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Denial is a ubiquitous psychological defense mechanism. It involves the repression of bad news, unpleasant information, and anxiety-inducing experiences. Judging by the German press, the country is in a state of denial regarding the waning health of its economy and the dwindling fortunes of its financial system.

Commerzbank, Germany’s fourth largest lender, saw its shares decimated by more than 80 percent to a 19-year low, having increased its loan-loss provisions to cover flood-submerged east German debts. Faced with a precipitous drop in net profit, it reacted reflexively by sacking yet more staff. The shares of many other German banks trade below book value.

Dresdner Bank - Germany’s third largest private establishment - already trimmed an unprecedented one fifth of its workforce this year alone. Other leading German banks - such as Deutsche Bank and Hypovereinsbank - resorted to panic selling of equity portfolios, real-estate, non-core activities, and securitized assets to patch up their ailing income statements. Deutsche Bank, for instance, unloaded its US leasing and custody businesses.

On September 19, Moody’s changed its outlook for Germany’s largest banks from “stable” to “negative”. In a scathing remark, it said:

“The rating agency stated several times already that current difficult economic conditions that are hurting the banking business in Germany come on top of the legacy of past strategies that were less focused on strengthening the banks’ recurring earning power. Indeed, the German private-sector banks, as a group, remain among the lowest-performing large European banks.”

Last week, Fitch Ratings, the international agency, followed suit and downgraded the long-term , short- term, and individual ratings of Dresdner Bank and of Bayerische Hypo- und Vereinsbank (HVB).

These were only the last in a series of negative outlooks pertaining to German insurers and banks. It is ironic that Fitch cited the “bear equity markets (that) have taken their toll not only on trading results but also on sales to private customers, the fund management business and on corporate finance.”

Germans used to be immune to the stock exchange and its lures until they were caught in the frenzied global equities bubble. Moody’s observes wryly that “a material and stable retail franchise in its home market, even if more modestly profitable, can and does represent a reliable line of defence against temporary difficulties in financial and wholesale markets.”

The technology-laden and scandal-ridden Neuer Markt - Europe’s answer to America’s NASDAQ - as well as the SMAX exchange for small-caps were shut down last week, the former having lost a staggering 96 percent of its value since March 2000. This compared to Britain’s AIM, which lost “only” half its worth. Even Britain’s infamous FTSE-TechMARK faded by a “mere” 88 percent.

Only 1 company floated on the Neuer Markt this year - compared to more than 130 two years ago. In an unprecedented show of “no-confidence”, more than 40 companies withdrew their listings last year. The Duetsche Boerse promised to create two new classes of shares on the Frankfurt Stock Exchange. It belatedly vowed to introduce more transparency and openness to foreign investors.

Banks have been accused by irate customers of helping to list inappropriate firms and providing fraudulent advisory services. Court cases are pending against the likes of Commerzbank. These proceedings may dash the bank’s hopes to move from retail into private banking.

To further compound matters, Germany is in the throes of a tsunami of corporate insolvencies. This long-overdue restructuring, though beneficial in the long run, couldn’t have transpired at a worse time, as far as the banks go. Massive provisions and write-downs have voraciously consumed their capital base even as operating profits have plummeted. This double whammy more than eroded the benefits of their painful cost-cutting measures.

German banks - not unlike Japanese ones - maintain incestuous relationships with their clients. When it finally collapsed in April, Philip Holzmann AG owed billions to Deutsche Bank with whom it had a cordial working relationship for more than a century. But the bank also owned 19.6 percent of the ailing construction behemoth and chaired its supervisory board - the relics of previous shambolic rescue packages.

Germany competes with Austria in over-branching, with Japan in souring assets, and with Russia in overhead. According to the German daily, Frankfurter Allgemeine Zeitung, the cost to income ratio of German banks is 90 percent. Mass bankruptcies and consolidation - voluntary or enforced - are unavoidable, especially in the cooperative, mortgage, and savings banks sectors, concludes the paper. The process is a decade-old. More than 1500 banks vanished from the German landscape in this period. Another 2500 remain making Germany still one of the most over-banked countries in the world.

Moody’s don’t put much stock in the cost-cutting measures of the German banks. Added competition and a “more realistic pricing” of loans and services are far more important to their shriveling bottom line. But “that light is not yet visible at the end of the tunnel … and challenging market conditions are likely to persist for the time being.”

