Two weeks ago we mentioned some banking shenanigans going on in Europe, specifically with Deutsche Bank. At the risk of getting our readers all worked up and leaving them hanging we now take a closer look.
This issue really began in 2008 when Deutsche Bank’s appetite for risky business got them into the club that was wrapping all of those bogus mortgage backed securities up for sale. We all know how that ended so no sense spending time there. Out of that meltdown came new government stress tests purposed to help make sure tax payers wouldn’t be footing the bill next time a bank got itself into trouble.
Well… a part of Deutsche Bank failed our stress test this year after being a regular poor performer since the tests were implemented. They are heavily involved in facilitating derivatives trading for international investors and a year or so ago found themselves back in a position where the amount of leverage they had on the books was getting uncomfortable. The New York Times reported earlier this month that Deutsche Bank is levered somewhere around 25 to 1. As a comparison JP Morgan is around 9 to 1 and Lehman Brothers was at 39 to 1 before its collapse.
So how do you get rid of leverage? Approach one is to sell some of those levered assets. This runs into issues because banks used to be big buyers of other banks’ risky assets. Due to new regulation and those stress tests, they no longer are. This is a good thing in this instance, but firmly closes the door on that option for Deutsche Bank. Ok so option two then, make more money so the risky stuff is a smaller piece of the pie. That would be great if German interest rates weren’t zero or negative. With rates that low there is little to no room for the banks to make money. And they can’t issue debt, because again, the other banks can’t be buyers so they don’t know if the market would be there for it.
Then along came the U.S. Department of Justice. In the ultimate playout of kick them when they’re down, our D.o.J. decided now was the time to levy a hefty $14 Billion fine on Deutsche Bank for participating in the mortgage security wrapping ring in 2008. This caused widespread panic as Deutsche Bank’s ability to meet this obligation with its current liquid assets is under serious question. So naturally their stock price plummeted. Down roughly 49% in the past year.
So is the bank going to collapse? Most think not. They have been negotiating with the DoJ for a smaller penalty as well as cleaning up their act and undertaking massive cost cutting measures to prepare to pay some type of fine. The German Government has also officially said that the bank won’t receive any funds from the state should the penalty stand as is. So if they needed emergency cash raising it would come directly from the banks bond holders (bad, bad, bad).
It would behoove the U.S. to find a more reasonable fine that would not cause the utter collapse of the bank. To put them in a position where they actually fail would be borderline ludicrous and not good for anyone. In the end though, this is playing out as a very real punishment for Deutsche Bank, who’s operations will be crippled as a result of these fines. It’s never good to see a company in such bad shape, but the U.S. and EU are proving their willingness to put their money where their policy is and bring down the hammer on banks who insist on playing with fire.
It seems the world was serious when they resolved never to see another 2008.