Deutsche Bank – Whistling Past Your Graveyard

C’mon folks.

Deutsche Bank is on the verge of collapse.  Let me remind you that back at the time of the financial crisis in 2007/08 I wrote specifically about them, calling the firm repeatedly DoucheBank as they had an utterly ridiculous derivative exposure compared against their capital.  In fact they made US bank exposure in this regard look like the work of pikers.

Not only has nobody done a thing about that in our markets Germany, I remind you, urged them to expand their exposure — and they have.  In addition total credit market debt has expanded by $57 trillion since 2007, a close to 40% increase!  GDP, on the other hand, has gone up nowhere near as much.  Indeed, global government debt has roughly doubled since 2008 — to $59 trillion.

One of the largest increases has been in college student loans, which are up a staggering 130% since 2007 in the United States alone.

The problem is that economic expansion — that is, the common output of the economy, has not matched debt expansion.  Not even close.  This is an unsustainable practice since without output expanding at a rate that exceeds expansion of debt you must eventually stop or the economy will contract even though debt is expanding, and once that begins to occur it is a black-hole event horizon from which you cannot escape until virtually everyone who is in debt has been liquidated and those who hold that debt will take monstrous losses — in many cases 100% losses!

When Donald Trump said in the debate that we were in a huge bubble he was exactly correct — we are.  We are in a bubble where market prices for stocks have risen dramatically, housing has gone up to a material (and unsustainable) degree, and the embedded but not measured in inflation statistical data cost of living (e.g. medical) has risen at a ridiculous rate as well.  Trump has repeatedly charged that policy from The Fed, which is largely responsible for this bubble, is political in nature; whether that’s the case or it has simply resulted from Fed hubris (which Greenspan and Bernanke both displayed in abundance and only Greenspan has admitted to) is immaterial to the outcome.

This deterioration has been reflected in labor productivity, which has now gone negative.  But that’s just one small place that we can measure; the other places are not measured but have far more impact.  Nonetheless, that the impact has managed to filter into unit labor productivity and costs is especially troubling.

Remember that bank leverage in the form of derivative exposure is what made the crash in 2008 happen.  Lehman, alone, blowing up was no big deal — companies fail all the time and Lehman, in terms of size, employee count and economic impact was a literal non-event.

It was the threat of cross-default on derivatives that took down the markets and the economy, and we now have it happening again but nobody is talking about it.

If you think Germany can bail out Deutsche Bank you’re delusional.  Their total derivative exposure grossly exceeds the entire net value of everything in Germany!  Not just the government’s resources, all private resources as well!  In other words even if the government wanted to bail them out, even if they’d survive bailing them out politically they can’t, even if they attempted to confiscate everything of value within the nation.


UPDATE 1: “Don’t Be Stupid”

First, it’s illegal for the German government to bail out Deutsche Bank.  That’s one of the (few) changes made in the EU post-2008, and it has gone into effect.

However, they can be bailed in.

Now let’s talk about what that means, and why in fact it’s worthless in a situation like this.

A bail-in would destroy the stockholder equity (first), then bondholder equity which is converted to stock.  That sounds ok but there’s a problem with it.

It works roughly like this: There are multiple “tranches” of bonds with various seniority associated with them.  This is done so the institution pays less to borrow on the “higher” (or “Senior”) tranches, because the lower ones are wiped out first before the Senior bonds take any loss.

The issue that arises is that all these institutions “engineer” their tranching through various machinations (including default swaps and similar) so that most of their debt issue is “Senior” or “Super-Senior.”  They do this to reduce their borrowing costs but the question becomes whether that “protection” is actually effective, and the only way it is effective is if the mathematical models used to derive that alleged risk are accurate.

This is exactly what was done with the various securitized mortgages from “subprime” lenders, incidentally — and we know how accurate those models were, right?

It works if the losses are modest because the lower tranches are literally wiped out and the more-senior ones are protected.  The problem comes if you can’t satisfy the financial requirements with those subordinate debt tranches because your modeled risk profile turns out to be dog squeeze — then the senior tranches get hit.

If these tranches are invaded you will get an immediate run on prime brokerage and other “depository” style accounts because the buyers of those “senior” debt tranches bought them with the full expectation that they were not 50%, not 80%, not 90% but 100% safe and as soon as that belief is invalidated the brown smelly stuff will hit the airmoving device at very high speed.

Indeed a mere belief that such an invasion will happen is probably enough to set off the exodus because once you get into the senior tranches the risk rises above zero that depositors will get hit.  And finally, and most-troublesome, unlike with a traditional operating company any such exodus from a bank itself further erodes the bank’s capital base and thus is additive to the pressure and the senior tranche loss risk!

Finally, remember that utterly nobody who lied about the solvency of their institutions went to prison after 2008.  Nor did any central bank personnel who lied about “subprime being contained.”  For this reason you cannot believe any such statement from anyone without strict proof, and given the (intentional) opacity of risk in these institutions strict proof is impossible to come by.

So yes, it is not as simple — or as “safe” — as people think it is.

This situation is definitely unstable, and if anyone thinks “balance sheets” are ok I will remind you that I was not in 2008 and still cannot possibly analyze any of the European banks on any sort of consolidated basis when derivative exposure and other means of hiding contingent liabilities are included, and those liabilities must be included in the event confidence in the underlying institution — or group of institutions — is lost.


This story originated at Market Ticker

Leave a Reply


Email Newsletter