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Bad banks become commonplace

Von Dr. Oliver Everling | 27.April 2009

Cause and effect in a nut shell: Dr. Tobias Schmidt, managing board member of Feri EuroRating Services AG in Bad Homburg, explains the logic of the current crisis in the banking sector. He sees at its core the mismatch of maturities and securitization. Short term liabilities were swapped via interest rate swaps into long term liabilities. Tax incentives made such transactions attractive, since those transactions combined tax advantages with the advantages of low short term interest rates. Without constant roll-over of short term debt such transactions would not have been possible.

Banks extracted risks then from their balance sheets by securitizations: Loans were bundled into put into loan portfolios. Credit default swaps helped managing the credit risks involved. The increase of investment banking correlated with the increase of lending. A growing market for structured products was the consequence.

Schmidt comments the policy actions to tackle the current banking crisis. National actions are capital injections and nationalization of private banks, guarantees for financial sector liabilities, purchase of assets and direct lending by Treasury, liquidity provisions and other support by central banks and relaxation of balance sheet guidelines.

The Geithner plan in the U.S.A. comprises subsidies for private investors for the purchase of toxic assets through a public-private fund; initial public capital adds up to around 100 bn. U.S. Dollar, in total up to 1 tr. U.S. Dollar. There are no plans for a bad bank in the U.K, but for insurance coverage and shared losses. Germany takes a decentralized approach with bad banks and an estimated volume of structured finance securities of 150 – 300 bn. Euro. A split of banks in a „good“ and a „bad“ bank is discussed, esp. for Landesbanken („Aida“). In Ireland a central bad bank shall buy risky loans up to 90 bn. Euro.

Schmidt sums up the fundamentals: Ongoing recession of world economy on the one hand, China showing first signs of recovery on the other. Massive debt emission will have negative effect on bonds. For further details visit http://www.feri.com/.

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