Credit rationing and the privatisation of the East German economy

Credit rationing was considered a severe problem for the quick privatisation of East German firms and for restructuring investments. It was argued that the higher the price for a firm the lower were the possible restructuring investments. However, this paper shows that this argument is not correct. Reducing the sales price attracts new buyers with riskier projects. For any given credit contract, this would lead to bank losses. To break even the banks therefore increase the equity-asset ratio. This reduces the funds available for restructuring investments. It turns out that the size of privatisation and the restructuring investments are entirely determined by the initial equity funds owned by potential buyers. However, a pure participation model, in combination with the taking over of the old debt of the East German firms by the Treuhandanstalt, would have been able to solve the problem of credit rationing for the privatisation of East German firms.