By Simon Johnson
Nov. 21 (Bloomberg) — You’ve probably never heard of Taunus Corp., but according to the Federal Reserve, it’s the U.S.’s eighth-largest bank holding company. Taunus, it turns out, is the North American subsidiary of Germany’s Deutsche Bank AG, with assets of just over $380 billion.
Deutsche Bank holds a large amount of European government and bank debt; it also has considerable exposure to lingering real estate problems in the U.S. The bank, therefore, could become a conduit for risk between the two economies. But which way is Deutsche Bank more likely to transmit danger — to or from the U.S.?
By any measure, Deutsche Bank is a giant. Its assets at the end of September totaled 2.28 trillion euros (according to the bank’s own website), or $3.08 trillion. In the latest ranking from The Banker, which uses 2010 data, Deutsche was the second- largest bank in the world by assets, behind only BNP Paribas SA.
The German bank, however, is thinly capitalized. Its total equity at the end of the third quarter was only 51.9 billion euros, implying a leverage ratio (total assets divided by equity) of almost 44. This is up from the second quarter, when leverage was about 36 (assets were 1.849 trillion euros and capital was 51.678 euros.)
Even by modern standards, this is very high leverage. JPMorgan Chase & Co. has a balance sheet about 20 percent smaller than Deutsche Bank’s, but more than twice as much Tier 1 capital, an important indicator of a bank’s financial strength. Bank of America Corp., whose weakness is a serious worry in the U.S. today, has twice Deutsche’s capital. (These comparisons use The Banker’s ranking of the top 25 banks.)
Healthy Capital Ratio
Globally, Deutsche’s capital ratios are relatively healthy, judging by the banking industry’s standard measures. At the end of the third quarter, its Tier 1 capital ratio was 13.8 percent (up from 12.3 percent at the end of 2010) and its core Tier 1, which excludes hybrid debt that can convert into equity, was 10.1 percent.
How does such a highly leveraged bank become “well- capitalized”? The answer is that “risk-weighted assets” were 337.6 billion euros as of Sept. 30. But what is a low risk- weight asset in the European context today? Incredibly, it is sovereign debt, which of course is far from riskless at the moment.
Perhaps Deutsche Bank holds mostly German government debt, which still has safe-haven value. But it’s likely that Deutsche also holds a significant amount of Italian and French government bonds.
Still, the bigger risks are probably in the U.S. Deutsche Bank is a significant trustee for mortgages, having been heavily involved in the issuance and distribution of mortgage-backed securities during the housing bubble. Yves Smith, writing on the naked capitalism.com blog, says Deutsche Bank is one of the U.S.’s four biggest securitization trustees. Many questions on whether paperwork was done properly and whether the rights of investors have been protected hang over these trusts.
Let’s take a look just at Taunus Corp., named after a range of mountains outside the parent bank’s Frankfurt headquarters. The latest figures (from the Fed data, using the consolidated financial statement at the end of the third quarter) show Taunus with total equity capital of just $4.876 billion. This implies an eye-popping leverage ratio of around 78.
Why would the Federal Reserve and the new council of regulators known as the Financial Stability Oversight Council allow Deutsche Bank to operate in the U.S. with sky-high leverage — with its huge implied risk to the rest of the financial system? Presumably, in the past, U.S. authorities have taken the view that Deutsche Bank had a strong enough balance sheet worldwide that more capital could be provided to its American subsidiary, if needed.
Such a presumption now seems questionable, at best. Earlier this year, Bloomberg News reported that Taunus needed almost $20 billion of additional funds to meet U.S. capital standards, and that Deutsche Bank was trying to declassify Taunus as a bank- holding company to avoid capital requirements entirely. It’s unclear where this process now stands, but it’s also not obvious how declassification would help U.S. or global financial stability. Financial reform advocates hopefully will press hard on this issue.
All of this raises troubling questions. Have U.S. bank supervisors really satisfied themselves, through onsite inspections, that Deutsche Bank’s risk weights accurately reflect market conditions and the increasing structural weakness of the euro area? Can U.S. regulators document their satisfaction beyond the materials produced for the European Banking Authority, which earlier this year oversaw stress tests that pronounced now-collapsed Dexia as well-capitalized? (Actually, Dexia had stronger capital ratios than Deutsche Bank.)
