At the end of August, the German government presented a draft law on the restructuring and orderly resolution of credit institutions (Restructuring Act), which draws lessons from the financial crisis. Ultimately, it is a question of the extent to which basic principles of the market economy continue to apply in crisis situations.
There is a simple rule for responsibility in a market economy: owners of a company bear opportunities and risks equally. If the company makes a profit, the owners are entitled to it. If the company is doing badly, they must weigh whether to invest to avoid a reduction in value or slippage. In the worst case, normal market conditions threaten insolvency. This can economically mean the total loss of the investment, for owners as well as for creditors.
This balance between opportunities and risks is at the core of market-based owner and creditor responsibility. It works when not only opportunities beckon, but also risks are imminent. Opportunities for profits and the risk of insolvency are the scales of owner and creditor responsibility.
In the financial crisis, this principle no longer applied.
Core experience of the financial crisis: too big to fail
The core experience of the financial crisis was bitter: banks were too big to go bankrupt. The consequences of insolvency would have been more burdensome for the financial market, the economy and the population than averting them through state aid. The negative example of Lehman Brothers was in front of everyone's eyes. "too big to fail" has become the buzzword for justifying extensive government guarantees and capital measures. Insolvency was no longer an option. The basic principle of the free market economy, the balance between opportunities for profit and (insolvency) risks, was out of kilter.
But what can be done if, on the one hand, the systemically important bank is not to be dropped in the event of insolvency and, on the other hand, responsibility is to be preserved in the market economy?? This question was already posed to the legislators of the Financial Market Stabilization Act at the end of 2008/beginning of 2009. And it confronts again, from a slightly greater distance, the legislator of the Restructuring Act 2010. There are two answers to this:
The first response is to recognize that the baby is already in the well when the law becomes relevant. The Restructuring Act is a repair kit, the accident has already happened. It consists of a situation in which a credit institution in danger of going out of business poses such a threat to other companies in the financial sector, to the financial markets or to the general confidence of depositors and market participants in the functioning of the financial system that the state, in deviation from the normal case, does not allow insolvency to occur. The first and most important lesson of the financial crisis is to avoid precisely such "too big to fail" situations in the future. This is also the aim of the new regulatory requirements, at international level z.B. the increased capital requirements of "Basel III". Meanwhile, no one assumes that this ideal goal, the complete avoidance of "too big to fail," will be achieved. Therefore, the legislator must provide for the worst case scenario and minimize the damage of a "too big to fail" for taxpayers and the market economy, that is the second answer – and the goal of the restructuring law.
The state helps under conditions
To the inevitable question of whether the state should help a systemically important institution, the Restructuring Act answers with a "yes, but": it helps. But the burden on taxpayers and competition must be kept as low as possible. This was already the goal of the financial market stabilization laws in 2008/2009 and is also now the goal of the 2010 restructuring law.
In doing so, the legislator starts from the principle: Financial market stability may require the rescue of a systemically important credit institution, but not the abrogation of ownership and creditor responsibility.
A distinction must therefore be made between the institution on the one hand, especially its systemically relevant parts, and the owners as well as creditors on the other hand –
at least as a guideline:
The first financial market stabilization package of October 2008 already provided that payments not legally owed to shareholders during the period of state aid would not be made either. Even then, it was recognized that rescuing companies in the interest of the common good and maintaining owner responsibility are not mutually exclusive.
In spring 2009, this principle was taken a step further, in the Supplementary Act on Financial Market Stabilization. It was clear that the scales of owner responsibility, which had been thrown out of balance by the certainty of the rescuing state, would only be redressed when the owners had to fear a situation economically comparable to insolvency. In the interest of financial market stability, the Financial Market Stabilization Supplementary Act enables the federal government to step in for a limited period of time, which is absolutely necessary in the case of comprehensive restructuring of an endangered company, even without or against the will of the previous owners. The instruments of intervention are of a private and public law nature:
Where previously 75% of votes were required for a capital reduction or exclusion of subscription rights at a shareholders' meeting, a simple majority is sufficient for the federal government under the Financial Market Stabilization Supplementary Act if the capital measure serves financial market stabilization purposes. Where previously an action to set aside a resolution of a shareholders' meeting already delayed registration, registration must now take place immediately. And the threshold for a squeeze-out of minority shareholders was reduced from 95% to 90%. These restrictions on shareholder rights, which are necessary in the interest of financial market stability, were z.B. used when the German government stepped in to rescue the Hypo Real Estate Group (HRE).
As a public law instrument, the Supplementary Act in the form of the Rescue Takeover Act permitted expropriation of the credit institution for the purpose of financial market stabilization.
The expropriation option, which was still created by the Grand Coalition, was highly controversial politically; it was therefore limited until the end of June 2009 – a point in time by which it was clear whether, in the case of HRE, the federal government would be able to obtain sole ownership with the help of the tightened corporate law instruments. That was the case. The rescue takeover law was never applied, the option – and the associated (effective) threat – remained in place.
Expropriation options will no longer exist in the future
Crisis management of the future no longer provides for this instrument. The Restructuring Act does not contain an expropriation option, but does contain extensive powers of intervention by the Federal Financial Supervisory Authority vis-A-vis faltering credit institutions. This includes the right to compulsorily sell off the systemically important parts of a bank that is in danger of going out of business and endangering the system, d.h. by administrative act, to spin off to a new entity owned either by a third party, by the restructuring fund belonging to the federal government or by the core bank and third parties or by the restructuring fund.
By only allowing support for the systemically important parts to be spun off in the Restructuring Act, but not for the core bank, the federal government is trying to avoid burdens on taxpayers by supporting bad parts of the bank. However, since in practice systemically important parts of a credit institution are not necessarily identical with the "good", i.e. profitable parts of the bank, it is conceivable that the restructuring fund will also support "bad" parts.
Bank levy may not be enough
Another component with which the restructuring law aims to keep the burden on taxpayers as low as possible is the bank levy imposed on all credit institutions.
It flows into the restructuring fund, from which future support measures are to be financed. However, since the bank levy is not expected to be sufficient to finance aid measures, the restructuring law allows state loans to be taken out in this case. So then costs will continue to come to the taxpayer. In addition, since the federal government guarantees the services of the restructuring fund by law, the law creates an implicit state guarantee, which distorts competition in favor of these banks.
Nevertheless, the restructuring law goes the right way. After all, if a "too big to fail" cannot be completely ruled out, there is nothing left to do but answer the question of whether the state, ignoring the principles of the market economy, should save a systemically important bank from insolvency with a "yes, but". Yes, it helps in the interest of financial market stability, but only under conditions that, as far as possible, maintain the responsibility of owners and creditors of the bank even in crisis situations.
Editor's note: PUBLICUS will report on the effects of the financial crisis – especially for municipalities and municipal budgets – from the perspective of strategic solution approaches and using best practice examples in loose succession.