No matter how hard it tries, Deutsche Bank’s subprime chickens keep coming home to roost. This week’s crisis: the aftershocks of a $14 billion fine imposed by the United States to punish Germany’s biggest lender for mis-selling subprime mortgage products.
Disputed reports of a state aid rebuff for Deutsche from Chancellor Angela Merkel pushed the bank's shares down this week to their lowest level in 30 years. On paper, Deutsche Bank is worth more than €60 billion but is currently valued at less than a quarter of that.
After posting record losses of €6.8 billion last year, the Frankfurt colossus suffered a serious credibility crisis in February over a miscommunicated bond-buyback.
In hindsight, all of that may have been the overture to the current drama. It’s a been a long, painful fall for Deutsche Bank. Its shares are now trading at just €11.50 – down from €47 in 2014 and €109 in 2007. Insurance on Deutsche credit defaults has spiked to levels not seen since the financial crisis. Covering a Deutsche demand of €100,000 now costs €2,420 annually – up from €589 in March 2015.
After flying high in the early 2000s on Wall Street, joining the international big league of high-risk, high-yield financial products, Deutsche Bank has spent the current decade nursing a post-crash hangover that won’t lift.
This is no ordinary hangover, however, nor is this an ordinary bank. This is Deutsche Bank, a year older than modern Germany itself, and, since 1870, the glue holding together Europe’s largest economy. But years of legal battles and restructuring woes have seen investors asking whether the Frankfurt giant is coming unstuck.
Last year, three generations of Deutsche chief executives lined up in a German courtroom to face charges that their loose talk had ruined Kirch, one of Germany’s largest media empires. All three were exonerated, but only after damaging court testimony exposed the bank’s inner workings.
Relief at shaking off the Kirch case was overshadowed by the simultaneous news of a record $2.5 billion fine to US and British authorities for manipulating the Libor interbank borrowing rate. The Libor scandal has yet to run its course. Former Deutsche traders were indicted last June in New York and one, Timothy Parietti, has admitted rigging the benchmark rate linked to trillions of dollars in securities and loans as part of a deal with prosecutors to help the US justice department with an investigation that it has signalled may yet claim more senior Deutsche scalps.
With all this going on, the average German would be forgiven for thinking that Deutsche, once a dull-but-serious bank with an occasional scandalous sideline, is now an institutional scandal with a sideline in banking.
Which takes us to the latest drama: the $14 billion put forward by the US justice department as the price for putting to bed Deutsche Bank’s subprime mortgage mis-selling of a decade ago.
Based on previous settlements with other errant banks, the Germans are confident the final deal will be significantly lower than this opening bid. But even a reduced fine could swallow in one gulp the entire €5.5 billion Deutsche has set aside for its legal battles that, according to one source, number in excess of 6,000. There was speculation on Friday night that a settlement involving roughly this amount will shortly be announced. This speculation, along with reassurances from the chief executive about its financial position, led to some recovery in the bank’s share price on Friday afternoon after it hit all-time lows of less than €10.
Deutsche has liquidity reserves of about €200 billion but, preparing for the worst, has begun selling off assets to raise more cash. Another option, selling more shares, would dilute existing stock and spook already nervous investors. That is not something Deutsche Bank is considering "at present", chief executive John Cryan told Bild on Wednesday.
The only other option is state aid, something Deutsche has resisted in the past. In Bild, the British-born chief executive bristled with indignation at claims he went cap-in-hand to Dr Merkel over the summer – and was rebuffed. "At no point did I ask the chancellor for help, I didn't even hint at anything of the sort," he said, insisting the bank was financially sound.
Some in Germany have drawn parallels to the Volkswagen diesel scandal: another blue-chip brand laid low by dirty dealings. But others see conspiracy theories, suggesting Deutsche is the latest firm to be dragged into a transatlantic tit-for-tat after VW and Apple .
As the finger-pointing starts, it's worth remembering that Deutsche Bank has dug this hole for itself. The go-to read for this is the 2011 US Senate report Wall Street and the Financial Crisis: Anatomy of a Financial Collapse. In emails quoted here, Deutsche's one-time top global trader Greg Lipmann described his bank's own security-backed products as "crap" but confessed to enjoying the challenge of trying to "dupe someone" into buying them.
Even in June 2006, as Mr Lipmann was warning his colleagues of the looming disaster, he admitted that it was difficult to quit the gambling table. “We are looking for ways to get out of this risk but, for now, the view has been: ‘We like the fees’.”
A colleague of his called Rocky Kurita, apparently a Vanilla Ice fan, put it another way in an email to Mr Lipmann a year earlier: "If there is a problem, yo, we'll solve it/Check out the spreads while my structurer revolves it."
Deutsche Bank’s US financial dealings involved, in butchery terms, repackaging low-grade offal as high grade round steak mince, offloading the “crap” before it began to stink, and pocketing the difference.
Only after the crash did many German banks in New York find out that they were the running joke of the street, viewed by other institutions as the useful idiots worth approaching to offload financial products no one else wanted to buy.
German financial analysts suggest many of the country’s banks were happy to take greater risks than the competition because their hybrid status – US investment banks with a continued domestic financing foothold – meant Germany would not let them fail. But that is the question that has come to a head this week: does Germany’s implicit guarantee still hold for Deutsche?
On paper, the European Union’s post-crisis bailout rules, implemented in Germany last year, lay out a clear liability cascade for struggling banks that put the taxpayer right at the end. But Deutsche Bank is not just a fallen star of Wall Street, it is a financier of Germany’s Mittelstand – the small- and medium enterprises that form the backbone of the domestic economy. They need a strong Deutsche Bank, as do the companies they trade with around Europe.
With elections looming next year, bailing out Germany’s largest bank would be an economic and political disaster for Angela Merkel – and at odds with her entire line in the years of crisis.
But the ambiguous words of wisdom – and warning – on the lips of countless Berlin politicians this week: Deutsche Bank is bigger than Lehman Brothers.
Lack of Schadenfreude
The level of fear in Frankfurt can be gauged by the utter lack of Schadenfreude among Deutsche’s private-bank competitors. In a worst-case scenario, next to Deutsche’s own investors, they would be on the bail-in hook to cover Deutsche’s losses through Germany’s private-bank deposit-insurance fund. In public, though, they insist there is no problem.
“We are not facing a compensation claim through Deutsche Bank,” said Thomas Schlüter, spokesman for the Association of German Banks, (Bankenverband), representing more than 200 private institutions. “There’s been a lot of speculation in the last days but everything has been repudiated.”
However, an analyst at one Frankfurt bank, who asked not to be named, said everyone was “shaken up” by the $14 billion fine. Can Germany’s largest bank shoulder such a burden, they wonder, and how much time and energy will that and other legal battles sap from bank managers who are supposed to be steering a radical restructuring effort to future-proof the institution?
“When a reputation takes as much damage as Deutsche, things can become a self-fulfilling prophecy,” said one banking analyst. “It is a question of trust. Do capital markets and private customers trust Deutsche Bank? If not, Germany – and Europe – has a big problem.”