The woeful state of Germany’s financial system reflects not only Germany’s economic malaise - “The Economist” called it the “sick man” of Europe - but its failed attempt to imitate and emulate the inimitable financial centers of London and New-York. It is a rebuke to the misguided belief that capitalistic models - and institutions - can be transplanted in their entirety across cultural barriers. It is incontrovertible proof that history - and the core competencies it spawns - still matter.

When German insurers and banks, for instance, branched into faddish businesses - such as the Internet and mobile telephony - they did so in vacuum. Germany has few venture capitalists and American-style entrepreneurs. This misguided strategy resulted in a frightening erosion of the strength and capital base of the intrepid investors.

In a sense, Germany - and definitely its eastern Lander - is a country in transition. Risk-aversion is giving way to risk-seeking in the forms of investments in equities and derivatives and venture capital. Family ownership is gradually supplanted by stock exchange listings, imported management, and mergers, acquisitions, and takeovers - both friendly and hostile. The social contracts regarding employment, pensions, the role of the trade unions, the balance between human and pecuniary capital, and the carving up of monopoly market niches - are being re-written.

Global integration means that, as sovereignty is transferred to supranational entities, the cozy relationship between the banks and the German government on all levels is over. Last October, Hans Eichel, the German finance minister, announced OECD-inspired anti-money laundering measures that are likely to compromise bank secrecy and client anonymity and, thus, hurt the German - sometimes murky - banking business. Erstwhile rampant government intervention is now mitigated or outright prohibited by the European Union.

Thus, German Laender are forced, by the European Commission, to partly abolish, three years hence, their guarantees to the Landesbanken (regional development banks) and Sparkassen (thrifts). German diversification to Austria and central and east Europe will provide only temporary respite. As the EU enlarges and digests, at the very least, the Czech Republic, Hungary, and Poland in 2004-5 - German franchises there will come under the uncompromising remit of the Commission once more.

In general, Germans fared worse than Austrians in their extraterritorial banking ventures. Less cosmopolitan, with less exposure to the parts of the former Habsburg Empire, and struggling with a stagnant domestic economy - German banks found it difficult to turn central European banks around as successfully as the likes of the Austrian Erste Bank did. They did make inroads into niche structured financing markets in north Europe and the USA - but these seem to be random excursions rather a studied shift of business emphasis.

On the bright side, Moody’s - though it maintains a negative outlook on German banking - noted, in November 2001, the banks’ “intrinsic financial strength and diversified operating base”. Tax reform and the hesitant introduction of private pensions are also cause for restrained optimism.

Pursuant to the purchase of Drsedner Bank by Allianz, Moody’s welcome the emergence of bancassurance and Allfinanz models - financial services one stop shops. German banks are also positioned to reap the benefits of their considerable investments in e-commerce, technology, and the restructuring of their branch networks.

The Depression on 1929-1936 may have started with the meltdown of capital markets, especially that of Wall Street - but it was exacerbated by the collapse of the concatenated international banking system. The world today is even more integrated. The collapse of one or more major German banks can result in dire consequences and not only in the euro zone. The IMF says as much in its “World Economic Outlook” published on September 25.

The Germans deny this prognosis - and the diagnosis - vehemently. Bundesbank President Ernst Welteke - a board member of the European Central Bank - spent the better part of last week implausibly denying any crisis in German banking. These are mere “structural problems in the weak phase”, he told a press conference. Nothing consolidation can’t solve.

It is this consistent refusal to confront reality that is the most worrisome. In the short to medium term, German banks are likely to outlive the storm. In the process, they will lose their iron grip on the domestic market as customer loyalty dissipates and foreign competition increases. If they do not confront their plight with honesty and open-mindedness, they may well be reduced to glorified back-office extensions of the global giants.

About The Author

Sam Vaknin is the author of Malignant Self Love - Narcissism Revisited and After the Rain - How the West Lost the East. He is a columnist for Central Europe Review, PopMatters, and eBookWeb , a United Press International (UPI) Senior Business Correspondent, and the editor of mental health and Central East Europe categories in The Open Directory Bellaonline, and Suite101 .

Until recently, he served as the Economic Advisor to the Government of Macedonia.

Visit Sam’s Web site at http://samvak.tripod.com; palma@unet.com.mk

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In 2005, American investors set a new record with net purchases of foreign stocks of more than $110 billion. American investors’ home bias is waning, research shows that foreign shares represent about 16% of the average portfolio and many financial advisors are now recommending that their clients allocate 10%-30% of their portfolios to non-U.S. stocks and bonds.

