Bail-out poker

BANKS used to inspire trust with marble halls and granite façades. The modern equivalent is a website that touts state guarantees bailing out depositors and other creditors. WestLB, the shakiest of Germany's state-owned wholesale banks, or Landesbanken, prominently displays an “overview” of the bank's many “protection mechanisms” on its site. Readers who click through are taken to a document that is comfortingly entitled “Belt and Braces”.

Even so, the bank teetered on November 24th. While its shareholders, a mix of local savings-bank associations and the state of North Rhine-Westphalia, were squabbling with Germany's federal government over who should take the hit for its losses on €85 billion ($129 billion) of toxic assets, the cost of insuring its debt spiked amid reports that the bank faced insolvency by the end of the month. At issue was uncertainty over whether WestLB would have enough capital when temporary guarantees from its owners expired.

In truth an insolvency was never really on the cards. WestLB may not be the global investment bank it once dreamed of becoming, but it is still too big to fail. The threat by its shareholders not to extend their guarantees seems to have been little more than a negotiating ploy (CreditSights, a rating agency, called it “bail-out poker”) aimed at getting the federal government to stump up more cash. As a tactic, it was not a great success. The bank's owners had bailed it out three times already in the past four years. After late-night talks they in effect decided to do so again.

WestLB will inject €3 billion in capital into a bad bank that will take over the toxic assets, the equivalent of about a third of its balance-sheet. Its shareholders have also agreed to guarantee €1 billion of losses on assets in the bad bank and they remain on the hook if losses go higher still. The government's bail-out fund, Soffin, agreed to pump €3 billion in capital into what remains of WestLB. This may convert into as much as a 49% stake in the bank next year, diluting shareholders. Under an earlier deal with the European Commission, WestLB had already agreed to cut its balance-sheet by half and sell itself off by 2011. It may now have to take even more bitter medicine in return for the additional aid.

The high price of salvaging what is left of WestLB should be a warning to politicians in other states, who have long viewed their local Landesbanken as playthings full of cushy jobs that could be doled out to friends. Unfortunately it is a warning that is not being heeded. When the savings banks that owned a large stake in WestLB tried to merge it with another Landesbank, they were blocked by the state government which wanted to protect Düsseldorf's status as a financial centre.

The pain is not over. A financial-stability report, released by the German central bank on November 25th, shows a sharp rise in loan losses in Germany, with write-offs likely to peak this year (see chart). The central bank reckons that German banks will end up writing down as much as €90 billion in bad loans and securities this year and next. Much of the burden is likely to fall on the Landesbanken. Non-performing loans at big commercial banks barely rose last year. At savings banks, which lend mainly to individuals and small businesses, they fell. The hike in bad debts was driven by the Landesbanken.

Shaky as many of them are, few are turning to the federal government's bail-out fund for fear that it would lead to their being broken up or merged. BayernLB, which lost more than €5 billion last year, was bailed out by the state of Bavaria. And HSH Nordbank got help from Hamburg and the state of Schleswig-Holstein. That dismays many in Berlin, who had hoped that the crisis might spur consolidation. Just forcing the Landesbanken to be less brazen about their dependence on state support would be a start.