There are a lot of threads to tie together in today’s reporting of news in the auto sector.

General Motors has reported a third-quarter loss of $1.15 billion. But all indications are that car sales continue to outpace expectations in the United States.  Meanwhile, there are conflicting stories that GM both plans to pay back its bailout money, and to use it to help its ailing European operations. I will try to tie all these stories into a common thread.

First are the earnings. This is the first report by General Motors since leaving bankruptcy.  The results are decidedly mixed showing increasing sales, but a large loss and declining liquidity.

The video above points to losses and negative cash flow. But Bloomberg has reported that GM had significantly positive cash flow in Q3: $3.3 billion worth. Irrespective, sales are up.

The New York Times’ Deal Book says:

Excluding taxes and one-time items like the costs related to restructuring its dealership network, G.M. said its operations lost $261 million from July 10 and September 30. The loss in North America was $651 million.

For the entire third quarter, including the final 10 days of G.M.’s bankruptcy, the company said its revenue was $28 billion, up 21 percent from the second quarter.

In addition, retail sales have revealed that car sales in the U.S. are still relatively brisk for October despite the expiration of cash for clunkers. So, GM is benefitting from more sales, but is still not making money and still seeing cash go out the door. Obviously, they are going to need to cut costs even more, unless they count on sales returning to pre-crisis levels.  However, all indications are that they do, as CEO Fritz Henderson says revenue growth is their number one priority.

“We have significantly more work to do, but today’s results provide evidence of the solid foundation we’re building for the new G.M.,” the chief executive, Fritz Henderson, said in a statement. “With a healthier balance sheet and a competitive cost structure, our focus is on driving top line performance.”

See the Bloomberg video below for my comments by Henderson.

Meanwhile, in what should be seen as a PR move, General Motors has also announced it will begin repaying government money. The first $1 billion to be repaid in December. The company will make $1 billion payments to the U.S. government and $200 million payments to the Canadian government every quarter. It has said it could repay all the aid money by 2011, four years ahead of schedule. Presumably, this does not include the equity government stakes which can be sold on in the open market in an I.P.O.

Given the fact that General Motors is still losing money, it would make sense for them to delay repayment. However, I reckon they are going to repay early in order to tamp down criticism about their government-funded bailout.

The same is true in Germany as well as GM has also announced it will repay ALL German state aid before month’s close.  That is big. It significantly reduces the German government’s leverage over GM plans for restructuring in Germany.

This makes the recent statements about using bailout funds to bolster European operations seem inexplicable. If GM is losing money and needs to use bailout funds to plug up holes in Europe because it has decided to renege on an agreement to sell operations, why is it paying back bailout funds?  Is it not obvious the company needs the money?

My interpretation of GM’s actions is this: they are still a loss-making company and their cost basis is unprofitable at present sales levels. In order to return to profitability, they will need to further reduce costs or increase sales. At present, management have opted to grow the top line – and this makes retaining the European operations vital as the auto technology at Opel is considered first class.

So, GM has reneged on the Opel sale, risking the political backlash, because it is flush with bailout cash.  However, it knows that its desire to use these funds to stabilize the European business is likely to invite populist outcries in North America. This is why they have announced the repayment schedule today; it is purely a public relations maneuver to quell any anti-bailout sentiment. They are repaying German state aid for similar reasons, but also because it gives them greater flexibility in making operating decisions about job cuts and plant closures.

As GM is not publicly traded, we do not have stock prices as a gauge of how receptive investors are to these latest moves. But, according to Bloomberg, GM 8 3/8 bonds maturing 2033 jumped significantly, adding $2.63 to move to $20.3 on $100 par value.

You can expect to see GM as a topic in both the business and political press for some time to come.

Related posts:

• GM looks to use US and Canadian tax money to bailout Opel
• GM and Chrysler to get more bailout money
• GM headed for bankruptcy
• GM considers keeping Opel, raising capital
• Chrysler: bulls make money, bears make money, pigs get slaughtered

An article in the National Post suggests General Motors may look to divert some of its bailout money to Europe in the wake of a chill in German government support for subsidies. Talk of using taxpayer money to benefit workers in other countries is sure to raise ire, especially in the United States where the unemployment rate has hit double-digit levels.

When General Motors was forced into receivership this past Spring, it received tens of billions in bailout money from the U.S. and Canadian governments in order to protect jobs in the auto sector.

For his part, Stephen Harper, Canada’s Prime Minister said the aid was regrettable but necessary.

The Vancouver Sun reported at the time:

Canada had no choice but to support the restructuring of auto giant General Motors Corp. with about $10 billion in taxpayer aid or face devastating economic consequences, Canadian government and union leaders said Monday.

Hundreds of thousands of jobs would have been lost and communities across southern Ontario would otherwise have been devastated, Prime Minister Stephen Harper and Ontario Premier Dalton McGuinty said at a news conference Monday, hours after the 100-year-old company sought protection from bankruptcy in the U.S.

"We could either participate in reshaping these companies for the future or stand idly by as they restructured out of Canada," Harper said in Toronto.

"The decision announced today is regrettable but necessary."

The federal and Ontario governments’ contribution to the restructuring is set at $9.5 billion US, according to a joint statement Monday from the prime minister and U.S. President Barack Obama.

For that, Canadian taxpayers will hold a 12-per-cent equity stake and will also appoint one independent director to the company’s board.

The U.S. government sunk even more into General Motors – $50 billion. All of this money and the ‘cash for clunkers’ program have allowed General Motors to return to life. However, many issues remain, the most consequential of which is GM Europe. 

Since late May, it has appeared that a consortium headed by Magna International was set to take over GM Europe on the condition of 4.5 billion in state aid from Germany. As early as August, stories surfaced in which GM was considering raising capital in order to keep Opel. GM never wanted to sell Opel and Vauxhall, but it was forced to do so by circumstance.

However, when GM abruptly backed out of the Magna deal early in November it enraged the German government, who are now not likely to offer any aid. At the time I said:

Will Obama now come up with the funds?  If this minister gets his way, there don’t seem to be a whole lot of solutions here.

Well, here is one solution via the National Post (note the part I have highlighted in bold):

General Motors Co. may use some of the money it won from Canadian and U.S. taxpayers in the spring to fix its Opel unit in Europe in the months ahead as it works out a new financing plan for the money-losing business.

Detroit-based GM plans to fund Opel’s turnaround using a mix of sources after deciding to keep the business itself instead of selling a majority stake to Magna International Inc. and Russia’s Sberbank. That could include tapping funds pledged by the federal and Ontario governments, said Chris Preuss, GM’s vice-president of global communications.

"We’re going to be needing to participate directly in the financing" of Opel, Mr. Preuss said in an interview yesterday. "The taxpayers of both Canada and the U.S. have a stake in this. But what was agreed upon was that we have to be able to run a global business."

Translation: GM has every right to use its bailout money as it sees fit.

GM continues to misjudge the political situation. They handled the decision to back out of the deal with Magna very poorly. We are now likely to see increasing signs of economic nationalism at play.

But, just as the backing out created huge waves in Germany, this latest salvo from GM is likely to enrage Canadians and Americans as they see their tax dollars at work to protect the jobs of Europeans. GM may think using Canadian and American bailout funds for GM Europe is a good ‘technical’ solution. But, it is a very poor choice politically and they will pay the price.

Related posts:

• Germany gives GM a stiff arm on state aid
• Germans reject Chinese offer for Opel
• GM considers keeping Opel, raising capital
• German Press: Fiat to sign a deal with Opel, not Chrysler
• GM board decides to keep European Opel unit

You could see this one coming given the humiliating circumstances under which the German Chancellor learned that GM was pulling out of the Magna deal.

The BBC is now reporting that Germany will give General Motors no aid to restructure it’s business. That’s 4.5 Billion Euros they now need to come up with.

Economy Minister Rainer Bruederle told GM executives that they had to be responsible for restructuring the unit.

Germany had previously offered 4.5bn euros ($6.7bn; £4.1bn) to support Opel and protect German jobs if the company was sold to car parts maker Magna.

On cancelling the sale last week, GM said it would still seek state aid.

The German minister’s comments now raise question marks over whether GM will get it.

"I expressed my expectation that General Motors should basically carry out the financing itself," Mr Bruederle said.

Will Obama now come up with the funds?  If this minister gets his way, there don’t seem to be a whole lot of solutions here.

Related posts:

• Germans reject Chinese offer for Opel
• GM looks to use US and Canadian tax money to bailout Opel
• GM considers keeping Opel, raising capital
• German Press: Fiat to sign a deal with Opel, not Chrysler
• Economic nationalism and GM’s decision to keep Opel and Vauxhall

I have been reading press accounts of the GM decision to back out of the Opel/Vauxhall sale to the Magna/Sberbank consortium from various countries. There are a lot of different perspectives on this event in the U.S., Belgium, Spain, Germany, Russia, the U.K and elsewhere, because a lot of players are involved.

The conclusion I come to is that economic nationalism is the driving motivator behind much of what you read. To the degree, we continue to experience a soft global economy, this should be seen as a warning of how individual actors will respond in future.