In their prescient, pre-crisis book, “Too Big To Fail” (not to be confused with the more recent Andrew Ross Sorkin book of the same title), Gary H. Stern and Ron J. Feldman, in 2004 nailed the incentive distortions that encouraged risk-taking and brought the financial sector to its knees. No one else came close to them in getting this right. Included in their analysis are examples of banks that could have been regarded as having moral hazard issues because of their size. Deutsche Bank is No. 4 on their list of large, complex banking organizations by asset size.
This dog did not bark during the 2008 crisis, partly because most foreign governments were seen as having strong enough balance sheets to back their banks’ worldwide operations. But this is no longer necessarily true for euro-area governments.
Even in 2008-2009, this may have been illusory. According to published reports, Deutsche Bank received considerable assistance from the Federal Reserve, including $11.8 billion through the American International Group bailout and $2 billion through the Fed’s discount window. Deutsche was the second- largest discount-window borrower and the largest user of the Fed’s Term Asset-Backed Securities Lending Facility during the crisis.
Asking for Trouble
Deutsche Bank and, if necessary, the German government should be required to inject substantially more capital into Taunus. Allowing business as usual is asking for trouble, particularly as Deutsche wants to remain focused on relatively risky investment banking. Recently it named as chairman Paul Achleitner, the finance director at Allianz SE, the German insurance company, and an ex-Goldman Sachs executive, worrying even some of its shareholders.
This would be a good time for Congress to dig more deeply into the risks that Deutsche Bank poses to financial stability in the U.S. and around the world.
(Simon Johnson, who served as chief economist at the International Monetary Fund in 2007 and 2008, and is now a professor at the MIT Sloan School of Management and a senior fellow at the Peterson Institute for International Economics, is a Bloomberg View columnist. The opinions expressed are his own.)
Real resources are always a true constraint for any economy. This has become an increasingly important point over the last 10 years as commodity prices have surged. But the debate over the cause of this surge and the lack and real resources is still very much up in the air. Some say it is due to an insatiable demand from China. Some blame the decline of the dollar due to irresponsible government action. Others say Wall Street is cornering the commodities markets and turning it into another profit making casino. The truth, in all likelihood, lies somewhere inbetween.
One of the more important themes I’ve discussed over the years here has been the financialization of our economy. Financialization has seeped into many facets of our economy in order to help the big banks maximize profits. This has led to massive deregulation, increasing reliance on the FIRE industry, a concentration of power in this industry and an economy that is increasingly volatile and dependent on this industry which produces little, but takes much. This financialization has been nowhere more apparent than it has been in the commodities markets.
A few weeks ago I wrote a piece about the continual imbalance in the commodities markets and a veteran of the energy market happened to be reading. Dan Dicker reached out through the comments section and offered to send me a free copy of his book, Oil’s Endless Bid (see here to buy a copy). I had heard of Dan’s book and had been meaning to read it for some time. Now, I get a lot of free books from financial people. A LOT. They all want me to promote their books on the site. 95% of the books never get mentioned on the site. As you’ve noticed, I don’t just crank out content for the sake of cranking out content and the “payment” of a free 300 page book is not really incentive enough for me to write about a book. So, a lot of books end up in my fireplace (I’m an energy conservationist obviously). This one is different because I think Dan is conquering an incredibly important subject and he does so from the position of an informed insider.
His perspective is very much in-line with the positions of Michael Masters who has been one of the more vocal proponents of this financialziation of the commodities markets. Dan Dicker is a 20+ year veteran of the oil markets and a long-time seat holder at the NYMEX. Dan’s book is a frighteningly eye opening perspective from someone who has been in the trenches and has witnessed the massive changes in real-time. Dan highlights the massive changes that occurred over the years as the industry has morphed from one that was dominated by big oil into an industry that is dominated by big banks (from the book):
“In the mid-1990′s, the participants and performance of oil trading slowly started to change, and by 2003, the dominating forces in oil trader were no longer with the oil companies. The list of NYMEX seat owners again shows just how deep the change was. Right before going public in 2006, only 22 seats remained in the hands of the oil companies that had direct involvement in the buying and selling of oil and oil products. But a much more significant percentage of seats were owned by companies that ostensibly had nothing to do with the buying and selling of physical oil.
That’s a total of 56 seats owned by investment banks! (And yes, I include AIG, which was an enormous booker of bets on oil too, not just in famously bad mortgage swaps.)
