How has Excessive Risk-Taking Impacted Deutsche Bank? (w/ David Enrich & Ed Harrison)
ED HARRISON: I want to think about the whole arc, narrative arc here in terms of Deutsche Bank as potentially emblematic of the financial system and how a bank like this with lax controls and this ROE target that's unreachable can continue to go on. My understanding is that when the financial crisis happened, Deutsche Bank actually came out of the crisis relatively well, that it seemed that they were doing well. Then by the time we get to the European sovereign debt crisis and beyond, suddenly they're the sick man of Europe. What happened in that timeframe, and how does it fit into the whole concept of they're taking on too much risk? DAVID ENRICH: That's a really good question. Deutsche Bank the enters the financial crisis with one of the biggest shorts on the US housing market of any bank. Goldman rivaled it for a big short, but it was the bank's traders had anticipated correctly the collapse of the US housing market, and a bunch of trading desks at Deutsche Bank made billions of dollars in profits off of that, which largely but not entirely compensated for the huge losses they, like many other banks, were suffering. Deutsche Bank did emerge from the crisis with a-- it had a relatively good crisis. It wasn't a relative position of strength. It also turns out many years later after the fact you can look back, and they appear to have been playing some really ridiculous accounting games with the valuation of derivatives and other assets, that if they had been accounting for that, and I don't want to say a more honest way, but in a more traditional way, their finances would have looked a lot worse over the time, and they may well have required a government bill but as it turned out, they didn't require direct taxpayer assistance. They got a bunch of loans from central banks and some of their trading partners got bailed out, but they came out of the crisis at or near the top of the global financial pecking order, which is quite an accomplishment. It led to Ackerman, Joe Ackerman, the CEO at the time and some of his underlings, including Anshu Jain who would be his successor, were extremely proud of the fact that they had emerged relatively unscathed from this once in a century crisis, and that pride contributed directly to the catastrophe that ensues because they come out of the crisis feeling really good about themselves, mistaking their luck for scale, to a large degree, and they forego this golden opportunity they've been given to fortify themselves. They do not invest in upgrading their technology or upgrading their compliance departments. They do not take this opportunity to read the bank of these hundreds of billions of dollars of risky, really very risky, in some cases, very illiquid assets that are polluting the balance sheet. They don't take this opportunity from a position of strength to go to shareholders and say, look, we survived without taxpayer assistance. That's great fortunate for us but right now, we need to fortify ourselves and bulk up our balance sheet and we need to-- or not bulk up our balance sheet, bulk up our capital and we need you guys to pony up more cash. Instead, they spent what money they had on growing fast in risky areas, especially in the US market and in emerging markets as well. At the same time, all these other banks that have been hobbled by the crisis, especially in the US, were forced by the Bush and then Obama administrations to take these hundreds of billions of dollars in taxpayer capital, which were extremely controversial at the time, but ended up saving the American-- not only saving the American financial system, but also getting it back in order at a pretty rapid pace, all things considered. Deutsche Bank went from being the survivor of the crisis to be in a period of months, to being the sick man because all these American banks have been recapitalized, they've been forced to consolidate. They've been forced to clean up their balance sheets, and Deutsche Bank, not having received any government assistance, has a relatively thin capital cushion and is not facing any pressure from Germany or anywhere else to slim down, curtail risks. Instead, it seizes what it perceives an opportunity to basically take over the world. It just goes way too far in that direction way too quickly. Then the European sovereign debt crisis hits, and Deutsche Bank has exposure all over Europe and Greek government bonds are the famous case because of the Greek government's instability and precarious finances. Those were paying very high yields, which made them very attractive to a bank like Deutsche Bank, which is trying to goose its returns. They were one of the biggest owners of Greek government bonds, which ultimately and you know the story, they basically got wiped out or there's a huge risk of them being wiped out. At the same time, investors newly attuned to the risks of leverage and derivatives from the crisis are taking a much closer look at Deutsche Bank's balance sheet and realizing that this is an institution that pre-crisis had a 50 to one leverage ratio and that had trillions of dollars on its balance sheet, not counting the trillions of dollars of off balance sheet derivatives. They're looking at this and saying, oh my God, this is terrifying. ED HARRISON: By then, it was basically too late because number one, the "no bailout" clause was pretty much everywhere. We're not going to bail out these Italian banks. We can't bail out Deutsche Bank, that is no taxpayer money. There's no tarp for you guys. DAVID ENRICH: Well, at least not with wiping out your equity. You can bail them out, but the first step is going to be to put the stock at zero. That is a very scary proposition for a bank or for its executives who are holding lots of stock themselves. The risk of that is extremely destabilizing for a bank because it means that touching that bank financially, you carry a risk of being completely zeroed out, which is not an attractive risk for especially given the returns were not very high. Deutsche Bank, there was a small window of opportunity Deutsche Bank had right after the financial crisis that it could have taken and probably saved itself. The seeds of destruction had long since been planted. Okay, they're under the ground starting to spring up into these huge plants. Now, this is not a good analogy. Instead of uprooting those seeds of destruction, they watered them happily. It was just out of control really, in a matter of months, honestly, even though the catastrophic nature of this didn't become entirely clear for a couple of years.