Easy decision to keep Opel

GM’s decision to keep GM Europe is fairly straightforward in my view. The cars and technology in GM Europe is something General Motors never wanted to part with. They only did so because of the need to raise cash in a weak economic environment. Now, things at GM (and Ford) are looking much better and GM has exited bankruptcy. There is no desperate need to sell.

Moreover, the EU was asking GM a lot of questions about the subsidy deal they struck with the German government in order to effect the sale of Opel. Other European nations, Spain and the U.K. in particular, were livid because they suspected an unfair subsidy of German jobs over Spanish or British jobs. But, it goes far beyond those two nations as GM Europe employs 55,000 people in places like Sweden, Poland and Belgium.

We saw what happened to ING, RBS and Lloyds due to the EU’s rules on competition. One could reasonably expect a similar crack down in the auto sector. Details will emerge at some juncture, but one could conclude that GM did a cost-benefit analysis in which the wrangling with the EU weighed heavily on their decision to back out of the Magna deal.

And, in the end, should we expect the restructuring GM performs to be qualitatively any different than what Magna’s consortium would have done? They too have announced 10,000 job cuts, a figure in line with what was expected under Magna’s control. So, on the surface, this looks like a net benefit for GM, a net loss for the Magna-led group, and a wash for workers and politicians.

Enter economic nationalism

But, unfortunately, that’s not how it is likely to be seen. Let’s look at it from a German perspective.  Germany’s Chancellor Angela Merkel went to bat for the Magna deal, winning what was widely seen as a measure of security for German workers at a critical time during economic weakness. This bolstered her election chances. As a result, the center-left SPD has now been replaced by the Libertarian-minded FDP in a coalition reminiscent of the Helmut Kohl days. Consider this a move to the right in Germany.

Nevertheless, Merkel has stuck with her allegiance to Barack Obama. In fact, as a result of this relationship, she was the first German Chancellor in 50-odd years to deliver an address before Congress just two hours before she learned of GM’s backing out. What’s more is the U.S. Government is the majority owner of General Motors. One would think the Obama Administration had some insight into the decision-making at GM. Either the Administration didn’t know and is being recklessly hands-off in an enterprise where it has sunk tens of billions or it did know and did Angela Merkel a disservice by not informing her of what was to come well before her speech to Congress.

So, you have an American company owned by the American government backing out of a signed agreement and potentially thousands of jobs at risk. Talk of plant closures at Eisenach, Bochum (and Antwerp in Belgium) and the loss of jobs is rampant in the German press. GM Europe’s head John Smith says, "if they like the Magna plan, they will also like the GM plan." That is not an argument likely to gain sway in a period of economic uncertainty.

The Germans are livid.  German workers have gone on strike. Meanwhile, you have the UK Business Secretary Lord Mandelson warning that the division of job cuts must be ‘fair.’ And the Spanish Opel workers had just OK’ed the Magna plans two weeks ago. This is a bit of a zoo, isn’t it?

It is every nation for itself – precisely what one would expect with a shrinking economic pie and a deep downturn.

Going forward

GM has mishandled this affair quite badly I believe. At least with the Magna deal, the Germans were in the driver’s seat. Now, all of the individual European nations are angling for their say in this matter. Yes, GM had little choice given the likely scrutiny it was under via Neelie Kroes, but it certainly could have handled the political aspects of this much better.

However, now that this situation is out, it gives us a bird’s eye view into how nations respond when a division of the spoils becomes an issue.  And what we have seen does not give confidence that a coordinated approach will prevail. I take this affair as a clear indication that economic nationalism is alive and well and very much a threat to our collective well-being.

Related posts:

• Germany gives GM a stiff arm on state aid
• GM board decides to keep European Opel unit
• German Press: Fiat to sign a deal with Opel, not Chrysler
• Germans reject Chinese offer for Opel
• GM considers keeping Opel, raising capital

The sale to Canadian auto parts maker Magna International and its partner, Russian lender Sberbank is off. With bankruptcy now behind it, General Motors now feels confident it can proceed with Opel under the GM umbrella.

From the GM press release:

Given an improving business environment for GM over the past few months, and the importance of Opel//Vauxhall to GM’s global strategy, the GM Board of Directors has decided to retain Opel and will initiate a restructuring of its European operations in earnest.

“GM will soon present its restructuring plan to Germany and other governments and hopes for its favorable consideration,” said Fritz Henderson, president and CEO. “We understand the complexity and length of this issue has been draining for all involved. However, from the outset, our goal has been to secure the best long term solution for our customers, employee, suppliers, and dealers, which is reflected in the decision reached today. This was deemed to be the most stable and least costly approach for securing Opel/Vauxhall’s long-term future.”

On a preliminary basis, the GM plan entails total restructuring expenses of about € 3 billion, significantly lower than all bids submitted as part of the investor solicitation. GM will work with all European labor unions to develop a plan for meaningful contributions to Opel’s restructuring. While Opel continues to outperform against its viability plan assumptions and immediate liquidity is stable, time is of the essence.

“While strained, the business environment in Europe has improved.” Henderson said. “At the same time, GM’s overall financial health and stability have improved significantly over the past few months, giving us confidence that the European business can be successfully restructured. We are grateful for the hard work of the German and other EU governments in navigating this difficult economic period. We’re also appreciative of the effort put forward by Magna and its partners in Russia in trying to reach an equitable agreement.”

I will be speaking about this issue in an hour’s time on the BBC. But, look at this as a result of economic reflation. GM has exited bankruptcy and feels confident enough of the future path of the economy to keep Opel instead of having to sell in a fire sale. 

The Germans are livid, according to the Wall Street Journal.

The governor of the German state of Hesse, where General Motors Co.’s Opel unit is headquartered, said Wednesday he is "concerned and at the same time annoyed that the months-long efforts to find a good solution for Opel have failed because of GM."

In a statement, Roland Koch, a confidant of German chancellor Angela Merkel, said that considering the "negative experience in recent years with GM’s corporate policy, I’m worried a lot about the future of (Opel) and its staff."

In a surprise move, GM’s board late Tuesday decided it wants to retain its core European operations after talks over a possible sale have been dragging on for months.

Koch said he expects GM to repay by Nov. 30 the bridge financing provided by the German state "so that the German tax payer doesn’t get harmed."

Remember that other EU countries came out of the woodwork saying, in effect, that the Germans had bought off GM and were being advantaged by unfair subsidies while in places like Belgium and Spain workers were suffering.

Very interesting. More after the BBC show!

Related posts:

• GM considers keeping Opel, raising capital
• GM looks to use US and Canadian tax money to bailout Opel
• Economic nationalism and GM’s decision to keep Opel and Vauxhall
• Germans reject Chinese offer for Opel
• Germany gives GM a stiff arm on state aid

Paul Krugman has noticed that trade has absolutely collapsed with this economic downturn. It is worse than the Great Depression.

Question: is this aiding global re-balancing?

Here are two data points from Europe today which lead to that question.

The BBC reports on Germany:

Germany’s trade surplus fell 43% in August after a drop in exports from Europe’s biggest economy, according to the national statistics office.

Germany exported 8.1bn euros (£7.45bn;$11.95bn) more goods than it imported in August, down from 14.1bn euros in July.

The fall in exports was the first for four months and had not been expected.

Most focused on whether this trade reduction, especially the decline in export from export-powerhouse Germany meant that recovery has stalled.  I think the more important question is whether the trade flows are representative of re-balancing.

On that same subject, we get data from debtor Britain via the Guardian saying the current account imbalance is also narrowing:

The trade deficit has narrowed during the financial crisis from £8bn to £6.2bn in the year to August, while the tentative global recovery is also helping exporters.

Britain’s trade deficit with the rest of the world narrowed modestly in August to £6.2bn as exporters sought to capitalise on the sliding pound, and the recovery in overseas markets.

Yawning trade deficits have been a symptom of Britain’s out-of-kilter economy over the past decade. Mervyn King, the Bank of England governor, has repeatedly said he would like the weakness of sterling to bring about a "rebalancing" in the economy, by boosting exports.

The trade deficit in goods has been narrowing since the crisis began, and official figures released this morning showed that it was £6.2bn in August, down from £6.4bn in July, and more than £8bn in August 2008.

The ONS said exports actually fell, by £100m over the month, but imports fell faster, by £300m, as consumers tightened their belts. However, Vicky Redwood, of Capital Economics, pointed out that exports rose by 1.6% in the three months to August – the first quarterly rise in over a year.

It certainly helps that the pound has fallen apart, but the decrease in Britain’s current account deficit is mirrored in debtor America as well.  So, while trade flows are diminishing, so too are trade imbalances.

Related posts:

• European-Asian trade falls off a cliff
• The Euro and Baltic currency overvaluation
• When will Sterling hit Euro parity?
• The Cult of Zero Imbalances
• Germany: Inflation tames retail sales

Below is a Market Watch video showing what ordinary Germans think heading into the general election.  Right now it’s looking like a right of center government of the CDU/CSU/FDP.  But, it will be down to the wire. Likely, there will be little change in economic policy, regardless of the result.

