Deutsche Bank's Obsession with Short-Term Profits (w/ David Enrich & Ed Harrison)
ED HARRISON: It sounds great so what went wrong? When we talk about the Trump connection is emblematic of what went wrong, what was it that went wrong at Deutsche Bank? DAVID ENRICH: Well, what went wrong is that starting in the mid to late-90s, a succession of top executives none more so than Joe Ackerman, who was the CEO from 2002 to 2012, just completely lost sight of any-- they stopped having anything resembling a long-term view of the business, they began operating with an obsessive and singular focus on short term profits. That sounds simple and it sounds obvious, but it took over the bank. ED HARRISON: Can you give me an example? DAVID ENRICH: Yeah. Ackerman, in I think 2003, he became CEO and he decided that the way to increase Deutsche Bank stock price in the short term was to substantially increase the bank's return on equities, basically the profits that go to shareholders essentially. It was in at that moment, I believe it was 4% return on equity, which is a very low number. He wanted it within two or three years to hit 25%. He wanted to go up six-fold. Look, 4% is very low but 25% is very high, especially for a financial institution that's supposed to be playing this intermediary role in the financial system in the economy. ED HARRISON: Especially given the size of its balance sheet as well. DAVID ENRICH: And given how achieving something like that in the space of 24 or 36 months requires like stepping on the gas isn't really the right analogy, that's like turning on like the rocket engines and then like tossing some like, I don't know, explosives in there then seeing what happens and that's basically what happened. Deutsche Bank, first of all, they achieved these milestones scheduled on Ackermann's schedule which is where we're at present, but they did it at a very expensive long-term proposition, which was that they stopped investing in anything that cost money. That means they stopped investing in technology, their internal technology systems as they hired teams of traders and sales guys and as they made acquisitions, they went from having a small handful of technology systems to having several hundred, probably more than 1000 technology systems inside the bank. These are computer systems that don't talk to each other, so it becomes almost impossible, if you ask a seemingly simple question like, what is Deutsche Bank's exposure to, I don't know, crease? There's no answer, or there is an answer, there's just no way to figure out what the answer is, which is a terrifying prospect if you're a bank CFO, or if you're an investor in a bank, or if you're a regulator of a bank. They didn't invest in compliance. There were these compliance and anti-money laundering stabs. Those are cost centers. They're expensive to hire. They're expensive to train, and they literally cost you business, their job is to say no to transactions. If you're trying year after year, quarter after quarter, to hit these very aggressive profit milestones, that just gets in the way. I think the most important thing, though, is that the financial incentives up and down, the hierarchy at the bank changed very rapidly to reward this short-term return on equity goal. The way that would happen is that bankers, traders, and just like even someone working at Deutsche Bank branch in the middle of Germany, they no longer were just doing business with whomever who seemed like a good credit risk. They were told to evaluate all relationships on the basis of a simple question, which was, will this relationship or this transaction generate a 25% return for the bank, and most don't. Generally, banks are not earning 25% returns on normal transactions, nor should they be by the way. ED HARRISON: That's a huge number for a state business. DAVID ENRICH: It means that they're either drastically overcharging their customers, which just isn't going to work because their customers will go to a bank that's charged and lower fees or lower interest rates, or it requires you, and this is the path the bank ultimately took, to rip off your customers, to break the law, to act without any sense of ethics. That is exactly what they did. The seeds were sown for this great catastrophic parade of financial scandals of the bank years later would find itself immersed in and at the time, that was a direct result of people again, up and down the hierarchy, being told this is serious. You need to achieve these targets, you, yourself, your group, your team, your division, the company needs to hit these targets, or else Joe Ackerman who has this terrifying temper and has a tendency at times of calling people out in public for their failures is going to potentially fire you or humiliate you or just get extremely angry at you. In financial terms, within the bank were changed so that people's compensation was based on hitting these targets. Humans respond to incentives. That's simple. I think also probably the most important determinant of success or failure within these institutions. People are given financial incentives, and they respond to those incentives in fairly predictable ways. In this case, the incentives were clear, it was to maximize short term profits, do not worry about the next quarter or the next year, much less five years down the road, hit the targets now or else. ED HARRISON: That reminds me, as you say that just as an aside, of Wells Fargo, and all the things that we know about what happened with regard to the fake accounts and things like that, you incentivize a certain behavior, and sometimes you get those-- DAVID ENRICH: It turns out that if you're telling branch managers that you need to open X number of accounts in a month or a quarter, they're going to do it and they're not going to, if you're not incentivizing them, not to break the law or rip off their customers or act unethically. It is very simple human psychology, it's not even human psychology, it's basic economics. You're going to when you reward people for behaving in a certain way, they, all else being equal, will behave in that certain way.