Deutsche Bank’s stock is down yet again on Monday as the turmoil rocking Germany’s largest bank continues into a second week.
Investors are concerned that the bank may not have enough cash to pay off a massive US fine stemming from the financial crisis, and continue its operations at the same time.
What’s more, Germany’s ruling coalition said that it won’t bail out the bank. For elected officials, a bailout would be political suicide. However, Deutsche Bank investors fear that a lack of a bailout could be murder for the company.
Last week, reports that hedge fund counter-parties were pulling their money from the bank sent the stock plummeting. Deutsche Bank CEO John Cryan sent out a letter trying to assuage the fears of his investors and employees, and in it he pointed out a potentially deadly sickness that has attacked the nervous system of his bank.
“Trust is the foundation of banking,” he wrote. “Some forces in the markets are currently trying to damage this trust.”
What’s fascinating about this is that what Cryan said about banking could apply to the market as a whole. All markets run on trust. And unfortunately, we’re not just seeing that trust evaporate at Deutsche Bank. Its problems are just a microcosm of the trust we’re seeing evaporate from markets and all around the world.
Dark and getting darker
To frame where we’re about to go here I’m going to bring up something I’ve talked about on this website perhaps 100 times before — the value of trust in markets.
And the person who has explained it best in the last two years is economist Dylan Grice, a portfolio manager at Aeris Capital. In a paper written in 2014 — a time when many were confident in the global economy — Grice saw only dark clouds forming.
He explained that he believed we were entering the trough of a cycle of trust, when people in markets would no longer have the will to cooperate with one another.
“In my opinion, the period between the Berlin Wall coming down and the September 11th, 2001 attacks on the United States was the peak of the recent cycle. The degree of cooperation and trust was probably as high as it had been since a century earlier, as the 19th century became the 20th century.”
But all of that has changed. As Grice was writing, relations between the US and Russia were hitting their lowest point in decades. Populism was just taking hold in Europe and the US, and things were heating up between the US and its allies in the South China Sea. Cooperation was waning, and the markets just hadn’t felt it yet, Grice posited.
But now the markets are certainly feeling it — ask any trader, banker or hedge fund manager getting spanked right now. Of course, at the same time, all the factors Grice mentioned have only gotten worse. Our trust has only eroded more, and analysts beyond Grice are starting to worry.
“The rise in populism seen in many advanced countries could be a precursor to increased trade-protectionism and growing fragmentary tensions in the eurozone, both of which would increase uncertainty and damage prospects for private sector investment,” said Brian Coulton, Chief Economist at Fitch.
And as such: “This year is likely to see the lowest annual growth rate for US GDP since 2009 as oil sector adjustments, weak external demand and the earlier appreciation of the dollar take their toll on industrial demand,” he said.
Last week at Bloomberg’s Most Influential conference in New York City, Economist Alan Kreuger explained that global trade, which has been slowing for the last 5 years, will probably grow more slowly than GDP worldwide this year.
“I think that part of the moderation is because the forces that caused such rapid globalization were naturally not going to go on forever,” he said.
He included the rise of China and (shout out to Grice) the fall of the Berlin Wall among those forces.
In other words, we’re not cooperating enough to make money. We don’t trust each other enough to keep the world rich. We’ve opened up the globalization can of worms, and there’s no going back to isolated economies. There’s only going forward. Adjusting to this new global economy, however, requires political trust we don’t have.
Smack talk still smacks
This brings us back to Deutsche Bank. The worst issues dogging the bank all have to do with trust. I’ll name three.
- The massive $14 billion fine the US Department of Justice announced last week (which has since been reassessed down to $5 billion or so — but we shall see).
- The fact that the EU said that it will not follow Basel banking recommendations for risk management, capital requirements and the like.
- The announcement from German regulators that they will not be bailing out the bank.
The first trust issue is obvious. The DOJ is punishing Deutsche Bank for a violation of trust in its dealings in the mortgage bond market. But that’s in the past. The following two issues have to do with the future, and as such, are potentially more insidious. Their solutions require trust that seems to be lacking here.
Let’s go with Basel first. The EU has objected to some of Basel’s rules because it thinks thinks onerous capital requirements will hurt its business.
The problem with this, though, is that if you’re an investor or a counter-party that does business with Deutsche Bank you’re thinking higher capital requirements might help them out a lot right now. Its balance sheet is about $2.5 trillion and it has around $15 billion in cash, leaving the bank highly leveraged and at risk of failure.
Billionaire investor Marc Lasry put it this way at the Bloomberg Most Influential Summit last week.
“So if it’s levered 10 times, the problem is it’s over 100 times. So just so — just maths. I mean I didn’t go to business school, but maths, if you’re down more than a quarter of a per cent and you’re levered 100 times, that means you’ve lost everything. It’s just how the maths works,” he said. “So they have got to be fully hedged. They have got to be perfectly hedged. And then all the stuff that they’re supposed to make money on has got to work.”
Right now this DOJ fine, and the fact that it looks like EU leaders can’t agree on policy that would make the leverage issue easier going forward, are threats to everything working out for the bank.
“I think Deutsche doesn’t really — doesn’t have any issues right now. But it’s just — the — the problem is the more people call — keep talking about it, the harder it becomes, right, and the more they — they will keep saying we don’t have issues,” Lasry said. “But it’s — it’s hard. It’s hard for somebody to be levered that much. It’s — you can’t withstand shock.”
That brings us back to the third problem — the government saying it won’t bail out the bank. The reason why it won’t is because Deutsche Bank has violated the trust of the German people and populism has taken hold.
That lead German politicians to violate a trust between the government and banking sector, according to Christopher Whalen, a Senior Managing Director at Kroll Bond Rating Agency.
Here’s what he said in a report released Monday [emphasis ours]:
“KBRA believes that public officials in the U.S. and in Europe need recall that global financial regulators have long followed a policy of avoiding public statements about financial institutions and for good reason. Ill-considered public statements, whether made directly or on background to the news media, serve to erode confidence in markets and in specific financial institutions. We believe that political leaders who seek to obtain partisan political advantage by making such statements play a very dangerous game. KBRA believes that political officials in Europe and the U.S. should avoid making public statements about specific financial institutions unless and until state assistance is actually extended. To do otherwise, KBRA believes, is harmful to investor confidence and the broader public interest.”
Whalen also wrote that investors should discount what Merkel said. He trusts that EU leaders will come to an agreement to save the bank.
The problem is that there’s not a lot of that going around these days.
This is an editorial. The opinions and conclusions expressed above are those of the author.