Of course, the most important purpose for some of these firms to own seats was to execute orders for clients, some retail, but many commercial clients who were being sold on the importance of risk management of energy costs. And during the years from the mid-1990′s though 2005, this made for a legitimate increase in the volume of crude. But commercial growth of risk management programs was a happy appetizer for the quick rise of the investment banks in the trade of oil. Oil companies that tried to maintain a presence and dominance in trading began to be overshadowed by the volume and influence of trading from these banks and their clients.”
These firms aren’t dominating the trading pits at these exchanges because they want to buy and sell commodities for real economic purposes. They are dominating the exchanges because they know there is big money in financializing the asset class of commodities. And they’re succeeding. They’ve sold the asset class as an investment and the investing public has eaten it up hook, line and sinker. Dan goes into much more detail about this destructive trend and its impact on the economy and ultimately concludes that massive change is needed. We need to get control of our economy again and wrangle it back from these big banks who are looking out for the interest of their shareholders and not the US economy. Dan Dicker’s book is one of the most important ones I have read in a long time. It should be required reading for the US Congress.
- Oil, gold keep losses after manufacturing data (marketwatch.com)
- Review 145: Griftopia (thelablib.org)
- Yergin, D. “The Prize” Chapter 35 (iranrevolt.wordpress.com)
- How US Banks Are Lying About Their European Exposure; Or How Bilateral Netting Ends With A Bang, Not A Whimper (zerohedge.com)
In 1999, the euro became official. A year later, Greece joined up. The Big Shared Illusion was that once countries adopted the euro, they wouldn’t default. They would limit their deficits. Every country would become like Germany, where debt was highly secure. So Greek debt, Irish debt and Spanish debt began to trade as if they were super-safe German or French debt. Countries like Greece that had been considered dicey investments then became overconfident, based on this Big Shared Illusion (BSI). The European Central Bank would take care of inflation, investors thought. And surely no one could then go bankrupt. The Greeks, once forced to pay high interest rates (as high as 18 percent in 1994), could now borrow at low interest. Happy days were here again!
The second stage of folly, based on the BSI, was that the conservative Greek government went on a reckless borrowing spree, and the banks went on a reckless lending spree. Big European banks were delighted to lend Greece money. And, sinking deeply into the BSI — or was it just selective inattention? — more than a few banks eventually began helping the Greeks hide evidence that all was not well. With the evidence kept hidden, more bonds could be sold to more investors, and that meant more commissions. Alice had quite profitably stepped through the looking glass.
But then, as early as 2005, many of these big banks began to wake up — they began to realize that the Greeks wouldn’t be able to pay the money back. But so what, some of them said. It’s called moral hazard: you know your risky behavior is not going to be punished because somebody else is going to have to pay for it. That’s what the banksters counted on in the case of Greece, and accordingly they kept the rivers of money (generated from selling secretly-risky Greek bonds) flowing. They were just making too much money at it, and couldn’t stop themselves — not when they knew they could get off, in the end, with little more than a slap on the wrist, while others would take the real hit for them.
So the Greek government was given the green light to borrow boatloads of money for their Olympics, which cost twice as much as projected. Magician-bankers at Goldman Sachs obligingly helped the Greek government disguise the danger of the debt — we’re talking billions — with clever little financial instruments called derivatives. The public hadn’t a clue what was going on, but who cared? — Goldman was making commissions hand over fist on all these bond and derivatives sales. So, all the southern countries on the euro-teat continued to borrow heavily (by way of these bonds that were being sold like hotcakes with Goldman’s help) — and spend heavily — and for a while these little countries boomed, while all this newly borrowed money was being spent, and then spent again. God bless the multiplier effect, and God bless banks like Goldman Sachs for helping make all this magic happen! .
The sh*t hit the fan when the Greek government changed hands in October 2009. The books were opened to the light of day, and it became obvious to one and all that there was a much bigger deficit than anyone thought. Investors then ran for the hills. Interest rates shot up. In November, just three months before the Greeks became the epicenter of the European economic crisis, the wizards of Wall Street (a.k.a. banksters) were back on the scene in Athens, frantically trying to peddle still more derivatives deals, so that the appearance of the debt would magically vanish. The New York Times summed up the banksters’ role in the crisis this way:
“As in the American subprime crisis and the implosion of the American International Group, financial derivatives played a role in the run-up of Greek debt. Instruments developed by Goldman Sachs, JPMorgan Chase, and a wide range of other banks, enabled politicians to mask additional borrowing in Greece, Italy and possibly elsewhere.”
