German Landesbanks in the Post-guarantee Reality

This paper investigates the topic of guaranteed debt of German Landesbanks during the phase-out of state guarantees in the last two decades. I use evidence from literature, as well as interviews with members of the management of Landesbanks and the European Central Bank to trace the historical origins of the guarantees, their benefits, and the reason for their cancellation. The core of the first part of the work lies in the analysis of effects of the transition period between 2001 and 2005, during which Landesbanks continued to issue guaranteed debt. I claim that a failed policy design has led Landesbanks to a hazardous strategy of taking on excessive leverage without implementing sustainable business plan changes. The excess funds raised during the transition period led Landesbanks to finance M&A expansion, venture into investing in mortgage derivatives, and induced risky lending behavior. Therefore, the transition period was the root of the vulnerability of Landesbanks to the global financial crisis. Furthermore, an analysis of the bailout packages for Landesbanks during the 2008-2009 financial crisis demonstrates that the lifeline from the state owners to Landesbanks did not end with the end of the transition period in 2005. In my thesis, I suggest an alternative design of the transition period. According to this design, the volume of unsecured liabilities maturing in each year of the transition period would limit the issuance of state-guaranteed debt. Such a constraint would prevent Landesbanks from excessive issuance of guaranteed debt and avert some of the issues related to irresponsible deployment of excess funds. In the second part of the thesis, I use historical bond prices to construct yield spreads of Landesbanks' unsecured debt above German government bonds and observe these spreads as they change over time. The analysis reveals that investors have required higher yield on Landesbank debt after the cancellation of guarantees, but spreads have remained lower for the bonds of Landesbanks with large state ownership relative to the bonds of Landesbanks without state owners. Investors seem to ascribe value to the implicit support of a state owner, even once explicit guarantees are not in place.