Related articles

Merkel Votes Scarce in Eastern Region – WSJ

German voters shun financial crisis debate – Japan Times

German election roundup – A Fistful of Euros

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Now that it has emerged from bankruptcy and received free money from the Federal Government, General Motors is seriously thinking about keeping Opel by raising capital.  The German government has been urging GM to make a decision about the bids it received for GM Europe from Magna, the Germans’ preferred bidder. But, the company has dragged its feet. We now know why.

According to the FT, one plan has GM stiff-arming the German government and raising 3 billion euros of capital.

The US carmaker and its advisers are studying a scenario that would see GM abandon the German plan and instead raise roughly €3bn ($4.3bn) of rescue funds for Opel and its British Vauxhall brand from the US and other European governments, including the UK and Spain.

I can’t imagine this sits well with the Germans as they should feel like GM has not exactly considered them at all in its plans.  This is certainly going to have repercussions for German elections coming forward. The FT says:

Were GM to abandon the German-backed sale process, it would be an embarrassment for Angela Merkel’s government.

As for GM, it does seem to be a good move.  Having secured huge concessions from unions and bondholders, the company is in better shape.  What’s more, it has received direct aide from the U.S. and Canadian governments and is further benefitting from government largesse due to the just-ended Cash for Clunkers scheme. 

With equity markets soaring, I bet they could even try raising money in the capital markets.

Related posts:

• GM headed for bankruptcy
• GM board decides to keep European Opel unit
• GM looks to use US and Canadian tax money to bailout Opel
• Germans reject Chinese offer for Opel
• German Press: Fiat to sign a deal with Opel, not Chrysler

The list of countries with deflation is growing by the month.  We have Spain, Switzerland, Britain, Ireland.  Now add Germany.

German consumer prices fell for the first time in 22 years in July, official figures have shown.

Prices fell 0.6% in July from a year earlier – the first fall since March 1987, when they declined by 0.3%.

The decline was largely due to falls in energy prices, which peaked in summer 2008, and analysts said Germany was unlikely to see a deflationary spiral.

Prices can fall for a short time without hurting the economy, but prolonged declines can be damaging.

Dirk Schumacher, an analyst at Goldman Sachs, said that the falling prices could help the economy in the short term.

"Falling prices are aiding consumer confidence and purchasing power. That’s aiding consumption," he said.

"This is not deflation. We’re still far away from that. It’s no cause for alarm," he added.

Right.  Keep telling yourself that.

Prices are falling.  This is deflation and it should underline for anyone with half a brain that deflationary forces of demand growth declines, deleveraging and overcapacity are still at work.

Source

Consumer prices fall in Germany – BBC News

Related posts:

• Switzerland gets deflation too
• U.S. CPI: Lowest since 1954 – deflation here we come
• Ireland gets deflation
• Britain gets deflation
• US consumer prices down 1%, core prices also down

Alcohol used to seen as a recession-proof good. This downturn is changing that thinking as evidence of cutbacks in spending, consumption, and on-premise drinking abound.  Back in the Spring of 2008, Nielsen conducted a bunch of surveys to see how the economy was affecting the consumption of wine and spirits.  The answer then was it was not yet a major impact. The Blog “Wine & Spirits Daily” reported:

When it comes to wine, 49% said the economy has had “no effect” on the amount they spend, while 37% said “just a little” and 13% said “significantly.” With spirits, 48% reported “no effect,” while 34% said “just a little” and 17% claimed a significant difference in spending. Beer, meanwhile, had 47% of consumers reporting that their spending hadn’t changed, while 40% said “just a little” and 13% said “significantly,” according to Nielsen.

But, by January of 2009, the industry was reporting a change in dynamic.  The Associate Press put out a story called “Is the alcohol industry recession proof?” which showed major impact being felt in the industry.  The big change in behavior is what is called off-premise drinking i.e. carry-out beer, wine and spirits instead of drinks in restaurants and bars in order to cut costs.

Consumers are eating out less as they try to save money, and when they do go, Cressy said, they’re limiting what they order. On-premise volume fell 2.2 percent last year.

Instead, people are drinking at home and buying from stores.

Off-premise volume rose 2.9 percent for the year.

So people are drinking, but they’re paring back, said David Ozgo, the council’s chief economist.

The number of drinking occasions is falling; he said he wasn’t sure yet how much they were dropping.

"They still want to have a good time, so a certain amount of those drinking occasions will be shifted to at-home," he said…

And the beer industry isn’t recession proof either, figures show. Earlier this month, SABMiller PLC, the maker of Miller Genuine Draft and Peroni Nastro Azzurro, said its beer shipments fell unexpectedly in the most recent quarter amid a worldwide slump in consumer spending.

And I know this trend has continued.  A source in the industry told me last month that her company was focusing on off-premise premium brands to add sales.  The point is to get customers to choose a premium brand in a higher price point now that they are spending less due to the off-premise drinking.

However, when it comes to beer, people are trading down. Real Time Economics says “Sorry, Bud: Natty Light Isn’t Just for College Anymore.”

Heineken sales sank 18% from the previous year in grocery, convenience and drug stores during the two-week period ended July 5, followed by Budweiser at 14%. Corona Extra sales dropped 11%, while Miller Lite declined 9% and Bud Light fell 7%. Coors Light sales held up better, falling less than 1% from a year ago.

Meanwhile, sales of “subpremium” beers including Busch, Natural Light and Keystone posted “substantial gains”, according to Ad Age, which didn’t provide the specifics.

It’s a sign that despite the cheap, frat-party image of those brands (and debatable taste), consumers are focused on one thing right now: the bottom line.

Clearly, people still want to get a buzz, but they are not willing to pay the same price for that buzz.

Nevertheless, alcohol consumption is down – not just in the US, but globally. Another source who works at a major national beer distribution center in German told me a few months ago that staff was being cut as sales are down there. This pattern In the land of Oktoberfest was confirmed by the recent report showing German beer consumption is now down. 

According to German-language weekly Spiegel, beer consumption is down 5% this year.  This decline in beer consumption in Germany is the most on record. All of the major German-owned brands are getting killed: Veltins (–6.5%), Krombacher (-53%), Bitburger (-4.6%), Warsteiner (-6.5%), König (-6.7 %) und Jever (-7 %).

There are some clear trends from the anecdotes and data; people are indeed cutting back on consumption, trading down, and going off premise.  However, the loser here is less the wine and spirits makers and more the hotels, restaurants and bars. The pullback in alcohol consumption and sales is another sign that the travel and leisure industry is due for more pain to come.

Related posts:

• Conspicuous consumption in China
• Germany: Inflation tames retail sales
• April U.S. retail sales: upside surprise?
• The Economy’s Four Horsemen
• Why the personal consumption data is important to the stock market

Germany never participated in the upswing of the housing bubble. This fact has led German politicians of all stripes to mistakenly believe their banking system was somehow immune to the problems infecting bubble markets like the US or Spain.  Unfortunately, it has not worked out that way because the globalization of finance has shifted risk far and wide within the global financial system. 

German banks have long had low returns on assets with bloated balance sheet and low margins in both retail and wholesale banking, particularly at the state-owned Landesbanken. This has caused the largest German financial institutions to either move into investment banking or reach for yield abroad. 

During the credit bubble years that meant loading up with higher yielding but supposedly bullet-proof AAA paper in markets like America’s residential mortgage-backed security market.  Unfortunately, many of these assets were toxic. And as these market bets have gone pear-shaped for Germany’s banks, these poorly capitalized institutions have become weak, limiting their ability to serve their traditional function domestically.

To date, there has been relatively little open debate about how sick the German banks are. Sure, HRE has been nationalized and Commerzbank has been topped up with cash.  But, the Landesbanken have become a bottomless pit, with repeated bailouts having been necessary. Government officials have threatened the Landesbanken. But little else has been done. Most German leaders – politicians, bankers and academics, have had their heads in the sand, thinking minimal recapitalization and reform efforts along with manoeuvres to fix a few bad apples would do the trick.

Have things now changed?  Read the excerpt from an FT editorial below. It was written by the president and research director of Financial Markets at DIW Berlin, the German Institute for Economic Research. I see this as a very public call for reform by high profile German finance professionals.  Let’s see what kind of response it receives.

Germany has seven independent state banks, or Landesbanken, which are jointly owned by the state governments and the savings banks. Established to provide state guarantees for regional business development, this practice was essentially outlawed by the European Commission back in 2002. Since then, Landesbanken have faced corporate governance problems. For example, the advisory boards of Landesbanken are supposed to control the top management but professional expertise plays no role in the allocation of seats. In some Landesbanken, neither the management nor the board had reliable information about their holdings of subprime mortgage products when the crisis hit.

Worse, the already doubtful sustainability of their business model – international wholesale banking – has been shattered by the financial crisis.

