World Economic News

Deutsche Bank Triggers Run on German Real Estate Funds

For the first time ever in post-war Germany, a so-called "open-ended property fund" was closed on the night of Dec. 13 due to an imminent liquidity crisis, the financial daily Handelsblatt reported Dec. 15. The Grundbesitz Invest fund counts 300,000 investors and belongs to DB Real Estate, Deutsche Bank's real-estate subsidiary. Its total capital amounts to 6.7 billion euros, invested mostly in office buildings, of which two-thirds are located in Germany.

On Dec. 9, DB Real Estate announced that due to the need for an overall re-evaluation of the real estate owned by Grundbesitz Invest, the fund would no longer accept any new investors. According to immediate market rumors, the re-evalution—which could take until February—would likely result in a downgrading of roughly 10% or more. As shares in open-ended property funds can be traded freely, the prices of such shares crashed by 10%. On Dec. 12-13, several thousand investors of Grundbesitz Invest withdrew all their capital; by the end of the day Dec. 13, the fund was running out of cash.

This was just another accident waiting to happen in the German real-estate sector. There had been an office-building bubble emerging in Germany, in particular in and around Berlin, shortly after reunification. Since 1995, air is coming out of this bubble. According to estimates by Commerzbank, German prices for office real estate have plunged on average by 26%. Many German real estate funds have not yet acknowledged this price crash in their balance sheets.

The usual procedure for a German bank in the case of trouble at one of its real-estate funds would be a bail-out, either hidden or public. As an example, earlier this year a crisis emerged at the fund Deka Immobilien, belonging to Deka Bank. The bank at that time intervened by firing the top managers of the fund, announcing that it would keep the fund open, and by guaranteeing all the fund's obligations "without any limit."

However, Deutsche Bank decided differently. Instead of seeking a bail-out, Deutsche Bank closed the fund, which means that for the time being, no investors can withdraw their capital. The reaction to this unprecedented step was a kind of panic in the overall German real-estate fund sector.

The German financial supervisory agency BaFin raised the alarm level by demanding daily information on any German open real-estate fund concerning capital inflows and redemptions. Deutsche Bank claims that it had informed BaFin in time. but it was leaked to the media that BaFin officials are upset by Deutsche Bank's decision and are demanding an explanation by DB head Josef Ackermann. German legislation allows the closing of such a fund only under "extraordinary circumstances."

Bank of England Warns of 'Downside Risks' to Financial System

The Bank of England warned of "significant downside risks" to the financial system in its biannual Financial Stability Review released Dec. 16. This is the last BoE report by Sir Andrew Large, the deputy governor responsible for financial stability, who is leaving the bank in January. Sir Andrew wrote that "we need to be particularly vigilant." The report raises "questions about whether, in some areas, standards of procedure, risk appetite, and financial discipline have weakened."

"We must remember that the financial environment is now more complex, opaque, interconnected, and leveraged, so a wholly benign outcome may not be a foregone conclusion," Large wrote.

"Market prices are at historically unusual levels." With some investors taking "on higher levels of risk," it is certainly prudent to plan for the possibility of a sharp reversion of prices to historically more normal levels (or even beyond them).... There could be a period of impaired liquidity during any such correction."

For the UK, the Bank report warns of the "rapid increase in highly leveraged financial products—a trend which, if anything, has intensified since June" when the last stability report was issued. "The relaxation of lending criteria in some markets and increased appetite for potentially illiquid instruments suggest that financial discipline may also have weakened somewhat. Previous experience suggests that such developments could herald future problems if assessments of risk were to change sharply."

The report warns about the rapid growth of the global mortgage-backed securities market, and the problem of settlements, "should a major risk arise."

While saying that—so far—the financial system has survived the GM and Ford shocks, the review says a fresh shock could prompt an investment stampede out of a particular market, destabilizing the financial system, as the collapse of the hedge fund Long Term Capital Management did in the late 1990s, The Guardian reported Dec. 16.

London Times Warns on Hedge Funds Risk

In a commentary by financial editor Patience Wheatcroft Dec. 16, The Times raises the specter of LTCM, citing the Bank of England Financial Stability Review. "Long Term Capital Management had, it seemed, a fully hedged low-risk operation, which aimed to make a sure profit from the difference between highly rated bonds and European securitized housing-related debt. All angles seemed to be covered. Yet LTCM careened towards bankruptcy, threatening computerfuls of derivative contracts, when one single event, Russia's 1998 debt default, suddenly persuaded a stampede of investors to run from even the most modest credit risk to the haven of low returns obtainable with safety. The Bank of England fears that the whole banking system may now be running the same sort of risk as LTCM," Wheatcroft reported.

There are other risks. Lord Turner, who is overseeing the government report on pensions (a senior Merrill Lynch director) and Chancellor of the Exchequer (Treasury Minister) Gordon Brown, are both talking about investing proposed National Pension Savings Scheme in private equity deals or hedge funds. "Those who are meant to protect savers, or to save the financial system from imploding one Friday afternoon, are appalled by such talk," Wheatcroft wrote.

She added that Financial Services Authority head John Tiner, "was wringing his hands at the Treasury Select Committee this week," because of a new EU law has made it possible for German hedge funds to sell directly to anyone in Britain, without FSA control. These hedge funds "have proved about as popular as a swarm of financial locusts in Germany," but now can be sold to UK investors.