American companies have gone global in a big way and stellar returns from investing in global stock markets over the past few years has left U.S. only investors green with envy and red ink portfolios.

But what is still the most-quoted market indicator in newspapers, on TV and on the Internet - the Dow Jones Industrial Index (DJIA).

Let’s look briefly at the history of this index, why it may be out of date and discuss a possible alternative to financial products that track it such as the Dow Diamonds (DIA).

Charles Dow created in 1896 the first Dow Jones Index that included nine railroad stocks, a steamship line and a communications company. In 1916, the industrial average expanded to 20 stocks; the number was raised again, in 1928, to 30, where it remains.

Charles Dow had the vision to create a benchmark that would project general market conditions and therefore help investors bewildered by fractional dollar changes. A revolutionary idea at the time, its implementation was simple. The averages were, well, plain old averages. To calculate the first average, Dow added up the stock prices and divided by eleven, the number of stocks included in the index. A special divisor other than the number of stocks is used to avoid distortions when constituent companies split their shares or when one stock is substituted for another.

Today, the DJIA is a benchmark that tracks American stocks that are considered to be the leaders of the economy and are listed on the Nasdaq and NYSE. The DJIA covers 30 large-cap companies, which are subjectively picked by the editors of the Wall Street Journal. Over the years, companies in the index have been changed to ensure the index stays current in its measure of the U.S. economy. In fact, of the initial companies included, only General Electric remains as part of the modern-day average.

The most recent deletions were when Kodak, International Paper, and AT&T were replaced by Pfizer, AIG, and Verizon. A few years ago, the Dow’s overseers made history by adding the first two stocks listed not on the New York Stock Exchange, but on the Nasdaq: Microsoft and Intel. Since 1959, other companies added include Disney, Wal-Mart, McDonald’s, and Home Depot.

You may be thinking that the S&P 500 Index has overtaken the DJIA in popularity. But over long stretches, the Dow 30 and the S&P 500 have correlated closely. The S&P 500 Index is also market-cap weighted leading to an unhealthy concentration in the largest stocks.

Furthermore, when the two have diverged, the S&P has been the more volatile, with higher highs and lower lows. Since January 2000, the steepest Dow decline was 30 percent, whereas the S&P 500’s was 40 percent. Nor have S&P investors, at this point, been compensated for the additional risk associated with that volatility. As this is written both indexes still stand below their January 2000 levels, but the Dow’s loss is milder.

Because the DJIA is made up of exclusively U.S. companies and by definition focused on industrial companies, it does not accurately reflect the performance of large swaths of the U.S. or global marketplace. There are a lot of good companies in the DJIA but it is no longer a good barometer of the American economy or the typical American portfolio nor a useful index for investment vehicles to track.

What’s better out there? Using a simple value-based model and some horse sense, I put together in January 2003 an index of 30 companies drawn from the S&P Global 100 Index. Called the Chartwell Global 30, it contains 15 U.S. companies and 15 foreign companies weighted equally just like the Dow.

In terms of sector weighting, the differences are surprisingly muted. The Chartwell Global 30 has more exposure to the medical and finance areas and less exposure to multi-sector conglomerates and industrial products.

While many American multinationals are outsourcing to reduce short-term costs, many foreign companies in the Chartwell index make significant contributions to the U.S, economy. For example, about 60% of the vehicles Toyota sells in North America are built here and the Swiss pharmaceutical company Novartis has its global research headquarters in Boston.

Making no changes and rebalancing on an annual basis, here are the results. In 2003, the Dow was up 3.15% and the Chartwell Global 30 was up 28.45%. In 2005, the Dow was down 0.61% and the Chartwell Global 30 was up 16.25%. One may ask if a two year test is inadequate but a back test of performance for the period 2000-2005 shows that the Dow is in negative territory while the Chartwell Global 30 is up 39%. An ETF tracking the Chartwell Global 30 will be available in 2006.

The Dow Jones Industrial Average was revolutionary at inception and has a well deserved storied past that parallels the evolution of the American economy. For the era of the global economy and investor, it’s time for a new revolution.

Carl Delfeld is head of the global advisory firm Chartwell Partners and editor of the the “Chartwell Advisor” newsletter. He served on the executive board of the Asian Development Bank and is the author of “The New Global Investor.” For more information go to http://www.chartwelladvisor.com or call 877-221-1496.