Everyone is denying everything.
By Don Quijones, Spain & Mexico, editor at WOLF STREET.
Judging by the slow-motion meltdown of a growing number of large banks in Europe, including Deutsche Bank (in the IMF’s words, the “world’s most important net contributor to systemic risks”), confidence in their solvency is evaporating. And the denial and blame games have begun.
Deutsche Bank CEO John Cryan denied any need to raise capital or ask for a bailout. That was followed by furious denials from Mario Draghi that the ECB’s low rates are partly responsible for Deutsche Bank’s current woes. Roughly half of all of Deutsche’s profits have traditionally come from loan interest; now, thanks to the madcap negative-interest-rate policies, that source of income is disappearing.
But the bank’s spectacular fall from grace — it has lost 90% of its market value since 2007 — is primarily owed to woeful, often criminal mismanagement. Hence, all the fines. As the WSJ’s Paul J Davies writes:
The bank faces all the problems that plague its peers, but it has most of them worse than rivals. Its costs are among the highest, its balance sheet among the most bloated and its longer-term profitability one of the least attractive.
Lies, Damned Lies and Contradictions
Things are so serious and the denials are flowing so thick and fast that many of the main players are contradicting each other — and sometimes even themselves — at just about every turn.
According to Draghi, Deutsche Bank is no longer “systemically important,” despite being assigned that exact same label by the BIS Financial Stability Board, the shadowy group of international financial bodies, finance ministries and central bankers that compiles the list of global systemically important financial institutions (G-SIFIs), in the process enshrining failure as the cornerstone of financial industry success. Its first ever list, which included Deutsche Bank, was published in November 2011, when the board’s chairman was… Mario Draghi.
As for the head of the IMF, Christine Lagarde, she proffered a wildly different take, telling CNBC that Deutsche Bank is a systemic important player in the global financial system, but “is on a solid base currently, and we are not at a stage in which I see the need for a government intervention.”
You can expect that opinion to change significantly in the coming days or weeks, as will Merkel’s dogged insistence that the EU’s Bank Recovery and Resolution Directive (BRRD) — which requires an 8% bail-in of a bank’s creditors, including very large foreign banks and hedge funds — be applied before taxpayers get put on the hook.
This was the line she held to steadfastly throughout the early months of Italy’s banking meltdown. In a recent interview she ruled out any state assistance for Deutsche Bank. A state-financed rescue could be a political liability for Ms. Merkel should she decide to run again in next year’s general election. But with Deutsche Bank’s assets amounting to 58% of Germany’s GDP, Merkel will not allow the bank to collapse. The damage to the German economy would be too enormous.
A License to Fail
Germany’s Allianz, a global systemically important insurer, has already made it abundantly clear what it expects the German government to do if Deutsche’s financial situation gets any worse, and that is to bail it out. “I don’t buy at all what’s coming out of Germany in terms of (the government) not wanting to step in ultimately if Deutsche Bank was really in trouble,” Allianz Global Investors AG Chief Investment Officer Andreas Utermann told Bloomberg. “It’s too important for the German economy.”
The question is how.
The answer, apparently, is to find a loophole buried deep within the EU’s bail-in ruling that would allow the German government and the ECB to save face while saving Deutsche with public money. You can bet that Europe’s best-paid financial lawyers have been scouring the text for the perfect escape clause. According to a Fortune article from July on Italy’s soon-to-be-rescued Monte dei Pachi di Siena, they may have found it: apparently the Bank Resolution and Recovery Directive only applies to banks that regulators have identified as distressed, not insolvent.
All Germany would have to do is prove that Deutsche is perfectly solvent, but just a little distressed. To do that, all it needs is an official-looking unclean bill of health — like say, a failed stress test.
To wit, from The Wall Street Journal:
Berlin could use a loophole in the bank-rescue legislation that allows a precautionary state recapitalization of a bank that has failed a stress test. The finance ministry could try to persuade the bank’s supervisor to test Deutsche’s capital cushion, allowing the government to step in with a capital injection should the bank fail the test.
While some economists see this as bending the rules, most say it would leave them intact.
And there you have it: a perfect temporary solution to another intractable problem. Just get Deutsche to fluff another stress test, as its U.S. subsidiary — the same unit that is responsible for the $14 billion fine that has pushed the bank to the very brink — has repeatedly done with aplomb in its U.S. stress tests. In simple terms, it’s a License to Fail (and get bailed out).
When failure becomes the ultimate virtue, you know the game is almost over. Once Germany’s über-austere government bites the bullet and rescues its own flagship bank with public money (as it quietly did with many of its smaller banks in the wake of the first leg of the global financial crisis), all attempts to reform Europe’s deeply dysfunctional financial sector will have come to naught.
And every other European country, from Italy to Greece, Portugal to Spain, would have a green light to do the same for their flag carriers. All they’d have to do is show that their banks are failing but are not insolvent. There can be no doubt they’ll find a willing accomplice in Mario Draghi’s ECB. Meanwhile, not a single thing will be done to address Europe’s very real financial problems, from its negative interest rates to its bloated leverage, via the Doom Loop that’s just waiting to spin out of control. By Don Quijones, Raging Bull-Shit.
Investors are not amused. Read… EU Banking Mayhem, One Bank at a Time, then All at Once