To compensate for their low rates of return compared to private banks of equal size, many Landesbanken before the crisis created structures to hold assets outside their balance sheets. Protected by state guarantees, they borrowed large sums of money in capital markets, which they invested in supposedly high-yielding subprime products with good credit ratings. When the products were subsequently downgraded, two state banks were forced to merge immediately. Four of the remaining seven state banks lost much of their equity and had to be bailed out by various state governments with tens of billions of euros.

This situation could get much worse: If the Landesbanken fail to clean up their balance sheets, the next decline in equity capital could prove lethal. To avert such an outcome, it is imperative to establish a “bad bank” to receive their toxic assets – and then continue the clean-up by reducing the number of Landesbanken through mergers.

The full Op-Ed is provided at the link below with recommendations and preamble lamenting a similar lack of reform-mindedness in America.

Source

No time to waste in reforming German banking – Klaus Zimmermann and Dorothea Schäfer, FT

Related posts:

• The Germans get tough with the state banks
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Every country has a problem child or two in the financial services sector. America has Citigroup and Bank of America. Britain has RBS and HBOS/Lloyds.  And Germany has Hypo Real Estate. 

I have been chronicling problems at the real estate lender on this blog for some time now and last posted on HRE in April (“HRE: defusing the German financial time bomb”).  Back then, the German government was looking to step in and effectively nationalize the company.  Subsequently, on June 23rd, Hypo Real Estate warned of heavy future losses. Having already received €100 billion in support from the government, you could be forgiven for thinking HRE is a bottomless pit. 

Now that the company is a ward of the state, taxpayers are on the hook for another 10 billion. But, Hypo Real Estate’s plight reveals stresses in Spain as well. Ambrose Evans-Pritchard reports.

"The bank clearly has a solvency problem," said Michael Endres, head of the board in an interview with Welt am Sonntag. "It wouldn’t surprise me if a capital injection of €10bn proved insufficient."

Meanwhile, the extent of credit damage in Spain is becoming clearer after America’s GMAC revealed that it had been selling Spanish mortgage assets at 14.5 cents on the dollar as it withdraws from global ventures to focus on the US home market.

Until now, it has been hard to measure the extent of the "haircuts" being suffered on Spanish mortgage securities since there is no obvious gauge such as the ABX Index used to track sales prices on US subprime and Alt-A debt.

The GMAC sales suggest that Spain’s property crash will inflict large losses on foreign creditors, mostly from Germany and France. The Spanish government has long insisted that higher credit standards in Spain have spared the country the sort of debacle seen in the US.

Hypo Real’s Mr Endres said earlier management had expanded at breakneck speed in foreign markets that they never understood, wading cluelessly into US housing through its Dublin operations. "The property market is like farming: you don’t buy a field until you have walked around it a few times," he said.

First of all, I would love to know what GMAC is doing in the Spanish mortgage market. Considering GMAC just got a second bailout in May, American taxpayers have the right to know what GMAC is doing and where. 

The revelation of GMAC’s involvement also makes clear how intertwined the global financial system is – an American auto lender gets a bailout and then dumps Spanish mortgage assets for a ridiculously low price. These losses make clear that a reckless German real estate company speculated away billions in the same foreign market, turning it into a government-owned company and requiring yet more money from German taxpayers.

But, I should also add that 14.5 cents on the dollar is extremely low given the fact that Spanish house prices have only fallen 13% to date (see my post “House price declines accelerate in Spain”).  What does that tell you about likely losses in the Spanish banking system going forward?

Related posts:

• Hypo Real Estate: 600 billion in off-balance sheet assets
• Germany: banking system collapse possible due to Hypo Real Estate
• Spain: Bleak forecast puts unemployment at 22% in 2010
• House price declines accelerate in Spain
• More problems at three European financial institutions

Roland Koch, the leader of the German state of Hesse, has dismissed the possibility of Chinese auto manufacturer BAIC acquiring German carmaker Opel.  Below is my translation of today’s Spiegel article explaining this.

Clear rejection of the Chinese: Hesse Prime Minister Koch has rejected the takeover offer for Opel by the car manufacturer BAIC. If someone seriously put in a word on behalf of the candidate from the Far East, it would be “an amazing thing.”

The Austro-Canadian auto supplier Magna can rely on the support of the ‘German princes’: In the takeover battle for Opel the chances of other candidates is dwindling. In a newspaper interview, Hesse Minister President Roland Koch (CDU) categorically rejected a takeover by the Chinese manufacturer BAIC.

The new European Opel could not be managed by a Chinese company, “that produces just 12,000 cars per year and do not even have the backing of the Chinese government,” Koch said to Hamburg’s Abendblatt newspaper. It would be “an amazing thing,” if anyone seriously believed in this solution.

An entry of Magna would be “the best solution, looking at the future of Opel, the locales concerned, and jobs in Germany, not least because of taxpayer money,” said Koch. Magna dealt “quite concretely with the American parent company, GM and has a big advantage over other bidders.” Koch acknowledged, however, that it is “still a long way” until Opel is rescued.

However, the opposition does not agrees with this strict interpretation of events. The chairman of the Bundestag’s budget committee, Otto Fricke (FDP), said to the “Rheinische Post”: “If the federal government does not even try and speak with the Chinese, it would be needlessly risking almost two billion euros in tax money.” While Magna, in the event of a takeover of Opel, requires guarantees by the German taxpayer in the amount of 4.6 billion euros, BAIC is requesting only 2.64 billion euros.

Even the Federation of Taxpayers urged the federal government to no longer unilaterally look at Magna. You must ensure that the best concept would be implemented for Opel and the taxpayer , said President Karlheinz Däke. Previously the CDU politician Mittelstandsbank Michael Fuchs and the Economic Council of the Union, which deals with the bidders competing with Magna, had requested re-examining the competing offers.

On the other hand, Prime Minister of Thuringia Dieter Althaus (CDU) said in the “Thüringer Allgemeine” that the decision for Magna as an investor is made. He expressed his expectation that outstanding issues will be resolved by next week. . Althaus was “surprised” about the objections raised.

This article makes clear that the GM Europe/Opel bailout and sale is very much a political event.  Just Wednesday in a post about the Rio Tinto situation, I mentioned that the Germans should handle the Chinese bid with care lest they be rightfully accused of protectionism.

Apropos protectionism, the German government has now confirmed an official bid for automaker Opel by a Chinese car company, Beijing Automotive Industries (BAIC). As the Chinese have become noted of late for being the high bidder, I suspect BAIC has put in a good offer. (Update 920ET: The Telegraph puts this offer at €660 million for all of GM Europe including Vauxhall) To be sure, the Austrian-Canadian auto parts maker Magna is on the verge of finalising its bid.  Nevertheless, the Germans are going to need to treat the Chinese bid with diplomatic aplomb.  We have already seen enough protectionism against Chinese companies.  Another slight of this nature would be proof positive that Chinese money is considered no good for buying top-tier western companies.

While some had conjectured that the BAIC bid is really a Chinese government bid, the Chinese automaker has no backing from the Chinese government, as Roland Koch alluded.  Koch claims this is a negative, but he is just rationalizing his decision to dismiss the bid out of hand.  In truth, the lack of involvement of the Chinese government would be seen as a good thing to most concerned parties.

The fact is the Chinese have put a superior offer to Magna’s on the table.  But, because of protectionism, this offer has zero chance of being accepted by the Germans.

Source

Koch lehnt chinesischen Einstieg bei Opel ab – Der Spiegel

Related posts:

• China detains Rio executive on suspicion of espionage
• Germany gives GM a stiff arm on state aid
• GM considers keeping Opel, raising capital
• German Press: Fiat to sign a deal with Opel, not Chrysler
• GM looks to use US and Canadian tax money to bailout Opel

Rio Tinto was one of those companies which levered up just as the economy was turning down, rushing its bottom line ad forcing it into the hands of Chinalco, a large Chinese commodities company.  However, as commodity prices have turned up and investors have simultaneously started buying shares, Rio was able to escape the Chinalco deal ad link up with rival BHP Billiton.

The Chinese are naturally sour, despite earning a nice deal breakup fee.  The question is whether their displeasure has taken a dangerous turn.  At the weekend, four Rio executives in China were detained.  Now, one is being held on suspicion of spying.

An Australian Rio Tinto employee has been detained by Chinese state authorities on suspicion of espionage and stealing state secrets, Stephen Smith, Australian foreign minister, said on Wednesday.

Stern Hu, an Australian citizen who is working as a marketing executive with the miner and currently living in Shanghai, is one of four Rio employees detained by Chinese authorities since Sunday.

Mr Smith ruled out any commercial link between the surprise detention of Mr Hu and his three colleagues and any commercial matters concerning Rio’s, bitter rejection of a $19.5bn deal with the Chinese state-owned minerals giant Chinalco last month.

They would say that, wouldn’t they.  The sequence of events should make one sceptical about why Mr. Hu is being detained.  Until this matter is adequately explained, we should all be vey nervous about what it portends regarding future Chinese retaliation for protectionist measures.

