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Hypo Real Estate: when the government expropriates shareholders

By La Rédaction de Money Week, 03 April 2009 - By Caroline Bruneau

Could the expropriation of shareholders, the last-stand rescue strategy adopted by the German government, happen here? The goal of the German operation: to save a little-known bank, Hypo Real Estate, from collapsing, taking all of the German banking system with it. HRE has accrued a debt of nearly €100 billion and the government is forced, under a special law for emergencies, to keep this sick monster afloat.

But why is it absolutely necessary to save this Munich-based bank? Hypo Real Estate Bank, founded in 2003, is the cornerstone of a German exception: the Pfandbriefe. This type of bond, backed by mortgage securities, has existed for 170 years and is considered to be the safest investment in the country. There is no institution, city or hospital that does not have Pfandbriefes in its bond portfolio.

The HRE has issued the equivalent of €900 billion in Pfandbriefes. If it goes under, the after effects will be so severe that the government cannot contemplate allowing it to happen. Which is why it is responding with an extreme measure: expropriating the shareholders to save the bank.

A monster is born, grows and nearly bites the dust

Created in 2003 as a Hypo-Vereinsbank spin-off, Hypo Real Estate was meant to act as a last resort strategy for the financial institution, recuperating all its risky funds. A bad bank before it’s time. Seeing an opportunity for wealth and power, the unknown Georg Funke, 48 years old and a minor figure at Hypo-Vereinsbank, became CEO of HRE.

The IPO met with success and HRE set up in Ireland to keep down its tax bill. It began to buy out small banks such as Württembergische Hypothekenbank, one of the most important issuers of Pfandbriefe, then a financial institute specializing in CDO (Collateralized Debt Obligation), the highly popular Wall Street subprimes. This was 2005.

HRE grew. Its CEO began the construction of an enormous villa in Munich. At the end of the year, HRE was listed on DAX, the major Frankfurt Stock Exchange index. The share price increased to €57.30.

The HRE directors began searching for the strategy that would allow them to become a sector giant. After the failed merge with EuroHypo, an institute specialized in financing public authorities, Funke set his sights on Depfa, German leader in secured bonds, based in Ireland. However, hidden in the Depfa’s capital was toxic accumulated material: extravagant subprimes, refinancing every three months.

The American real estate market, thanks to which Depfa yielded an incredible 30% return, crumbled. The head of HRE couldn’t care less. In July 2007 he paid out €5.7 billion to acquire the Irish bank. This acquisition seemed risky to outsiders: in reality no one understood what the two institutes were doing.

When the subprime crisis arose at the end of the summer, Funke swore that he had no risky funds. However, in January 2008, he ended up admitting to €390 billion in subprimes. At the same time, the German banks embarked on an act of contrition and revealed the skeletons in their closets. Funke, however, on the telephone with analysts, continued to praise his exceptional work and his confidence in the future.

Emergency funds

Investors did not believe him and the stock price plummeted. Depfa began to show signs of weakness. The Federal Financial Supervisory Authority, BaFin, noticed irregularities.

On 16 September, the day after the Lehman Brothers bankruptcy, the head of HRE appealed to the government: his bank no longer had any assets. He needed €35 billion. When the minister’s emissaries arrived, they discovered that the problem was much more serious and, during the night, negotiated an emergency fund of €50 billion.

€100 billion euros have now been injected. Axel Wieandt, Josef Ackerman’s right arm at the Deutsche Bank, has been called to the rescue so he can pick up the pieces. Half of the personnel at HRE will be fired and the buildings sold. HRE is on its knees. It will result in a shareholder vulture fund.


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