Bad Banks: The Case of Germany

This paper discusses the instrument of equalisation claims, which has successfully been used in two previous German debt crises as a method for stabilizing the balance sheets of financial institutions. A modern version of this method would swap temporarily illiquid assets for government bonds with open maturit, in order to avoid the problem of evaluating the toxic assets in advance. Not only will this method save taxpayers' money, but it also upholds the market principle of liability, thereby avoiding incentives for inefficient risk-prone behaviour in the financial sector. The current German bad bank approach principally follows this approach, but severely suffers from unnecessary complexity and voluntary participation.