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All is not well in the German economy

Analysis: Despite new growth, experts sound the alarm on a looming credit crunch.

Guests mingle at a 1930s Great Depression theme party in the Belvedere palace in Potsdam outside Berlin July 25, 2009. Dressed in the salon fashion of the 1920s and '30s, about 500 guests danced to Charleston and Foxtrott in the 19th century Italian style castle, celebrating decadence and burlesque culture of the Great Depression era, in what the organisers "Boheme Sauvage" said was the best way to escape the mundane reality of today's financial crisis. (Thomas Peter/Reuters)

BERLIN — Economic headlines last week bore unexpected good news for Germany: With positive, if modest, growth of 0.3 percent in the second quarter of the year, Europe’s largest economic engine had officially moved out of recession.

But there are more dark clouds gathering on Germany’s economic horizon. Indeed, the president of Germany’s banking association reminded the country that its financial system was a long way from exiting crisis mode.

“It is obvious that every bank will have more to deal with in the next 18 months, in terms of defaults by clients and non-performing loans, than they have had up to now," Andreas Schmitz, president of the Federal Association of German Banks, told the Financial Times.

For those who had been tracking the German economy during the crisis, it was clear what Schmitz was hinting at: German banks had not weathered the storm well, and a credit crunch loomed. That doesn’t bode well for the greater German economy, whose diverse export-dependent businesses rely on lines of credit to finance them in normal times, much less the turbulence of the past year’s global crisis. Already, 57 percent of the country’s largest engineering association — an organization whose members include heavyweights like Volkswagon and Siemens — have reported difficulties accessing credit. In March, only 5 percent of companies reported such problems.

“We shouldn’t be surprised by these developments,” said Fabian Kreidner, an economist at the Free University in Berlin. “We’ve been in denial a long time.”

Independent economic analysts, including Klaus Zimmerman, president of the German Institute for Economic Research, have seen in Germany’s precarious bank balance sheets reminders of Japan’s “Lost Decade” of the 1990s, when the Asian economic powerhouse failed to clean up its banking sector and the country’s economy stalled for years on end as a result. “The problem is going to come when we want to get out of the crisis,” Zimmerman said. “The banking sector has to be there and be healthy. And the banks won’t be able to participate.”

Indeed, the problems with Germany’s banks are compounded precisely by the fact that the country’s political world has made a habit of ignoring their severity. In the early days of financial freefall, Chancellor Angela Merkel and Finance Minister Peer Steinbrueck didn’t shy from pointing fingers at the banks in Britain and America for their risky speculations, but had little to say about their own lending institutions.

It turned out, though, that in many cases German banks were even more deeply leveraged than their Anglo-Saxon counterparts. In fact, it was precisely those German banks that were the most highly regulated — the state-owned and controlled regional Landesbanken — that were found to be the most exposed to the infamous sub-prime mortgage derivatives.