Germany stepped up efforts to stabilize its banking sector on Wednesday, approving a draft law allowing forced nationalizations and saying it would use its new powers to take control of lender Hypo Real Estate.
The German step is the latest example of state intervention in the banking sector as countries across the globe abandon free-market principles and move to shore up institutions seen as crucial to the functioning of their broader economies.
The new German legislation, which was backed by Chancellor Angela Merkel's cabinet on Wednesday but must still be approved by parliament, breaks a postwar taboo in giving Berlin the right to expropriate, or dispossess, shareholders in domestic banks.
Merkel's "grand coalition" agonized for weeks before choosing this path, aware that it is linked in the minds of many Germans to Nazi seizures of Jewish property in the 1930s and East Germany's assault on private business after World War Two.
In the end it decided it needed the "Enteignung" option to ensure it could take control of Munich-based Hypo, but imposed strict time limits on any expropriation to make clear it was not mulling similar moves with other banks.
"We examined this very carefully and I don't believe we have any alternative," Merkel told reporters.
Hypo has received 102 billion euros ($128.4 billion) in guarantees from the state and fellow banks over the past year but remains in dire financial straits.
Berlin has said the bank, which was hit hard by its exposure to the collapsing U.S. mortgage market a year ago and has spiraled downwards since, cannot be allowed to fail because of its key role in the German Pfandbrief, or covered bond, market.
But taking control of Hypo and preventing it from sucking in more taxpayer money has been complicated by the fact that U.S. private equity firm JC Flowers owns a quarter of its stock.
Berlin has been negotiating with Flowers, which bought the stock last June for 22.50 euros only to see it plummet to just above 1 euro, but has yet to reach a settlement.
Before taking a decision to expropriate, Berlin has vowed to explore all other options.
The favored solution appears to be to take control through a simultaneous capital reduction and increase which would push up the state's holding and allow it to squeeze out other shareholders.
The new legislation makes this possible by reducing the threshold needed to inject fresh capital to 50 percent plus one share from a previous threshold of just over 75 percent.
"Only if this does not work would the last resort come into play, and that is an expropriation," Merkel said.
On Wednesday, Finance Minister Peer Steinbrueck also evoked the possibility of a government takeover bid for Hypo, a statement which helped push the bank's shares up over 43 percent by the time the market closed.
He gave no further details on how this could be done.
Hypo Real Estate is not the only German bank that has been hit hard by the global financial crisis and forced the government to intervene.
Last month Berlin took a 25 percent stake in Commerzbank, the country's second biggest bank.
On Wednesday Commerzbank reported an operating loss of 822 million euros for the fourth quarter and its Chief Executive Martin Blessing said the bank was going through one of its most difficult periods ever.
Reuters has reported that a joint "bad bank" pooling the troubled assets of Commerzbank and Hypo Real Estate is being examined, but Commerzbank finance chief Eric Strutz rejected such a move.
"I can only give a clear rejection to cooperation with Hypo Real Estate," Strutz said.
"We think that every financial house must find its own solution." Germany has been mulling steps that would allow struggling banks to rid themselves of their bad assets, but Steinbrueck said on Wednesday that he would not present any new concept before the end of March.