The Cost of a Rescue
October 3, 2008
The banking crisis spread to Germany this week when the German government offered a lifeline to commercial mortgage lender Hypo Real Estate as it teetered on the verge of collapse.
The news came on the same day that the United States House of Representatives failed to pass the $700 billion (500 billion-euro) bailout plan proposed by Secretary of the Treasury Henry Paulson. That plan has since been approved by the Senate, with a few alterations, including up to $100 billion in tax break extensions for middle class families and businesses.
The German government has come up with a similar plan to bail out Hypo Real Estate, albeit a slightly less expensive one. On Thursday, the European Commission gave the go-ahead for the 35 billion-euro deal.
The government bailout in Germany came just one week after German Chancellor Angela Merkel denounced the US plan as being "too little, too late." She had since changed her mind and urged the US Congress to pass a rescue package.
The House is tentatively set to revote on the bill on Friday.
It all comes down to the taxpayer
Apart from the price tag, there are other differences between the rescue plans on both sides of the Atlantic.
In the US, the bill that has been passed by the Senate calls for a government office to be set up which will initially take control of $250 billion in "troubled assets." According to Helge Berger, professor of economics and monetary theory at the Free University in Berlin, they will pay above market price for these assets, which basically amounts to a government subsidy.
"The government will assume that it will hold this paper to the very, very end, hoping that it will gain in value," he added.
The German deal, on the other hand, is a 35 billion-euro private loan from a group of banks which is then guaranteed by the German government -- and ultimately by the German tax payer.
But these methods aren't quite as different as they may seem, said Berger.
"It may be that private banks are doing the financing right now, but they hold none of the risk, and I think that's very important in economic terms," Berger said, emphasizing that the loan is guaranteed with public funds.
Berger made it clear, however, that, just like in the American plan, the German one provides the government the option of seizing the company in the event of a default.
Governments benefit from acquiring bank shares
Other countries in Europe are feeling the crunch too. Great Britain has nationalized lender Bradford & Bingley, while the Benelux nations of Belgium, Luxembourg and the Netherlands bailed out the insurance and banking group Fortis with 11.2 billion euros.
With both of these plans, the respective governments didn't just get troubled assets, they also got shares in the banks. Berger said sees this as a huge advantage, since there are still viable credits owned by these financial institutions, which in turn are then owned by the governments.
Though the Benelux nations manage to reach an agreement on Fortis, the European Union as a whole is having trouble deciding on a joint response to the financial crisis.
Europe divided on bloc-wide bailout
On Thursday French Finance Minister Christine Legarde suggested in an interview with the German newspaper Handelsblatt that the EU should set up a European-wide rescue plan. France currently holds the rotating EU presidency.
"What happens if a smaller EU state is affected by a looming bank collapse? Maybe this country does not have the means to save the bank," she said.
Stock market expert Ulrich Barts, based in Frankfurt, is in favor of the plan. He said that banks need to start trusting one another again. Barts also called for more regulation, saying that a serious look should be taken at how banks sell products and that they have to reveal the risks involved in the products they sell.
"You also have to put in some sort of measure to allow the European Union to act as a whole in order to help the financial sector in such a crisis and to detect possible problems earlier and then be able to act as the authorities have in the US," he added.
The proposed plan reportedly totaled 300 billion euros, though both the French and Dutch governments have denied such a proposal has been made. However, no matter what the final cost is, Germany has said it is against it.
Chancellor Merkel will be attending the emergency finance summit on Saturday in Paris, which was called by French President Nicolas Sarkozy. The leaders of Britain and Italy, European Commission President Jose Manuel Barroso, European Central Bank President Jean-Claude Trichet and Eurogroup Chairman Jean-Claude Juncker will also be there.