Apropos protectionism, the German government has now confirmed an official bid for automaker Opel by a Chinese car company, Beijing Automotive Industries (BAIC). As the Chinese have become noted of late for being the high bidder, I suspect BAIC has put in a good offer. (Update 920ET: The Telegraph puts this offer at €660 million for all of GM Europe including Vauxhall) To be sure, the Austrian-Canadian auto parts maker Magna is on the verge of finalising its bid.  Nevertheless, the Germans are going to need to treat the Chinese bid with diplomatic aplomb.  We have already seen enough protectionism against Chinese companies.  Another slight of this nature would be proof positive that Chinese money is considered no good for buying top-tier western companies.

Source

Rio executive held by China on suspicion of spying – FT

Related posts:

• Should we expect a protectionist China?
• Germans reject Chinese offer for Opel
• China wants all of Repsol’s Latin American oil assets
• China slams U.S. profligacy
• China’s skyscrapers will be ten times New York

You probably saw in my links that Fiat had bowed out because of German government demands. The Magna story also comes via the BBC:

Canadian car parts maker Magna International is the preferred bidder for GM Europe, owner of Opel and Vauxhall, Lord Mandelson has said.

The UK business secretary said a deal between Magna and GM was very near.

He was speaking after reports that Magna had reached an agreement in principle to rescue GM Europe.

The other potential bidder, Fiat, did not attend Friday’s talks with the German government, saying Berlin’s position was "unreasonable".

GM in the US is expected to declare Chapter 11 bankruptcy on Monday.

Here is the associated video of Lord Mandelson spinning the details about how government in the UK sees things.

Related posts:

• GM considers keeping Opel, raising capital
• German Press: Fiat to sign a deal with Opel, not Chrysler
• Opel and Fiat spells bankruptcy for Chrysler and GM
• Fiat as the engine for change in the auto industry
• Germans reject Chinese offer for Opel

I was on the BBC yesterday talking autos and my commentary was almost entirely political.  So, as we await the likely General Motors bankruptcy, I think it bears discussing how political this process has been and will continue to be.

General Motors is a monster company employing a quarter million people worldwide.  It sells $150 billion in cars – or at least it used to. It is not just a producer of vehicles.  It is also a supplier.  It has been through several joint ventures and has owned a number of foreign manufacturers, Isuzu and Opel being but two. In short, the company is a very big player, financially, economically and politically.  Yet, somehow you get the impression that many in the financial media think we could just turn the lights out and go home.  Witness the video below of CNBC anchors Mark Haines, Erin Burnett and Phil Lebeau and a trio of auto analysts trying to impress upon Haines how important GM is.

The GM bankruptcy is a very big deal and will have wide-ranging implications.  Let me review a few of the issues here starting with the politics.

2010 elections

In the U.S., we have just witnessed an historic election that some are comparing to the election of Ronald Reagan in 1980 and Franklin Roosevelt in 1932.  Indeed, there has been a sea change in the political climate here in Washington since January, with the Democrats and their agenda taking precedence over the Republicans.  But, none of that is going to last if we don’t see a recovery that lasts through the mid-term elections in 2010. And that is already very much on the minds of politicians in Washington.  Here is the calculus.

In 2008, the Democrats benefitted greatly from Barack Obama’s election as President, taking large majorities in both houses of Congress.  Their mandate was to work with the President to fix America’s economic problem.  So, Obama’s and Congressional Democrats’ first priority is to end the recession as quickly as possible.  I guarantee you there would be hell to pay if this is not done well before November 2010 when the next general election is held.

From Obama’s perspective, it is crucial that he fix the banks and fix the auto industry as these were the two economic issues front and centre in the election which he said he could tackle.  With the banking industry stabilised, the Obama legacy rides crucially on how the Auto Bailout proceeds. Under no circumstances is the Obama Administration going to allow General Motors to do to the economy in 2009 what Lehman Brothers did to it in 2008. They are going to fix GM no matter what it takes.  And if this includes heavy-handed tactics, so be it.

So, be very clear that the GM and Chrysler issue is an existential question for this administration.  Handle it well and you get the Roosevelt treatment and ensure a good outcome for your party in 2010.  Screw things up and the depression bears down on America and you’re out of office in due course.  The key policy decision is how to ensure a favourable outcome. And when I say favourable, I mean one that ensures as many jobs as possible while minimizing any wider economic fallout.  Other issues like treating bondholders well, not committing taxpayer monies to the effort, or keeping government out of the auto industry are going to be much less important.

German General Election

And if Obama is concerned about his political fortunes because of an election next year, you can bet that Germany’s Chancellor Angela Merkel is concerned given her election is later this year. In Germany, cars have a mythical status.  The Autobahn was begun in the Depression as a way to jumpstart the German economy. The first such road was completed in 1931 between Bonn and Cologne, a road I drove I have driven at least 2 or 300 times (it is a great road for fast driving, by the way, and was opened by Germany’s first Chancellor Adenauer when he was Mayor of Cologne.  I believe the Bonn Porsche dealership is literally a few hundred meters from the entrance).  Shortly thereafter, also during the Depression, the Germans began the car company Volkswagen (literally “the people’s car”) as yet another car-oriented way to jumpstart the economy.

Today there are hundreds of thousands of jobs in Germany tied to the auto sector, which has huge importance in the Rhineland, Germany’s industrial heartland and part of the most populous German state North Rhine-Westphalia, as well as in Lower Saxony, Bavaria, and Baden-Württemberg.  In short, destroying auto jobs is a sure-fire way to lose an election.  The ruling coalition is keenly aware of this and that is why they too will be very involved in the GM bankruptcy as it affects Germany through GM subsidiary Opel.

Below is the video of me discussing this yesterday on the BBC (I know I should put these videos up more often, so I promise to get a hold of the footage or audio whenever I do a media appearance).

And I haven’t even mentioned the politics in Sweden, the U.K., Austria, Canada or Italy where this expected bankruptcy is equally important.

As for the finance side of things I only want to highlight a single issue, credit default swaps.  Back on April 30th, I wrote an article called “CDS contracts and the implosion of several Eastern European economies.”  In it, I argued that the ‘insurance’ of credit default swaps changed creditor behaviour in a way that made bankruptcy more likely.  I also warned that credit default swaps were going to be an issue in the Chrysler and GM bankruptcies (for a German-language take on the same, see Blicklog’s “Warum Gläubiger von GM ein Interesse an der Insolvenz haben“).

Think about this for a second: what if CDS contracts were exchange-traded?  Then, we would know exactly who held what CDS exposure.  So the motives of creditors would be made much more transparent and I believe this would help to prevent bankruptcies. The likes of Whitney Tilson, managing partner of the hedge fund T2 Partners, have been making similar noises of late.  If any financial reforms do indeed result from this financial crisis, my hope is that this be one of them.

Related posts:

• Bank failures to surge in coming years
• Bloomberg is coming down hard on Goldman
• Obama Team considering a pre-pack Auto bankruptcy
• Fannie and Freddie: The politics of finance
• Roland Burris: more political tomfoolery in the U.S.

Volkswagen and Porsche have finally hammered out a merger plan after some bitter infighting. My understanding is that the new company will carry the Porsche name and trade under its ticker symbol. In addition, the company plans to raise more capital to pay off debt before the merger goes through. Why Porsche took on so much debt is beyond me.  Just this past March they had record earnings due to some hedges they took out on their purchases of shares in VW.

Reuters reported then:

Porsche SE landed a 6.8 billion euro ($8.99 billion) windfall from its share options in Volkswagen during the first half, lifting its pretax profit to more than twice its revenue.

The European automotive group said on Tuesday that earnings before tax rose to 7.3 billion euros in the six months to end-January, easily surpassing the average estimate of 3.65 billion euros from a Reuters poll of 11 analysts.

Volkswagen’s pro-rata earnings contribution to Porsche fell to 444 million euros from 484 million euros a year ago.

Late in October, news that Porsche had secured access to about 74 percent of VW ordinary shares — draining the company of almost its entire freefloat — led the stock to quintuple within 48 hours to 1,000 euros per share, briefly making the Wolfsburg carmaker the most valuable company in the world.

Porsche then sold a small package of VW cash-settled call options to relieve buying pressure, sparking outcries from investors such as Deutsche Bank’s German retail fund business DWS that the carmaker had manipulated the market and broken securities trading laws.

Although the German securities regulator Bafin began an official investigation, no findings have been published, and Porsche has repeatedly protested its innocence. Porsche, which last reported early in January that it had increased its direct stake in VW votes to over 50 percent, encountered problems last week rolling over a 10 billion euro credit line and had to increase its pool of lenders to clinch enough commitments.

The merger is definitely a consolidation play as it unites 10 brands under one roof including the main brands of Porsche, Audi, and Volkswagen.  Porsche and Volkswagen already share platforms like the Touareg/Cayenne and parts in order to reduce production costs.  However, with the two now one company you can bet their will be more cost savings.  I have yet to hear any talk of headcount reductions given that VW and Porsche operate in very different markets.  Obviously, as Lower Saxony has a blocking minority interest in VW, and given we are in an election year in Germany, major cuts are not likely.

See the BBC video below for more details.

