Deutsche Bank – what does it have hiding under the bed?

If you ask anyone on The Street or in The Square Mile who their likely candidates are to set off the The Next Big One, the answers probably wouldn’t surprise you.  Greece, definitely.  Spain, oh yes, they’re teetering.  Peer-to-Peer, very dangerous.  Sub-Prime, it’s called a Bespoke Tranche Opportunity now, you know.  Brexit, hard or soft, it’s just not good news.

One name on the lips of no-one is that byword for solidity, productivity and uninterrupted success: Germany, and its prime mover in banking, Deutsche Bank.

Germany (and its strange bedfellow, France) have always represented the beating heart of the European project, especially with respect to its financial health.  Germany is widely (and usually quite rightly) regarded as an economic powerhouse and a model of level-headed perspicacity.  The perception of the German stereotypes of efficiency and solidity has remained firm, until now.

Deutsche Bank is in a groß pickle indeed.

Deutsche Bank are struggling to come to terms with a penalty of $14bn imposed by the US Department of Justice for the alleged mis-selling of mortgage-backed securities in the early days of the “Great Recession”.  It will not escape the eagle-eyes of market analysts that this figure is greater than the current market capitalisation of the bank.  No matter, say DB and its dour and plain-spoken CEO, John Cryan (forged in the furnaces of the People’s Republic of Yorkshire), we will not have to pay all of this by halves.

The world at large would be forgiven for thinking that Angel Merkel never misspeaks.  That said, we cannot think of a single reason why she would have felt the need to state on the record that Berlin would never consider a DB bail-out.  The Donald she is not; she is known for measured and strategic responses to the Big Questions.  Shares in DB have now sunk to just above €10 per share, a 30-year low without the hope of state intervention.  All we need now is some Northern Rock style doom-mongering from Robert Peston and we’re straight back to the 00’s.

Why should we care?

DB is estimated to hold assets valued at around £1.5trillion.  This figure represents a sum half the size of the entire German economy.  I will say that again: the entire German economy.  Deutsche Bank is the 11th largest bank in the world.  Moreover – and here’s the kicker – it is reported to hold over $61 Trillion of derivatives on its books.  Just enough to fund 21st Century Socialism then?

Should Deutsche Bank collapse, and the German government chooses not to come to the rescue, then this would be a significant blow to the world’s financial system.  The contagion would spread to Italian, French and Spanish banks, and then lights would be going out all over Europe.

The problem never really went away.

Deutsche Bank has in fact been wobbling for over a year now.  The present crisis is only a present manifestation of a wider and more pernicious problem.  DB never truly came to terms with and dealt with the risk it holds on its books.  The International Monetary Fund has been warning about the Bank for a while, stating that it “appears to be the most important net contributor to systemic risks”.

Foreign central banks are now fleeing the U.S. Treasury trade in increasing numbers, with Bloomberg reporting this week that U.S. bond investors are selling like crazy.

Joe Baratta of the $356 billion Blackstone Group, sounded his own warning:

For any professional investor, this is the most difficult period we’ve ever experienced. “You have historically high multiples of cash flows, low yields. I’ve never seen it in my career. It’s the most treacherous moment.”

Deutsche Bank themselves are aware of the issues, pointing out that the U.S. economy has activated all four of their “recession warning indicators“, a condition which usually indeed results in a recession. The clue is in the name.

Elsewhere in Europe, Credit Suisse is trading below its 2012 lows, as is Barclays.

Deutsche Bank is a systemically important institution with an enormous balance sheet.  If this company is wobbling, then what does that say for the problems will hiding within the rest of an interconnected system?  It appears that the banking crisis of 2008 never really went away, and was just washed further down the beach by a tidal wave of quantitative easing.