Germany Launches 'Bad Bank' Plan

It has been a long time in coming, with divisive debates and numerous changes. But on Wednesday, Chancellor Angela Merkel's cabinet in Berlin finally decided in favor of a "bad bank" law designed to remove toxic assets from bank balance sheets. The hope is that the plan, put together by Finance Minister Peer Steinbrück, will jump start the flow of credit into the German economy, which is suffering through the worst recession since World War II.

The plan must still be approved by Germany's parliament, the Bundestag, but the size of the majority held by Merkel's coalition government makes passage likely.

It is estimated that German banks hold more than €200 billion ($274 billion) in toxic assets—of an estimated €3 trillion worldwide. Berlin's new plan calls for banks to set up their own companies in which to park these junk securities. The new companies would then refinance the toxic assets—essentially loans in danger of default—by issuing state-backed bonds to the mother bank.

The plan would remove the risk of major writedowns from bank balance sheets and thus, Steinbrück hopes, restart the flow of capital among banks and into the real economy. And, best of all, the funding would come from the €500 billion bailout fund, known as Soffin, passed last autumn.

"We don't need any additional capital," said Steinbrück on Wednesday. "The umbrella that we currently have is sufficient." He said that the Soffin fund has some €260 billion left.

If it works, the plan would put an end to the quarterly announcements by banks of huge writedowns as the junk debts default. Such writedowns have had grave consequences for banks' reserve capital holdings, leading many financial institutions to the brink of collapse.

Still, the banks would not be completely free of their past business mistakes. Should a bank's "bad bank" make losses, shareholders would forego part or all of their dividend. Furthermore, banks would have to provide overseers a detailed look into the toxic assets being parked in the bad bank, an attempt to improve transparency.

A similar plan is currently in the works for Germany's wobbling state-owned banks, but it has not yet been finalized. Germany's economy, Europe's biggest, is expected to contract by 6 percent this year with worries growing that unemployment will tick sharply upwards to over 5 million by the end of next year.

Provided by Spiegel Online—Read the latest from Europe's largest newsmagazine

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