More Losses to Come

Dr. Michael Schroeder is the head of the department of International Finance and Financial Management at the Center for European Economic Research (ZEW), a non-profit economic research institute in Mannheim, Germany.

Deutsche Welle: Dr. Schroeder, how will Lehman's collapse affect Europe?

Michael Schroeder: That question is difficult to answer. Lehman doesn't have much systemic risk, or risk with a high probability that it will pull down other banks in its wake. So I don't expect the direct counterparts in the banking sector will be hit very strongly.

But it is a signal that much greater-than-expected problems in the banking sector are yet to come. Some experts thought one or two months ago that the worse of the subprime crisis was over. But as we see in the news, this is not the case. It was very optimistic.

World stock markets dropped sharply at the Lehman bankruptcy news. Why does the failure of one US bank have such far-reaching financial effects?

I think it has to do with the fact that there still very high losses to come in the near future. We see that hedge funds, or so-called monoline insurance companies, or other banking institutions could go bankrupt or near-bankrupt by the end of the year -- particularly in the US but also perhaps in Europe, due to collateral damage in the sector.

The expectations are now that high losses could come in the next two or three months. This will also hurt the business cycle in Europe. But it is difficult to predict to how great an extent; how strong the impact will be.

Should consumers in Germany be concerned?

Well, yes, German consumers should be concerned because the business cycle will be relatively weak over the next year. But the consumers themselves are part of the problem. The economy gets weaker, they become more risk averse, then they consume less, and it drives the cycle downwards. ... Germans should consumer more, to combat this cycle.

The US government opted not to bail out Lehman. Yet the German government recently went to the aid of the IKB Bank, when that lender nearly collapsed in the wake of the subprime crisis...

I think bailing out banks or companies has a lot to do with so-called systemic risks. I do not expect that Lehman really will have a strong effect on other banks or banking systems … So the US was right for not bailing out Lehman Brothers, in my opinion.

I also didn't understand why the German government bailed out IKB. In my opinion it was absolutely unnecessary, and it imposes relatively high costs to the taxpayers in Germany.

One US analyst is comparing this Monday to a certain Black Monday back in 1929. Is that realistic?

That is absolutely exaggerated ... I don't believe we have an unmanageable, or even an extremely strong, crisis right now. The stock markets and all the other markets have reacted realistically.

There are, of course, very high losses. But it is not a catastrophe.

Is there a lesson to draw from this turn of events?

We need a new framework for the banking industry that should be instituted when this crisis is over. We need clear rules that say when to bail out and when not to bail out a company.

Politicians should make it clear that banks can go bankrupt. ... There are many medium size banks that should be allowed to go bankrupt when they have no liquidity anymore.

We also need to have a framework for how it should be handled when a bank is bailed out. Managers shouldn't be allowed to get away with being extremely risk-loving and then not have to pay the price if that strategy fails.

When the economy absorbs losses it should be clear who has to pay for these losses. The taxpayer shouldn't always have to pay.