Euro rescue leads to planned debts

“Under communism, banks are nationalized and then go bust, under capitalism, banks go bust and then are nationalized.”(Christine Lagarde)

First German subprime crisis due to junk real estate and interest rate bets

Since the end of the 1980s, not only the legal predecessor group of Hypo Real Estate Holding AG (HRE) has been piling up debts by financing – in some cases immorally – overpriced tax-saving real estate – and has often been ordered to pay damages for this. In Germany it is said to have been a junk real estate bubble of about 1 million properties, financed not only by this banking group.

Further losses were generated by speculation on short-term low interest rates to refinance long-term loans to states and their municipalities. Around 150 billion euros in state aid were the result, and at the same time millions in bonuses were paid to the management. Capitalization of profits – socialization of losses.

Since then, we have also seen such real estate bubbles caused by cheap money and/or faulty credit ratings in the USA and Spain, for example. In the end, it is the taxpayer who pays directly or indirectly for the settlement of such disasters, but before that it is the investors who have been defrauded by direct investments in such capital assets.

Hardly any credit checks

In order to supposedly “strengthen” the financial centres in Europe, the capital requirements for banks were lowered, hedge funds were permitted, including the sale of credit claims against bank customers to “Moscow Collection”, and the “hiving off” of loans into special purpose vehicles, thus effectively extending the risk of bank and insurance bankruptcies.

Ratings paid for by debtors and issuers of securities continued after the 2008 subprime crisis. Making a full credit check on debtors compulsory again would have encouraged “toxic assets” to be identified as such at an earlier stage.

Instead, lawmakers have allowed the introduction of so-called “hidden liabilities” to allow 19 of 20 top life insurers to continue to hide their losses from financial bets with their customers’ retirement money on their balance sheets by not reporting the losses they suffered. Critics say that it is lucky if savers with investments in life insurance policies later earn half of what they were charged when they took out the policies.

Financial Market Stabilisation Act in 2008 has de facto the opposite effect

In order to prevent financial institutions in particular, which had speculated in the subprime crisis, from becoming insolvent, the de facto abolition of over-indebtedness as a reason for insolvency was also decided for them – a positive forecast by any “clairvoyant” that the company will mostly probably be able to master its crisis is sufficient.

The increase in capital requirements to strengthen the ability to bear risks has been successfully prevented by the lobby of the financial houses. If it goes bang, the taxpayer’s liable. And for insurers, confidence that the banks are likely to be rescued is enough.

The good old days, when “balance sheet truth, balance sheet clarity, the commercial principle of prudence, the lower of cost or market principle in the recognition of assets” still had any meaning, are history – this can now only be found in textbooks: the legal situation today corresponds more to a collectively organised balance sheet doctoring, which has far less to do with economic reality.

The EU has failed to establish a balance-sheet culture in which the worst-case risks are presented transparently: Perhaps then no one would buy energy shares any more, because the GAU risk per nuclear power plant is around 200 billion euros – compulsory insurance covers just 2.5 billion euros.

Bank profits from loans with high interest rates to states of dubious creditworthiness

Since the subprime crisis in 2008, banks have become increasingly distrustful of each other and have hardly lent any money to each other, because they have become aware of “the price” of threatening insolvency of financial institutions (banks or insurance companies) at any time due to deregulation and politically undesirable supervision and risk management, at the latest since the Lehman Brothers bankruptcy.

French banks in particular expected better business from buying government bonds from the GIPS states (Greece, Ireland, Portugal, Spain) at substantial interest rate premiums. The interest surcharge is the price for a default risk – but when this becomes real, politicians start to put together so-called rescue packages for states at the expense of European taxpayers and to effectively “support” the banks.

At first, these seem to be largely just “guarantees” – but every bank apprentice learns that “guaranteeing often means paying in the end”. In this case, the “European taxpayers” would then be primarily liable for the faulty credit ratings of certain banks in Europe. The so-called “Euro-Bond” has long since been introduced and implemented through the back door – only politicians prefer to remain nobly silent about it.

Euro transfer union since 2008: over 450 billion in cheap German loans for insolvent states

Fortunately, the European Central Bank has already been transferring an average of over 100 billion euros a year to the central banks of the GIPS countries and Italy since 2008. In fact, one can say that these central banks of the GIPS countries have fired up the printing press since 2008 – in return, the Bundesbank lends correspondingly less money to German credit institutions; and the foreign central banks then owe (via the ECB), among others, the Deutsche Bundesbank the repayment of these so-called ECB target balances.

However, the ECB’s possibilities to grant such Target loans will be exhausted in a few months – the successor vehicle is called the EFSF. The only catch for the taxpayer is that even today such loans appear to outsiders to be virtually unsecured in terms of collateral.

The foreign central banks then lend this fresh money from their own printing presses to the foreign commercial banks, and these in turn to their affiliated lending customers. Whether that money will ever flow back is written in the stars. What is certain, however, is that this cheap ECB money, with around one percent in ECB lending rates annually, is a welcome gift in these states to cheaply provide the economy (primarily to finance foreign trade deficits) with an illusory flourish. The road back to the reality of one’s economic performance is unpleasant.

