The planned sale of German state bank Sachsen LB could collapse at the last minute unless the Saxon state government agrees to cover all debts associated with the bank's risky Dublin dealings.
The potential buyer, Landesbank Baden-Württemberg (LBBW), has claimed that the total debts accumulated by the bank in high-risk financial instruments amount to €43 billion, far higher than initially claimed.
As a result, LBBW is unwilling to proceed with the purchase by the end of the year unless the Saxon state government in Dresden puts up a €4 billion guarantee to cover risks associated with the bank's high-risk financial instruments based in Dublin.
Debts accumulated by these instruments, or conduits, after exposure to the US subprime lending market left the bank facing bankruptcy in August.
The German Savings Banks Association (DSGV) stepped in with a €17 billion rescue package and LBBW provided an additional €250 million with the option to take over the bank by the end of the year.
Those negotiations began in earnest at the weekend and ran into difficulties almost immediately.
LBBW is concerned about the risks associated with two other Dublin-based subsidies, Georges Quay and Sachsen Funding, and will pull out of the deal without further guarantees, LBBW sources told the Süddeutsche Zeitung newspaper.
"We won't do anything that would negatively affect our own balances," a bank spokesman said.
The Saxon government is now in a difficult situation: a state guarantee is not only unlikely to meet EU approval, but it is exactly what got Sachsen LB into trouble in the first place.
In 2005, the European Commission won a long-running legal battle against Germany, prohibiting state guarantees for the country's landesbanks.
Brussels said the practice was unfair because it boosted the state banks' credit ratings and allowed them to borrow money more cheaply than private competitors.
It was after losing their privileges that many landesbanks turned to the risky but lucrative end of the credit market to boost their profits - in Sachsen LB's case with catastrophic results.
The Saxon government had hoped to earn at least €300 million from the sale of the stricken bank, but analysts suggested yesterday that state premier Georg Milbradt may have to sign away the bank for nothing.
Such a move would be politically damaging for Mr Milbradt, but considerably cheaper than trying to raise the €4 billion demanded by LBBW - a quarter of the state's annual budget.
Another scenario might even see Mr Milbradt paying LBBW to take Sachsen LB off his hands.
The current deal stipulates that LBBW will only be liable for losses incurred from 2011 onwards, meaning the German taxpayer will cover the Dublin subsidiaries' losses until then.
Conservative estimates suggest Sachsen LB will this year lose €1.7 billion.