In dozens of deals across the Continent, banks provided cash upfront (i.e. loans) in return for government “payments in the future,” with those liabilities then left off the books. Example: For big fat loans (i.e. bonds that were sold to investors), the Greek government traded away such things as the right to collect fees at airports, and the right to collect lottery proceeds (i.e. “payments in the future”) . . for years to come. In other words, Greece traded major sources of future government revenue, for big money NOW. And banksters like Goldman encouraged this foolhardy undertaking because they were making so much money off of keeping the Big Shared Illusion going. And damn the final outcome when the house of cards finally collapsed. Others would pay the price, not banks like Goldman.
But with potentially destructive financial winds gaining hurricane force, it became clear that Greece would need a whole lot of money if investors in their bonds were ever going to get paid back. So the government jumped on the austerity train to nowhere — making draconian cuts in services, pensions and wages, which only increased their deficits. And then they had to ask the EU for more money. Public workers were fired in order to pay the banks their pound of flesh. Then pensions were slashed to pay the banks still more. But there still wasn’t enough money to pay the banks all that they were owed.
If you’re a country that has your own sovereign currency — like the U.S. — then you have some options in such a situation. You can do monetary expansion to head off deflation, for example, and devalue your currency. But once Greece went on the euro, it said good-bye to such options. So it cut, cut, and cut, but is now going bankrupt anyway. The country is mired in falling incomes (that reduce consumer spending, thereby leading to layoffs and ever lower average incomes) and is also mired in rising deficits, and is therefore sinking ever further into what might be called the Herbert Hoover death spiral.
Meanwhile, members of the EU are flipping out. Contributions to the bailout agreed to in July . . are supposed to be proportional to a country’s economic status, and thus the Germans have the biggest chunk to fork over. But most Germans are not keen on the notion of doing this just so that the Greek and French banks can get paid. Hey, they’re thinking, wouldn’t it be cheaper to recapitalize our own banks directly?
The French are really flipping out, because after the Greek banks, their banks ended up holding the biggest hordes of Greek debt (i.e. bonds). So they’re worried about their credit rating once it is widely realized that the bonds they are holding are essentially “toxic waste” that’s worth maybe half of its nominal value, if that.
So the bailout decision has been postponed until mid-November.
The realization is dawning that this sh*tstorm is too big, and that the Greeks can’t fix themselves. So they may have to go bust. And if Greece goes bust, that means the Greek debt will be written down, way down, to maybe half its initial value, or less. Which means the Greeks would then only owe half the money they currently owe to the banks and other bond holders. Thus all banks and other investors in these junk bonds will take it on the chin. Hard. And because these banks were in crappy shape anyway (despite their phony stress tests), the possibility of cascading bank defaults arises.
Thus the proposal to build a firewall around Greece, so that if it does go bust, everybody else will be protected. (Good luck with that.) And then wait “til the same thing happens in Portugal, Spain, and maybe Italy.
In a nutshell, Europe is in the process of deflating and collapsing, in order to protect banksters.
Sadly, this doesn’t have to happen. The big banks could be taken over by the government, recapitalized, and their management fired — FDR-style and S&L style. Admittedly, this is unthinkable in the world of bank-centric, neoliberal economics, in which the banks essentially own the governments. On the other hand, the anti-bank constituencies, on both the left and the right, are much bigger now than they were when the financial crisis began, and with the Occupy Wall Street movement spreading around the world by leaps and bounds, the banksters might be taken down after all. So, will the banksters prevail, or will their victims, who are building their forces at warp speed?
In a way, the Greek crisis is a chance to do things right: take the big banks into receivership, reorganize them, let their investors take a major haircut, and then sell them back into the private sector once their toxic assets are sold off. But that proly ain’t gonna happen. Therefore, because there’s not enough money in the EU for a bailout, the International Monetary Fund will likely have to step in. And guess who’s the major member of the IMF? The United States! That’s right, there will be smoke, and there will be mirrors, but there will be no one warning the American taxpayer to “Get ready to hand over some more money to the banksters.” Yet that’s what’s likely to happen: The bailout will come from the United States — even though right now Treasury Secretary Geithner is denying it.
What you have just read is my interpretation and synopsis of an article written by Lynn Parramore at Alternet.
- Greece’s Situation (by Daniel Jianu in Athens) (deindc.wordpress.com)
- EU Officials Said to See Risks Amid Call for Talks on Debt Swap (businessweek.com)
- Greek’s 2nd rescue deal not enough, creditors say (usatoday.com)
- Understanding the European debt crisis (theglobeandmail.com)