One way out of the dilemma, for example, is “internal real devaluation” in Greece, i.e. lowering wages, salaries and goods prices, and raising taxes so that the external deficit is reduced in a timely manner. It already seems that a holiday in Greece costs twice as much as one would have to spend in Turkey for roughly the same services. In particular, the unequal treatment of certain segments of the population in “internal devaluation” combined with a “sell-off of state assets to global investors” then drives people into the streets.

Introduction of the planned economy to control the flow of credit

States are sovereign debtors – overnight Greece could leave the eurozone, declaring its sovereign debt in the euro repayable at only a small fraction. This was the case with Argentina, for example – the country devalued its currency and thus became competitive again for its own exports.

More favourable for Greece is a continuation of the transfer union, currently via ECB target loans and in future via the EFSF, ideally leveraged – thus turning the end with horror into a non-transparent horror without an end for the taxpayer in the euro area: however, the question will arise whether this is possible without amended EU treaties and without parliamentary approval?

It is also questionable how, in the long term, the mentality and work ethic of all Europeans will be “brought into line” with the existing EU treaties: This will make a birth defect of the euro and its treaty foundations evident, even if the Federal Constitutional Court has (still) understandably ignored these economic findings. For years there has been a debate about how the future European peace order will change and renew itself.

Today, pensioners and taxpayers are apparently expected to pick up the tab, and a partial confiscation of citizens’ assets by European states is also widely perceived as a looming threat. Some financial experts believe that, not without reason, there has been a drastic expansion of reporting obligations and data collection of assets at home and abroad of German citizens by the state in recent years, even without wealth tax, so that the government knows which existing assets could be accessed if necessary.

Consequences for the German taxpayer

One of the main problems of the euro is the impossibility of ensuring almost uniform economic growth in all euro countries. If the adjustment of foreign trade through “internal real devaluation” (without civil war and renewed redistribution “from the bottom up”) were not successful, or through a euro exit of certain countries, a permanent transfer union could be imminent.

Then, however, the state will have to liquidate its assets (e.g. its gold holdings), raise taxes on its citizens, cut pensions, and, if necessary, introduce a new levy along the lines of the equalization of burdens. In the long run, however, this is not a solution, because payday comes in the end – regardless of whether the taxpayer will be able to shoulder it.

The voters at the ballot box and the people on the street will force politicians to abandon the sleight of hand to hide the debts and risks as soon as the first guarantees fall due and suddenly higher collateral has to be demanded again, also from private borrowers and states.

Bad ratings will be banned

Since international rating agencies have already announced that they will downgrade the ratings of other EU states – including Germany – as a result of this situation, the publication of ratings is to be banned. But so are financial bets on sovereign default. Admittedly, the legal system – in order to enforce this – only reaches as far as the respective national border – financial betting abroad cannot be banned, and neither can ratings as a free expression of opinion there. So one would have to make every doubtful statement about the “final victory” and every listening of “enemy transmitters” a punishable offence.

Insurers are being pushed into sovereign debt financing

While insurers will not be directly forced to underwrite mandatory bonds in sovereign debt. However, European government bonds are prescribed by law as 100% safe, so that no equity capital is required from insurers for them, whereas other investments are made much more expensive under Solvency II. In this way, a “funded” old-age provision for citizens is then built up, based on the hope of interest and redemption payments from the states.

Thus, the previous hope that new generations of contributors would be found in the pay-as-you-go system is being replaced by the hope that future generations of taxpayers will pay interest on and repay the government bonds held by insurers to finance their pensions. This allows two objectives to be achieved at the same time:

For the investment money of retirement savers there are unlimited investment opportunities in government debt, declared by law to be safe, and for the states unlimited funds of the

retirement planning citizens. Moreover, the interests are thus aligned: With the state bankruptcy, the old-age provision of the citizens with the private insurers would also collapse. By privatising pension risks in this way, the government does not have to fear uprisings over cuts to social pensions – the willingness to persevere increases when everyone is in the sinking boat together.

The end of the casino mentality?

So it is time that financial houses not only generate additional income through “risk premiums”, but also realise write-offs if the financial bet did not work out, because in the long run the taxpayer will not want to bear the losses of such financial houses that opted for financial bets at the expense of the taxpayer instead of investments with sound credit monitoring.

In the euro area, instead of buying up dubious junk bonds, especially those of the GIPS states, with questionable repayment in the future without any price markdowns, the ECB should perhaps demand a market interest rate for each state when granting loans that reflects the credit risk and thus removes the raison d’être of any rating.

by Dr. Johannes Fiala and Dipl.-Math. Peter A. Schramm

by courtesy of (published 10/25/2011)

and (published in May 2012 under the headline: The euro bailout: from junk real estate to junk states).

and (published in
Computers in Crafts 11/11,



Under the headline: The euro bailout: from junk real estate to junk states?


und (published in
Infinity 11/2011, pages 34-35 under the headline: The euro bailout)

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About the author

Dr. Johannes Fiala Dr. Johannes Fiala

Dr. Johannes Fiala has been working for more than 25 years as a lawyer and attorney with his own law firm in Munich. He is intensively involved in real estate, financial law, tax and insurance law. The numerous stages of his professional career enable him to provide his clients with comprehensive advice and to act as a lawyer in the event of disputes.
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