Related posts:

• No one gets a bonus at Commerzbank and no dividend either
• Volkswagen: if the American carmakers can get bailout funds, so can we
• Deutsche Bank buys Postbank
• Fiat as the engine for change in the auto industry
• Are covered bonds really the solution?

Last week I wrote a post suggesting that the Germans were getting tired of bailing out their banks and had moved to more draconian solutions to ‘fix’ the banking sector. Nationalizing Hypo Real Estate this week will be the first move in that direction.

But the Germans are not nearly finished in their effort to clean house. Next on the list are the state banks, the Landesbanken.

The Financial Times reports:

The German government has issued an ultimatum to the country’s seven Landesbanken to agree by July to consolidate the troubled state-owned banking sector or face exclusion from Berlin’s plan to take toxic assets off banks’ books.

Government officials told the Financial Times that four of the banks held so many troubled assets that it was “impossible” to see how their owners – German regional governments and municipal savings banks – could save them without Berlin’s help.

For the first time, Berlin had “a very good chance” of forcing the Landesbanken to shrink their balance sheets and merge into “one, two or three” banks by 2012, an official said. They would be “German players with some European scope”.

The merger of the sector into one federally-owned Landesbank would create one of the world’s biggest banks by assets, although any resultant entity would have to shrink rapidly.

For those like me who have been very critical of the slowness of European governments to take matters in hand in this banking crisis, this should be viewed as good news. In a recently leaked document, it was HRE, the Landesbanken and Commerzbank with the lion’s share of potentially crippling toxic asset exposure.

Now, it looks as if HRE and the Landesbanken, have been taken care of.  Commerzbank is the only problem child left to solve.

Source
Berlin issues ultimatum to Landesbanken – FT.com

Related posts:

• Germans must get their head out of sand on banks
• German banks loaded with 816 billion in toxic paper
• Commerzbank gobbles up Dresdner
• The German $400 billion toxic asset time bomb
• Germany partially nationalizes second-largest bank

The first bank nationalization in German history is about to take place. At issue is Hypo Real Estate (HRE), a troubled Munich-based company that lends to commercial property developers and to build offices, hotels, roads, airports, you name it.

This issue has been building for nearly 7 months. Back in late September, just after Lehman went under, the Germany government was forced to bail HRE out as it ran into funding problems at its Irish subsidiary, Depfa. Since then, the situation at HRE has gotten considerably worse. Cognizant that it had a Lehman situation on its hands, the German government went so far as to change the laws to allow it to nationalize HRE. This is about to happen.

The Financial Times writes:

The government has given HRE shareholders until May 4 to accept the offer. As of Thursday more than 7.5 per cent of HRE shares had been tendered, giving the government control of 16.2 per cent of the company. It already held a stake of more than 8.6 per cent after a small capital increase last month.

At the end of the offer period the government hopes it will control enough HRE votes to force through a much larger capital increase at a shareholder meeting. It could eventually use “squeeze-out” rules to force out JC Flowers and other remaining minority shareholders.

If this does not work – as it may not, if enough shareholders reject the tender offer – a recently passed law will allow expropriation of HRE shares. It would be the first nationalisation of a German bank since the 1930s.

Expropriation would be compensated but the government has warned this is likely to be at a lower price than that proposed in the tender offer.

The US firm hinted at a legal challenge to try to stave off expropriation, pointing to expert opinions that “indicated considerable reservations” about the expropriation law and another piece of legislation approved last month. “JC Flowers is reviewing, in the interest of its investors, all options,” the firm said.

Some JC Flowers investors, holding less than 1 per cent of HRE shares, will accept the government’s offer.

I have written a number of posts about the situation at HRE:

• European banking collapse including nationalisation of three banks – 29 Sep 2008
• Germany: banking system collapse possible due to Hypo Real Estate – 4 Oct 2008
• The Germans guarantee all savings deposits – 5 Oct 2008
• The German $400 billion toxic asset time bomb – 17 Jan 2009
• Hypo Real Estate: 600 billion in off-balance sheet assets – 20 Feb 2009
• More problems at three European financial institutions – 29 Mar 2009
• German banks loaded with 816 billion in toxic paper – 26 Apr 2009

I have been following this story closely because I used to work for the predecessor bank of HRE. In the mid-1990s, I worked at a consulting company in Munich under the now head of HVB Group in a project to re-engineer HRE predecessor Bayerische Vereinsbank’s credit processes. My boss, an extremely decent man, later moved on to Goldman Sachs and then over to HVB as their CEO.

I mention this because I see HRE’s problems as linked to its predecessor organizations and the culture of risk that developed after the Berlin Wall fell. Obviously, this is just my view given that I in no way have worked for HRE.

Here’s my understanding of the matter. Bayerische Vereinsbank and Bayerische Hypothekenbank both ran into trouble due to ‘Verspekulierungen (bad speculation)’ in the period immediately after German re-unification. Vereinsbank and Hypobank were front and center in the speculative property bubble that developed in the former East Germany after the Wall fell. This was one reason my consulting firm was working at Vereinsbank.

In 1996, Hypobank revealed huge losses in eastern Germany even though the Board of Directors had been aware of the problem since early 1994 (does this sound familiar).  In fact, fraud was a factor at Hypobank.

Vereinsbank had their own problems.  So, subsequently, in 1998, those two organizations came together as Hypo Vereinsbank (later HVB Group) in a merger of necessity despite being bitter crosstown rivals. They are the largest banks in Bavaria with a long crosstown rivalry and history dating back to 1780 at Hypobank and 1869 at Vereinsbank.  The deal was touted as a Munich counterweight to the big three German banks Deutsche Bank, Dresdner Bank and Commerzbank, all based in Frankfurt.

Unfortunately, they were forced to write off 3.5 billion that same year because of Hypo’s eastern German speculation. (Later in 2005, 7 years later, bad bets on the Vereinsbank side were uncovered as well costing the bank 2.5 billion).

Fast forward to 2003 and HVB spins off HRE before HVB itself gets taken over by Unicredito two years later. Now, I haven’t been integrally involved with HVB or HRE since, but again the history of risk taking is there.  And I should mention that HVB and Unicredito are problem children with huge exposure to Eastern Europe.

By 2007, HRE was a force to be reckoned with and they looked to increase in size. They bought Depfa at the top of the market in a deal not unlike the Golden West Financial deal that Wachovia did in 2006.

Now Depfa, which caused HRE’s near collapse in October, is not an Irish company at all. It is in Ireland merely as a tax dodge (another example of how the Irish are massively and unwisely leveraged to the financial services industry). In reality, Depfa is a German institution, the Deutsche Pfandbrief  Bank. (As an aside, back in 2008, Hank Paulson talked a lot about Pfandbriefs as a panacea for the U.S. mortgage market.  I have two posts on that from last summer here and here).

So Depfa was lending long and borrowing short. When Lehman collapsed it ran into liquidity problems, so a consortium of German bank creditors struck a deal to bail out HRE and its subsidiary.  But, this deal collapsed and the German government was forced to step in.

In reality, HRE was a ticking time bomb and this is the reason it had run into liquidity problems (By the way, this is much the way I see Northern Rock – which was also nationalized by the UK government).  The company has massive commercial property (CRE) exposure and the CRE market is imploding in financial centers like Frankfurt, London and Dublin and elsewhere.   HRE is highly leveraged to these places.

HRE is also systemically important because it has a huge loan book in commercial property in Germany, Ireland and in Europe more generally. It also has a lot of off-balance sheet exposure a la Citigroup. Its failure would cause great distress to the market it operates in.

Moreover, it has counterparties and lenders. So, its demise would adversely impact those institutions. I don’t have a list of those lenders in front of me but the consortium banks which failed to bail it out in October are the biggest ones. I’m sure it’s a list of who’s who in German finance.

What has the press left out in all of this? Dunno. I would say the bailout is similar to what we are seeing with systemically important institutions in every single Western country (Fortis in the Benelux, RBS in the UK, Citigroup in the US).  In short, a property bubble and massive bust has meant that the most imprudent lenders now face ruin. Unfortunately, the web of actors in our financial system is so intricate and the imprudent lenders so large that governments are loathe to allow them to simply collapse. The demise of Lehman Brothers has sent a signal that this raises a very real spectre of Financial Armageddon.

Come May 5th, a large part of this problem will be solved for the Germans.  The only German non-state bank left with massive exposure is Commerzbank, and its day is coming too.

Sources
JC Flowers rejects Berlin’s offer for HRE – FT.com
HRE: Die erste Enteignung in Deutschland – Handelsblatt
HypoVereinsbank – Wikipedia (German)
HypoVereinsbank – Gourt (German)
Depfa Bank – Wikipedia (German)

Related posts:

• The German $400 billion toxic asset time bomb
• Commerzbank gobbles up Dresdner
• Germany: banking system collapse possible due to Hypo Real Estate
• German banks loaded with 816 billion in toxic paper
• Hypo Real Estate need for 10 billion also reveals huge problems in Spain

The German car maker Daimler wants to put the Chrysler chapter behind it, so it will give up its remaining 19.9% stake and forgive all remaining loans. See BBC story.

