house bet

Gambling and Losing Town Money

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Quiet towns a hub of speculation?
  • Why it matters

    Why it matters

    A large number of cities and towns across Germany bet taxpayer money on complex investments – and often lose money.

  • Facts

    Facts

    • In 2011, the German Federal Court ordered Deutsche Bank to pay €540,000 in damages to the mid-sized company Ille.
    • The case became a blueprint for other businesses and municipalities trying to recover losses from complex investments that banks sold them.
    • As a rule, regional and higher regional courts generally side with the bank’s clients.
  • Audio

    Audio

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The small community of Rheingau-Taunus, nestled in the wealthy German state of Hessen, has a debt of 162 million Swiss francs. The size of the loan is not the problem. It’s the currency.

When Switzerland’s central bank shocked the financial world by ending its peg with the euro in February, the franc rose rapidly in value – and so did the Rheingau-Taunus district’s debt.  The expensive foreign currency loan could end up costing Rheingau-Taunus up to €50 million, as the Swiss franc has fallen from its peg of €1.20 to €0.96 currently.

That explosion in debt was enough to get the attention of state government officials in Hessen, which is now the latest state pushing to ban cities and other municipalities in Germany from speculative investments in the future. The local state government, a coalition between the center-right Christian Democrats of Chancellor Angela Merkel and the Green Party has prepared a proposed law in the state’s capital of Wiesbaden, according to information obtained by Handelsblatt.

The need to ban municipal speculation should already have been clear well before the threatened losses in Rheingau-Taunus. Cities and towns across Germany have gambled with taxpayer money in past years. Many investing in complex interest derivatives that went sour in the 2008 financial crisis.

“With interest derivatives, it also took a while before the full extent became known”

Sven Petersen, Managing director of Sachsen Asset Management consultants.

Most recently, several cities and municipalities across Germany – including Gelsenkirchen, Essen and Bochum in North Rhine-Westphalia – also speculated on foreign currency loans, hoping it might save them some debt payments in future. The bets wound up blowing up in their faces.

The key question for both states and their communities is: Did town treasurers gamble, or did their banks poorly advise them?

There are already dozens of legal battles involving investments in interest derivatives by municipalities, many of which are confident they will get banks to pick up at least some of the tab for their speculative failings of the past.

A 2011 civil court ruling – in which Deutsche Bank was ordered to pay damages to a small business, Illi, for an interest swap transaction gone wrong – opened a flood of suits by businesses and municipalities trying to recover mounting losses from complex investments that banks sold them.

Often the cases involve losses in the tens of millions. As a rule, regional and higher regional courts generally side with the bank’s clients. When banks appeal damage awards, they argue that the interest swap transactions were not highly complex – and that plaintiffs should have understood them and the consequences.

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Sven Petersen, managing director of Sachsen Asset Management consultants, said he now expects more community losses to be revealed in the area of foreign currency loans. “With interest derivatives, it also took a while before the full extent became known,” he said.

With a speculation ban, Hessen would follow similar 2012 legislation to change the municipal code in the eastern state of Saxony. Because states monitor the financial transactions of cities and towns, their interior ministries have municipal authority.

According to the Frankfurter Rundschau newspaper, Hessen will change the municipal code to stipulate that “borrowing always take place in euros.”

Most other German states were already wary of foreign currency loans. Bavaria, Brandenburg, Lower Saxony, Rhineland-Palatinate, Saxony, Schleswig-Holstein and Thuringia refused to allow such loans. In contrast, there are no regulations limiting currency swaps in Baden-Wuerttemberg, Mecklenburg-Western Pomerania, Saxony-Anhalt and Saarland.

Some have taken a compromise approach. In North Rhine-Westphalia, for example, municipalities must put aside extra cash to cover risks from foreign currency loans. This didn’t stop communities in the state from suffering at the hands of the Swiss franc.

In chronically cash-strapped municipalities in North Rhine-Westphalia,  “interest and loan optimization” was widespread, with help from derivatives or foreign currency loans. Town treasurers would try to relieve the municipal budget and lower their interest burden. After the financial crisis hit, though, such deals often ended up losing money.

The German Association of Cities and Towns has worked on a “sample instruction” for taking up new loans and debt restructuring. For example, municipalities should ensure that exchange rate risks don’t jeopardize budgets and they don’t exceed a certain range.

Many communities have already cut back as a result. From 2011 to 2013, the foreign currency debt level in municipal budgets dropped from €2 billion to €658 million, the association said.

 

Donata Riedel has worked for Handelsblatt for 20 years and writes about economic policy. Elisabeth Atzler is Handelsblatt’s banking correspondent. To contact the authors: riedel@handelsblatt.com and atzler@handelsblatt.com

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