Der TARP: Germany Is Hiding a Big Banking Problem

by: Perry D.

I didn't fully understand, at first, the speed and magnitude of the German government's support of the nearly $1 trillion Greek bailout package earlier this month.

And, before that, it seemed odd to me that economically tiny and almost insignificant Greece appeared to have such outsized leverage in the bailout negotiations.

Then there were the reports (not convincingly denied) of French President Sarkozy banging on the table and shouting to German Chancellor Merkel threats that France would abandon the euro unless Germany complied and supported the bailout. Wasn't it Germany -- certaintly the German public -- that was the angriest, most offended party here? Weren't they the ones in a stronger position to make threats about abandoning the euro and in a better position to dictate terms?.

Then, overnight, we get the German government's surprising, bizarre, panicky -- borderline stupid -- ban on short selling which, so far, is predictably making market turmoil in Europe even worse. The measure specifically restricts short-selling of shares in 10 big German banks, including Deutsche Bank (NYSE:DB), Commerzbank (OTCPK:CRZBY) and Allianz (AZ).

Ahhh... now I get it. It's called leverage... and I'm talking about more than one type of leverage.

Greece had Europe -- and especially Germany -- over a barrel all along.
Germany is hiding a big banking problem -- a problem that could be, proportionally, on the same scale as that of the U.S. financial system's through 2008 if not greater. And like U.S. banks through our financial crisis, German banks -- and the German government -- might be hiding the full scale and scope of the problem. Unusually erratic Chancellor Merkel is certainly behaving as though this is the case.

This could be what's driving up the LIBOR spread again, a telltale sign of banking system stress that flashed dangers signs like this leading up the Lehman Brothers disaster. It's certainly what's behind the jump in credit default swaps on German banks -- now approaching the levels of the PIGS countries -- as investors seek insurance from the risk of German bank failures.

In credit research published earlier this week, Royal Bank of Canada analysts said the lack of disclosure by German banks of their Greek exposure was partially responsible for market volatility. It said German banks had not fully disclosed their exposure to Greek debt and the risk they could be forced to write down a lot of it. They estimate, based on BIS data, that as much of 75% of German bank exposure to Greece has not been disclosed. The say Commerzbank has the highest exposure to Greek debt.

Speculation about a German bank bailout will put added pressure on German bunds (government bonds) as traders speculate Germany will embark (indeed, in many respects, it has already embarked on a stealth bailout) on a massive, U.S.-like transfer of debt and risk from the private sector to the public sector. Call it Der TARP (not Le TARP). And we're in for the same American-sized public outrage at big banks -- in Germany.

PIMCO, the mega-bond fund, is in for some serious heartburn. It bet big, and urged clients to bet big, on German Bunds (government bonds).

Again, I remain bullish on Europe for longer-term, macroeconomic reasons as European and American economic policy and conditions converge, but for shorter-term financial reasons, it's going to be a very bumpy ride this week and beyond -- especially for Europe. It won't help if Germany continues to dance around the truth, as the U.S. has danced around the truth.

Disclosure: None

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