Germany’s response to the crisis reflects its commitment to protect its own banks
We are frequently told by supporters and critics of German economic policy alike that the future of the euro zone depends on the relationship of Germany’s economic success to other euro zone states. In these terms a sustainable European currency requires either the export of the foundations of German economic strength to the periphery, or Germany’s willingness to relinquish its obsession with ordo-liberalism and achieving a large current account trade surplus.
In both narratives the position of German banks features rather little. Yet Germany has been dealing with a profound banking crisis since 2008. Crucially, the reality is that the German government has primarily responded to the euro zone crisis in ways that advance the interests of the German banks.
As the financial crisis broke in the summer of 2007, German banks were significantly more leveraged and much more dependent on short-term wholesale funding than either American or UK banks or indeed those in other member-states of the euro zone. The application of regulatory rules allowed German banks to accumulate effectively unlimited international assets in relation to the capital they held if those assets were triple-A rated. As a consequence the balance sheets of German banks were full not only of sub-prime mortgage-backed securities, but also sovereign and bank bonds issued in the periphery of the euro zone.
Some German banks also became extraordinarily exposed to derivatives. Even now, Deutsche Bank, the largest of the German commercial banks, remains in an extremely risky position. It is quite probably the most highly leveraged bank in Europe, as well as having the largest gross derivative exposure in the world, a staggering €55.6 trillion according to its 2012 accounts.
When the euro zone crisis began in October 2009, it was German and French banks that were most exposed in the periphery. More than 40 per cent of the foreign claims on the periphery of Greece, Ireland, Portugal, Italy and Spain were French and German, and the proportion was much higher when considering only members of the euro zone itself. The German banks were particularly exposed in Spain, Italy and Ireland.
Although German politicians, led by Angela Merkel, have put considerable effort into framing the euro zone’s problems as a crisis for debtors in the periphery, it was just as much a crisis of creditors in the core, especially Germany and France. Although the eventual German moves to support bailouts for Greece, Ireland and Portugal were portrayed domestically as acts of sacrifice to save the periphery from the consequences of its own fecklessness, they were in reality moves that protected creditors from default. In a nutshell, the choice the German government had in May 2010 when it supported the first Greek bailout was: either to contribute to a repayable loan to Greece at the level of the euro zone and so reduce the risk of contagion to Spain and Italy, or to put together another round of bailouts for its banks at the national level.
Thereafter there has taken place a large-scale withdrawal of French and, particularly, German capital out of the periphery. Between the third quarter of 2009 and the fourth quarter of 2012, German exposure to the periphery fell by more than 50 per cent. This was not an accidental consequence of the euro zone crisis. It was what the actions taken at euro-zone level, both by EU governments and the European Central Bank (ECB), made possible. Nothing was probably more consequential in this context than the ECB’s Long-Term Financing Operation (LTFO).
In the second half of 2011 it had become virtually impossible for German and French banks to borrow in American money markets. Meanwhile, Spain and Italy’s problems in sovereign bond markets mounted. Shut out of funding markets and with the risk of default mounting on their lending, the German and French banks were saved, on the one side, by the US Federal Reserve Board providing the European Central Bank with dollar swaps to distribute to European banks dependent on dollar funding and, on the other, by the LTFO. Importantly, the latter created a mechanism by which the German and French banks could sell their periphery assets to periphery banks that borrowed the money from the ECB to purchase them.
In sum, once the precarious position of the German banks is understood, the politics of the euro zone over the past few years takes on a rather different nature than that suggested by the dominant narrative of the crisis. The extent of Germany’s commitment to maintain the euro is actually far from clear. This is not because Germany necessarily has good reasons to leave the euro zone, but simply because, as yet, its willingness to act to save the euro has not in fact been put to the test. Far from involving domestic sacrifices imposed to save the euro, Germany’s handling of the euro zone crisis thus far has been, first and foremost, an opportunity for Germany to ‘Europeanise’ the burdens of its banks.