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Deutsche Bank struggles raise global concerns

By Claes Bell · Bankrate.com
Sunday, October 2, 2016
Posted: 5 pm ET
Dietsche Bank struggles raise global concerns

Thomas Lohnes/Getty Images

With trouble brewing at major global banks and a tumultuous election season nearing its peak, it's feeling a lot like 2008 these days.

It's easy to see parallels between shaky Deutsche Bank and financial crisis instigators like Bear Sterns and Lehman Brothers, and hear echoes of big-bank misconduct from that era in the Wells Fargo hearings.

A lot has changed since that previous troubled era -- banks are better capitalized, regulators are more vigilant and the trouble isn't happening in our backyard -- but one thing is the same:

The failure of a massive global bank like Deutsche would have major consequences for the global economy, and ultimately the U.S.

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A slow-motion crash

In some ways, Deutsche's crash has unfolded in slow motion.

The bank weathered the financial crisis relatively unscathed. Then CEO Josef Ackermann proclaimed he "would be ashamed if we were to take state money during this crisis" in 2008.

But the company is now on its third CEO since then.

And the bank's stock price never recovered to anywhere near its pre-crisis highs. In May of 2007, it hit $160 a share -- today it stands at $13, having fallen more than 50% this year alone. On Sept. 29, Deutsche Bank hit an all-time intra-day low at $11.19.

Word came this week that hedge funds are withdrawing funds from the bank, and the price of credit default swaps, which act as insurance against the failure of the bank's bonds, has skyrocketed of late. In other words, trying to insure against the bank failing is akin to trying to buy homeowners insurance on a house that's already on fire.

The bank's bonds are still rated as investment-grade by many ratings agencies, says Mayra Valladares, managing principal of MRV Associates, a financial industry consulting firm.

But that might not mean much.

"The market is very much more on top of this than, I hate to say in this situation, the ratings agencies," says Valladares. "Let's not forget that Lehman was single-A (a top-tier credit rating) the day it declared bankruptcy."

The problem of determining Deutsche's true solvency or lack thereof is aggravated by the fact its risk-management systems have a reputation of being antiquated, slow and inaccurate, she says.

In effect, Deutsche's leaders are like pilots trying to fly a massive plane with faulty instruments.

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Bailout looming?

One thing is clear, says Roy Smith, a professor of finance at NYU's Stern School of Business:
Deutsche Bank is in crisis.

"It's clear that a run has been started," Smith.

That was touched off by news that the U.S. Department of Justice planned to demand $14 billion in fines from the bank for its role in the original financial crisis. Agence France-Presse reports) that the bank may be settling for $5.4 billion.

While the bank has taken some actions to protect itself, they may not be enough, Smith says.

"Deutsche Bank has raised a lot of capital, it has cut its expenses, it has shored itself up as much as it can, but it's still suffering quite a bit.”

In particular, Smith says, it’s suffering from two fundamental issues -- heavy post-crisis regulation and Europe's glacial rate of economic growth.

"The bank is doing its best, but it is not a strong bank, relative to other banks, relative to the environmental and regulatory conditions it faces, so it's not in a great position to withstand a run," Smith says.

"It's stronger than the U.S. banks, and particularly the U.S. investment banks, who were subject to the run in 2008. In other words, it's got bigger walls against collapse than those others did at that time," he says.

But that might not save it, especially if global investors get spooked to the point where its sources of short-term funding dry up.

Instead, the bank will likely be bailed out and then broken up under a new and untested process called the Single Resolution Mechanism, says Valladares.

"Unlike the FDIC, that for decades has been the legal authority in the U.S. to resolve a bank, the Single Resolution Mechanism is pretty new," Valladares says.

Danger to the U.S.

Even if European regulators fail to step in and save the bank, which would endanger contemporaries like Barclays or Credit Suisse, U.S. banks aren't as susceptible to collateral damage from Deutsche's troubles as European banks, says Smith.

Still, the sheer size of Deutsche Bank, and the interconnectedness of the global economy, may make its demise a threat to the U.S. economy, says Valladares.

The bank's assets as of the end of 2015 amounted $1.8 trillion (with a "t") at today's exchange rates, on par with Citigroup.

And U.S. banks may have more liability to Deutsche than they realize, thanks to the complex framework of derivatives that crisscross the globe.

"When I go to a regional (U.S.) bank and see they have a lot of position with Deutsche, I know the bigger ones certainly do," Valladares says. "So there's a tremendous of counterparty risk, and I sure hope that the regulators are asking the banks to be measuring right now how much exposure they have to Deutsche.”

Why Deutsche isn't Lehman

If all that sounds scary, there are some key reasons why Deutsch's troubles aren't likely to lead to the kind of economic collapse we saw in 2008.

1. Central bankers are ready to step in.

Prior to 2008, no bank close to the size of Lehman Brothers had ever failed, and there was some disagreement about what would be the possible consequences of letting such a bank fail. Lehman's failure quickly settled the debate by plunging the world into the worst financial crisis since the Great Depression.

Central bankers are unlikely to let something like that happen again, says Smith.

While Germany chancellor Angela Merkel has said she won't act to bail out the bank, if things get bad enough for Deutsche, there's little doubt that European authorities will step in to prevent a sudden collapse.

And the European Central Bank likely will step in to offer its services as "lender of last resort," Smith says.

2. U.S. banks have a lot more liquidity.

Thanks in part to regulations written after the financial crisis, U.S. banks have much bigger liquidity reserves than they did prior to the 2008 crash, Valladares says.

They could use those reserves to absorb losses from Deutsche Bank and keep the banks going should some sources of funding dry up.

Smith agrees.

3. Regulators are much more on top of their game.

Many bank regulators admit that they were taken off guard by the downward spiral that hit U.S. banks in 2008. Not so, this time, Valladares says.

"They've been through various reorgs, the people are better trained," and they take the issue of systemic regulation more seriously than they did in 2008, she says.

Worries remain

For her part, though, Valladares, like many Americans, sees an ominous parallel between then and now as this, and the Wells Fargo drama, unfolds.

"Look at what's happening with Wells Fargo," she says. "How can that sort of stuff still happen in this day and age of regulation? Well guess what, when somebody really wants to ignore risk management and rules on fraud, you know, they find a way."

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