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August 18, 2010

American bankers, lending people's money to Germany was very profitable

Scott Stockdale

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In a case being watched closely by thousands of bondholders around the world, investors in defaulted pre-WWII German government bonds will finally get their day in court, after a U.S. Court of Appeals ruled that American courts have jurisdiction to decide whether the bonds are enforceable.

The plaintiff in the case, Tampa-based company World Holdings LLC, claims it has been stonewalled when it sought payment from the German government.

"The court decided that the complaint filed against Germany can proceed to discovery and that the case should not be dismissed because Germany is a 'foreign sovereign,' " said Michael Elsner, who represents World Holdings in the case.

"We requested damages in the hundreds of millions of dollars range, it's a number over $450 million," the lawyer added.

Because the 1920's and 1930's were turbulent times in the world economy, many investors sought to mitigate their risks by investing in bonds that were guaranteed by supposedly sound sovereign governments such as the United States, or Western European countries like Germany, France, the United Kingdom and Switzerland.

German bonds were prominent among these issues, with The Dawes Bonds (1924), followed by a multitude of other German issues, culminating in the Young Bonds of 1930.

To understand the history of the bonds, it is necessary to go back to post-World War I Germany.

In order to make reparation payments and rebuild the shattered German economy, German financiers were sent to New York to seek financial assistance.

The financiers’ negotiations in New York resulted in German states, cities and industries issuing billions of dollars worth of dollar-denominated bonds, backed by gold, good in times of war or peace, and printed in both German and English, with the English version taking precedence.

These bonds were guaranteed by the German Government and backed by trustees like J.P. Morgan and Citibank. The top investment banks in the United States were underwriting and promoting these bonds.

No sooner had the Young Plan gone into effect than German felt the full weight of the depression, as it was one of the hardest hit countries in the world.

Realizing that Germany was in no position to pay, U.S. President Hebert Hoover issue a one-year moratorium on German bond payments, on June 20, 1931.

In 1932-33, German industrial production fell 50% from its 1928 level, leaving the country in no position to make debt payments.

After Hitler came to power in 1933, he repudiated foreign debt.

In June 1933, German discontinued payments to a sinking fund used to amortize the bonds and in 1934, it ceased making interest payments on both the Young and Dawes Bonds. Although Germany was in default of its debt obligations, the outbreak of WWII made it impossible for bondholders to pursue any remedies.

Following WWII, German affirmed its pre-war liabilities, including the Dawes and Young Bonds, at the Conference on German External Debts in London, in 1953.

A payment plan was negotiated; and on February 27, 1953 Germany, the United States, and 17 other countries signed the London Debt Agreement (LDA). Also in 1953, the United States and Germany signed a treaty regarding certain matters related to the Validation of German Bonds under the LDA.

The 1953 Treaty states:

No bond, coupon, dividend warrant, renewal certificate, subscription warrant or other secondary instrument ... shall be enforceable unless and until it shall be validated either by the Board for the Validation of German Bonds in the United States established by the Agreement on Validation Procedures, or by the authorities competent for that purpose in the Federal Republic (of Germany).

By December of 1958, the validation board in the U.S. had closed and bondholders were left with no choice but to send their bonds to Germany for validation.

The lending of other people's money to Germany was very profitable for these Wall Street bankers; but when it came time to redeem the bonds, they abdicated their responsibility, leaving German debtors to decide if they were going to pay their creditors, the bondholders.

Ironically, Wall Street bankers issuing debt instruments they could not, or would not, honor, is the crux of the current financial crisis.

Meanwhile, with a few isolated exceptions, German officials would claim bonds sent to them were invalid because they had already been repurchased.

When asked to produce evidence to support this claim, they would invariably refer to a secret list of serial numbers of bonds they claim were repurchased and sitting in Reichsbank Berlin, where they claim they were looted in April and May of 1945 by invading Russian troops.

Consequently, under terms of the 1953 treaty, the bondholders must show the bonds were held outside German as of January 1, 1945, to ensure payment.

World Holdings claims the validation is unnecessary because the LDA only applies to accenting bondholders: not those who didn't accept the terms of the LDA.

Moreover, in the intervening years, with Germany left with the sole say on the validity of the bonds, bondholders were told that under the validation procedure they must send their bonds to Germany.

Whether deemed valid or invalid the bondholders would almost never get their bonds back.

Although, in accordance with banking practices for hundreds of years, repurchased bonds were either stamped or perforated, the bondholders’ bonds were unmarked.

In later years, German officials would stamp or perforate these unmarked or imperforated bonds sent for validation, and return them to bondholders marked “Invalid.”

Now after many years of obfuscating, Germany will have to defend its validation procedures in a U.S. Court, something few, if any experts, believe it can do.

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