Germany's Toxic Banking Problems Worsen

(CORRECTED: See below.)

For a country famous for its efficiency, Germany’s banking industry is in a tangle. This weekend, a German newspaper published a leaked list from the country’s financial oversight group, BaFin, showing that German banks are sitting on €816 billion (around $1 trillion) of toxic assets.

Commerzbank, Germany’s second largest financial institution after Deutsche Bank, owns €101 billion of the sour assets, while Hypo Real Estate, which is potentially undergoing a 90 percent takeover by the German government, has €268 billion in toxic assets.

A 25 percent plus one share stake of Commerzbank is due to be sold to the government, after the bank had to tap the taxpayer-funded government Financial Markets Stabilization Fund in order to finance a €4.7 billion takeover of Dresdner Bank.

The Dresdner acquisition, however, only made matters worse, as Commerzbank inherited roughly €50 billion of toxic assets from that deal. In other words, Commerzbank borrowed taxpayer money to buy toxic assets which will need further financing via more taxpayer funds.

Not surprisingly, officials were furious about the leak. But a leak is the least of their concerns right now. At Seeking Alpha, market commentator Edward Harrison (no relation) elaborates:

Moreover, it is not altogether obvious which markets are deemed ‘toxic.’ German banks have a lot of residential real estate-related paper. But they also have assets related to the imploding European commercial property market and the Eastern European property markets. I suspect that the problem is even larger than is mentioned here.

Regardless of whether the German banking problem is larger or not, one thing is for sure: it’s messier than many Germans want it to be. Harrison points out that unlike the rest of Europe, Germany doesn’t have a culture of government intervention in financial firms, and that taxpayers are growing impatient with the round-about handling of the turmoil.

To make matters worse, J. Christopher Flowers, who runs U.S. private equity firm J.C. Flowers & Co., has threatened this week to take court action against the German government as he tries to salvage a €1.1 billion investment in Hypo Real Estate. While the government wants to go ahead with its 90 percent takeover at a much-reduced bargain price, shareholder Flowers is asking Berlin to wait for an offer more in keeping with what might be found in time on the open market.

The affair is unfortunate given Germany’s painful history. Flowers’ case centers upon enteignung, the German legal term applied to government appropriation of personal property. In many German minds, that brings back all sorts of Nazi-era memories of when Adolf Hitler flagrantly confiscated Jewish assets. As if all that wasn’t bad enough, the government is standing for reelection in September.

But stuck as it is between European and American banking models, German banks’ problems aren’t likely to go away any time soon.

NOTE: An earlier version of this post incorrectly noted that Deutsche Bank will be taking a stake in Commerzbank.