Related posts:

• Volkswagen: if the American carmakers can get bailout funds, so can we
• Foreign Press Alert: 2 Sep 2008 – Germany
• Fiat as the engine for change in the auto industry
• German Press: Fiat to sign a deal with Opel, not Chrysler
• Magna is going to get GM Europe

On Friday, the German daily Süddeutsche Zeitung (SZ) leaked a bombshell – a confidential report by Bafin, the Federal Financial Supervisory Authority, found that German banks were sitting on over 800 billion euros in toxic assets. Just three months ago, the reports coming out suggested the problem was only half as large, 400 billion euros.

This new account has been all over the news in Germany because Germans are becoming quite frightened about the health of their banking system and are angry because the German economy was largely absent from the bubbles of the past decade. Germans are beginning to ask quite openly why banks like Commerzbank and the state-owned land banks as well as institutions like Hypo Real Estate are being rescued with taxpayer money. This is a debate now ongoing in a number of countries, the U.S., the U.K. and Ireland most prominent among them. In an election year in Germany, this issue is sure to have an impact.

The account in SZ reads as follows (my translation):

Giant Billion euro risk: The financial crisis has hit German banks far harder than was previously known. Loans and securities in problem areas add up to 816 billion euros, according to a Bafin paper made available to the Süddeutsche Zeitung.

The financial crisis has hit German banks significantly harder than was previously known. This news comes from an internal study from the Financial Supervisor Bafin. The paper first gives an overview of which loans and securities institutions own in the problem lines of business. Their risk adds up to 816 billion euros. Particularly affected are HRE, several Landesbanken Bank and Commerzbank.

At Commerzbank alone, according to the Bafin study available to the Süddeutsche Zeitung, there are securities and loans worth 101 billion euros affected by the financial crisis. This includes 49 billion euros from the balance sheet of the acquired Dresdner Bank. Commerzbank is, thus, similarly affected by the financial crisis as the Land Bank of Hamburg and Schleswig-Holstein, HSH Nordbank, for which Bafin tallies 105 billion euros.

In Westdeutsche Landesbank with 84 billion euros and the Landesbank Baden-Württemberg with 92 billion euros, the supervisors see risks of a similar magnitude. Much better are Deutsche Bank with 21 billion euros, as well as Postbank and Hypovereinsbank with five billion euros each. The worst according to the Bafin paper, prior to nationalization, is Hypo Real Estate (HRE), which holds 268 billion euros in problem assets.

Banks back out bill

Most of the 17 listed banks reject the figures as misleading. “We do not know who put the figures together and they cannot be verified,” said a spokesman for Commerzbank. HSH Nordbank said the bank auditors and Rescue Fund Soffin of HSH had sufficiently and adequately accounted for losses. Other institutions have referred to figures in their annual reports or that they had secured the facilities.

Commerzbank has received state aid of 18.2 billion euros to date. In its annual report the Bank itself had broken down risks and pointed to other “significant liabilities” that threatened different areas of the securities and credit business. However, among banks, investors and supervisors it is still controversial as to which paper can be understood as junk.

A Bafin spokeswoman said to SZ, that the figures do not deal with actual or potential losses. The data also could not be used “to draw conclusions about the creditworthiness of banks.”

Study of great significance

The internal study is of great importance for the government. The calculations by Bafin flow into the plans for the establishment of so-called Bad Banks — repository institutions for problem assets. According to the plans of the Ministry of Finance, only about one third of the assets listed in the document will come into question for removal into a bad bank. The government wants, with the help the Bad Banks, to restore the function of financial markets and lay the foundation for a rebound.

The figures from Bafin, are, therefore, no surprise for the government. Even in the documents that Finance Minister Peer Steinbrück had sent Chancellor Angela Merkel weeks before for the preparation of the banking summit on Tuesday, there was talk of 853 billion euros of potentially vulnerable assets. These figures from the beginning of the year, are no longer deemed up-to-date. The paper cites a new measurement date, the 26th of February.

This account should make clear how shaky many of Germany’s financial institutions are. Moreover, it is not altogether obvious which markets are deemed ‘toxic.’ German banks have a lot of residential real estate-related paper. But they also have assets related to the imploding European commercial property market and the Eastern European property markets. I suspect that the problem is even larger than is mentioned here.

If you recall, there was a big dust-up in February over a leaked EU document which suggested there were 16.3 trillion in toxic assets amongst European banks. In my view, the Europeans have their heads in the sand regarding the magnitude of the problem. The banking situation is much worse on the continent than its citizens are led by government to believe.

In any event, Bafin is now seeking to obtain prosecutions for the damaging leak. Forget about the toxic asset problem, go after those who have brought it into the full light of day.

Source
Bilanz des Schreckens – Süddeutsche Zeitung
Bafin erstattet Anzeige – Süddeutsche Zeitung

Related posts:

• The German $400 billion toxic asset time bomb
• Germany partially nationalizes second-largest bank
• The Germans get tough with the state banks
• Are European banks sitting on 16.3 trillion in toxic assets?
• Germans must get their head out of sand on banks

I want to make clear the significance of the Treasury’s Chapter 11 bankruptcy plan for Chrysler if Fiat pulls out.  It will mean massive job losses and and a huge down-tick in consumer demand.  There will be no second half recovery. Geithner and Obama will look very much like greenhorns and lose a lot of credibility.

This is a very real possibility given the statements coming out of the German press.  While the U.S. Government is integrally involved in both the Opel-Fiat-GM and the Fiat-Chrysler love fests, it remains to be seen that they can strike a deal that is agreeable to all parties. These are very, very complicated negotiations, involving legal and employee issues in three different countries.

Handelsblatt, the most widely-read Finance paper in Germany said the following earlier today:

In searching for an investor to survive, first serious interested parties for struggling carmaker Opel have crystallized. Fiat Group and the Austrian-Canadian auto supplier Magna are the hot contenders for the Rüsselsheimer company. “Fiat and Magna are possible partners. But it should also be clear that there no decisions have been made,” said the Hessian Minister President Roland Koch (CDU). The Rhineland-Palatinate’s Minister for Economic Affairs Hendrik Hering (SPD) also confirmed that Fiat and Magna count as the main contenders for Opel.

An entry of Fiat would be problematic because of its high debt and the excess capacity of the Italians, Herring said through his spokesman Joachim Winkler. Opel employs about 3,400 workers in an engine and transmission factory in Rhineland-Palatinate.

As early as next week, we probably should have a memorandum of understanding between Fiat and Opel signed. Fiat and the management of Opel declined to comment. Opel works council chief Klaus Franz, however, confirmed that Fiat seek a majority takeover. In negotiating circles it is said that Fiat has already been talking with the Federal Government in the past week.

For the struggling General Motors subsidiary, a long-awaited new investor is in its grasp. But the looming entry of Fiat, ensures trouble, even before completion of negotiations: the employees’ side, announced opposition to the Italians. They feared massive job cuts if the majority Fiat took over. Works chief Franz yesterday intentionally brought the talks with Fiat into the public in order to torpedo the unwanted merger.

Amongst deal makers, it is said that GM management in Detroit and the federal government favor a quick solution with the Italians. Fiat managers met yesterday together with Jochen Homann, State Secretary for the Federal Ministry of Economic Affairs, in Washington to deal with the U.S. side over the Italians start at negotiations. The federal government has, in the case of an entry at Opel, made guarantees and is therefore very much involved in the search for investors. Even representatives of the Hessian state government are already in Washington. Opel’s headquarters are in Hesse.

Opel has already scheduled a Tuesday press conference. GM boss Fritz Henderson had said last Friday that the U.S. company is talking with more than six interested parties, for whom it has opened the books. Opel wants to largely decouple from GM and is looking for investors for an independent company in which GM has only a minority participation.

With a merger of Opel and Fiat, two companies would be back together, which split in dispute n 2005. At the time, GM paid 1.55 billion euros, in order not to have to take over the automotive business of Fiat. In 2000, GM and Fiat had started the joint development of engines and transmissions in Europe. At the same time, the U.S. group bought ten percent of Fiat’s shares. Again, this has been reversed. Opel and Fiat are direct competitors in many markets. Works chief Franz is, therefore, afraid of a “dramatic loss of jobs at Opel and plant closures in Germany.”

An Opel-Fiat merger will be resisted by the unions in Germany. But, just as with the Dresdner-Commerzbank merger, this can be overcome if there are no good alternatives.

GM has the best hand here as it is going to get rid of Opel come hell or high water. Fiat is next because they have a choice of Opel or Chrysler. Opel is next because it has multiple suitors lined up and the German government is probably willing to bail it out temporarily if a suitor can’t be immediately. Chrysler and the U.S. Government are in the worst situation because they need a deal desperately. Their best alternative to a negotiated agreement is bankruptcy.

