that BayernLB’s troubled subprime portfolio totalled well over 100 billion euros. The bank then wrote off 1.9 billion euros on that year’s balance sheet. In April 2008, because of the financial crisis this increased to 4.3 billion euros. Since its holding of Lehman Brothers paper proved worthless that September, the total burden rose to 5.2 billion, and in October to 6.4 billion euros. At the end of November the Bavarian government announced a rescue package totalling 31 billion euros, 10 billion of which were equity injections from the federal and state governments. The money will also be used to cushion the results of later scandals such as investments in the Austrian bank HypoAlpeAdria and the disastorous financing of Formula 1.
Since 2008, the balance sheet of what were then 11 state banks has been reduced from 1.7 trillion euros to 900 billion today. Only seven Landesbanks have survived. The largest of these, Landesbank Baden-Württemberg (LBBW), was recapitalised by its owners – the Savings Banks Association, the State and City of Stuttgart – with five billion euros. By founding the “Garantie-Portfolio Baden-Württemberg”, the state also created a risk shield of 12.7 billion euros. As was announced at the beginning of 2018, approximately 430 million euros of this amount was left after the settlement.
HSH Nordbank , which belongs to the federal states of Hamburg und Schleswig-Holstein, had at its peak over 40 billion euros in shipping loans, and has so far cost taxpayers more than 16 billion. The sale to US investors Cerberus and Flowers is due for completion at the end of 2018, provided that any outstanding issues relating to deposit protection and financial supervision can be resolved.
A further Landesbank, Nord/LB, is said to have scored the worst of all eight major German banks in the European Banking Authority’s most recent stress test. Its shipping portfolio is currently estimated at 12 billion euros, and its existing capital requirement at 2 billion. Confidential documents leaked to the press give a detailed insight into the state of the bank: it hasn’t been able to gain oversight or control of its risks for years and speculation about a takeover is rife.
Perspective for the Landesbanks
Hessische Landesbank (HeLaBa), is the only Landesbank to have survived the financial crisis without capital support from its public owners. Before the crisis, its strategy of maintaining a conservative risk profile proved to be relatively successful, but it was scorned as old-fashioned because it had largely abandoned investment banking. Helaba has limited itself to business with the Sparkassen, and through its co-operation with Frankfurter Sparkasse has a strong presence in retail banking, and can hardly be regarded any more as a typical Landesbank.
The Landesbanks, under the significant influence of politicians, were the real focus of the crisis in Germany because they lacked a sensible and viable business model beyond co-operation with their regional savings banks. The Landesbanks today are still too far removed from the day-to-day business of the local savings banks and not close enough to the global players of the financial market. Plus they are driven rather by political influence than banking expertise.
As for their future, they have little scope for going into competition with the Sparkassen, since the German banking market is already saturated. However they could establish centres of competence to offer services such as payments, specialist financing, and foreign business to the smaller savings banks. Deka-Bank could be a model: the public banks have already established it as a centre of competence for the securities business. A prerequisite however, is that these banks should rid themselves of the political interference which was the ruin of the original Landesbank system. And for this purpose a single bank would suffice.