Source
Fiat und Magna buhlen um Opel – Handelsblatt
Fiat in talks to buy Opel and Vauxhall – Guardian

Related posts:

• Opel and Fiat spells bankruptcy for Chrysler and GM
• Fiat as the engine for change in the auto industry
• Chrysler: bulls make money, bears make money, pigs get slaughtered
• Germans reject Chinese offer for Opel
• GM headed for bankruptcy

Press reports coming out of Germany are suggesting that the Germans are looking to hook up Opel with Fiat in order to prevent a lot of job losses when General Motors goes under.  In my view, this means curtains for both Chrysler and GM and could spell some massive increases in jobless claims and unemployment this summer.

GM as already said that it would be shutting down 13 plants this summer to work off inventory. But, a GM bankruptcy would guarantee a lot layoffs, and these would be permanent.

Press Reports out of the U.S. suggest that U.S. lawmakers still believe that Fiat is going to swoop in for Chrysler while it is in Chapter 11 and save Chrysler and prevent a lot of layoffs.

The Treasury Department is preparing a Chapter 11 bankruptcy filing for Chrysler that could come as soon as next week, people with direct knowledge of the action said Thursday.

The Treasury has an agreement in principle with the United Automobile Workers union, whose members’ pensions and retiree health care benefits would be protected as a condition of the bankruptcy filing, said these people, who asked for anonymity because they were not authorized to discuss the case.

Moreover, Fiat of Italy would complete its alliance with Chrysler while the company is under bankruptcy protection.

I have my doubts.

The most advanced, according to industry circles, are the preparations for an alliance of Fiat of Opel. The rumor is that next Tuesday the signing of a non-binding letter of intent is planned.

Fiat is going to pick EITHER Opel or Chrysler, not both. My gut tells me that Opel is in the driver’s seat here.

The Obama Administration had better wake up because it is being played by Fiat.  They could themselves with two bankrupt automakers, no suitors, and a lot of angry, unemployed workers.

And, then you can kiss your recovery goodbye.

Sources
U.S. Is Said to Prepare Filing for Chrysler Bankruptcy – NY Times
Fiat und Magna greifen nach Opel – FAZ

Related posts:

• Obama ready to put Chrysler into bankruptcy
• German Press: Fiat to sign a deal with Opel, not Chrysler
• Chrysler: bulls make money, bears make money, pigs get slaughtered
• The case of the dissident Chrysler bondholders
• Fiat as the engine for change in the auto industry

This past Sunday Felix Salmon wrote a post called “10 reasons for the lack of German econobloggers.” I found it inaccurate and offensive. Let me tell you why.

I was in Germany at the time I read the post and had been there for the better part of the week. In reading and watching German news, I was very heartened that there was a comfortable debate about the goings-on in finance and in the German and world economy.

Now, I would sum up Felix’s arguments regarding German bloggers as a typical and stereotyped Anglo-American view of Germany and the German-language realm. The core of the view is that Germans are hidebound, hierarchical, conservative and obedient. This is at odds with the ethos of the blogosphere. Therefore, Germany and the German-speaking world will never have a good blogging community.

I happen to think highly of Felix’s work but his views here are out of bounds. Moreover, he’s just plain wrong. There actually is a good thriving German-speaking econblogging community. I have four of the blogs on my blogroll and often correspond with their writers. They are:

• Immobilienblasen:  the blog title means property bubble in German.  I have aways considered Immobilienblasen a good bilingual effort that does a good job of bridging the German and Anglo-American world.  It has been around since well before the econblog space got noticed.
• Zeitenwende: this is a Swiss blog in German and has been a very good source of information fr me on the goings on at UBS, Credit Suisse, Glencore and other Swiss companies. It went on a brief hiatus earlier this year, but I am happy to report that it is back.
• egghat’s blog: Egghat is another German blogger who has been around for quite some time (since before the econblogging space became noticed after Lehman’s demise).  Although, he writes completely in German, egghat does have a lot of good information on the U.S. financial crisis as well.
• Blick Log: this is the most recent German-language blog I have been turned on to.  Very, very good detail on the German situation specifically.  If you want to know what is happening at HSH Nordbank, WestLB or Deutsche Bank, this should be on your list.

There are any number of other German blogs as well (Boersennotizbuch is one) that are not on my blogroll of which I am aware.

As to the substance of Felix’s argument – that German cultural traits prevent a flourishing blogosphere, I would say there might be kernels of truth in what he says. For instance, I was walking through the town centre in Duesseldorf on Monday. And whenever I came to a traffic light I felt that dreaded social pressure I always felt to be coercive and corrosive when I lived in Germany not to cross on red. Social pressure is subtle and the pressure to conform to social norms is one of the key ingredients that created a massive credit bubble. Here it was in action at the pedestrian crossing.

Nevertheless, Felix overstates his case. There are very good German blogs. Moreover, the German press is and always has been MUCH more critical of the government than the U.S. press has been. One could legitimately argue that magazines like Spiegel and even ARD and ZDF, the public television stations, take on a role in Germany that the mainstream media in the U.S. do not.

The arguments that there are few German bloggers compared to U.S. bloggers could be made regarding Australia, Canada, France, Spain, Ireland, or even the U.K. In the U.K, you have Alphaville, Willem Buiter, Alice Cook, and Mark Wadsworth as examples but there are not nearly enough econbloggers in the U.K. given the severity of the economic crisis there. And, it’s not because the Brits are ‘too German’ that there aren’t more blogs there.

Like Felix, I wish there were more blogs outside of the U.S. because they might give us a different perspective. But to say that the Germans will never develop a good econoblogosphere is just plain wrong.

Related posts:

• German deposit guarantee sets up a German-British row
• The Germans guarantee all savings deposits
• GM’s German subsidiary may cut ties
• Video: How German elections are shaping up
• German readers: Inflation – country analysis

There is quite a buzz in the German press about Hypo Real Estate.  But, what should really get one’s attention is its massive off-balance sheet exposures (hat tip Ulrich).  The long and short of  reports is that Hypo Real Estate has assets valued at 1 and 1/2 times its entire balance sheet in off-balance sheet vehicles. This would bring total exposure to German taxpayers to a cool one trillion euros (1,000,000,000,000).

While there have been numerous reports of HRE’s imminent nationalization due to the recent law enacted in Germany allowing such, these reports raise the stakes considerably.  If you recall, HRE almost brought German banking to its knees during the Panic in October after Lehman collapsed (See my post “Germany: banking system collapse possible due to Hypo Real Estate“)

At the bottom of this post are a number of media sources in the German and Austrian press on this subject.  Here’s how German blogger Egghat puts it:

So far, here and there, one could read that the balance sheet of HRE was a measly 400 trillion euros. This would make HRE, according to balance sheet assets at the end of 2007, the eight largest bank in Germany. The largest balance sheet total for 2007 belonged to Deutsche Bank, with a little more than two trillion euros.

Yesterday, according to the Hannoversche Allgemeine, several financial experts from the Bundestag confirmed that HRE credit and credit derivative transactions amount to one billion euros, especially in “off-balance sheet activities.” This would put HRE, when we return to the balance sheet rankings fom 2007, basically to 2nd place amongst the largest banks in Germany. Alleluia! Quite amazing that this message has received so little attention in the media so far.

Update 20 Feb 2008 1536EST: Hypo Real Estate has issued a press release in regards to the reports about its off-balance sheet derivatives exposure(hat tip egghat). The text reads as follows:

Hypo Real Estate Group clarifies facts regarding hedge transactions

Munich, 20 February 2009 – Hypo Real Estate Group has clarified facts regarding media reports on its derivatives positions. Hypo Real Estate Group said on Friday that these reports showed a misinterpretation of the Group’s derivatives positions. The Group explained that in fact, the clear majority of these derivative transactions had been concluded in order to hedge against credit and market risks, pointing out that such transactions were regularly disclosed in the annual report.

In line with current practice adopted by other banks and market participants, Hypo Real Estate Group uses derivatives to hedge against credit and market risks arising from fluctuations in interest rates and foreign exchange rates, for example. Such hedges are connected to underlying transactions: the purpose of hedging is to avoid risks, not to enter into additional risk exposures.

Hypo Real Estate Group currently has derivative transactions in its books with an aggregate nominal volume of approx. one trillion euros. In line with accounting standards, the market value (as opposed to the underlying nominal amounts) is carried on the balance sheet. Hypo Real Estate discloses nominal values of derivatives in its annual report. In accordance with accepted market practice, derivatives positions are backed by additional collateral. Only mark-to-market changes in value impact on liquidity; there is no need to refinance nominal amounts of derivatives. “

Sources
Milliarden-Geschäfte stehen nicht in der Bilanz – Standard Austria
Hypo Real Estate erschreckt Berlin: Eine Billion verliehen – HAZ
HRE-Bilanz außer Kontrolle? – ARD Boerse
HRE Bilanzsumme eine Billion? – egghat
Hypo Real Estate Group clarifies facts regarding hedge transactions – Hypo Real Estate, pdf

Related posts:

• Hypo Real Estate need for 10 billion also reveals huge problems in Spain
• Germany: banking system collapse possible due to Hypo Real Estate
• German banks loaded with 816 billion in toxic paper
• The German $400 billion toxic asset time bomb
• The Germans guarantee all savings deposits