By Dennis Kelleher and Joe Cisewski
(this op-ed originally appeared in American Banker)
Deutsche Bank has finally publicly admitted the precariousness of its financial condition. That’s the good news, along with its announcement that it is supposedly finally going to do something about it. The bad news is that its transformation plan is going to make its financial condition worse while becoming more of a threat to taxpayers, the financial system, and the global economy.
This suggests that Deutsche Bank has learned the wrong lesson from ten years of poor management and regulatory forbearance: A too-big-to-fail bank almost always has options to reward its shareholders and senior management at the expense of its own financial condition, taxpayers, and the public interest.
Deutsche Bank announced that it was going to close its global equities sales and trading operations, cut back its investment banking, create a “bad bank” to segregate its riskiest, most toxic assets, and eliminate 18,000 jobs. The bank stated that that this comprehensive restructuring is aimed at improving profitability, although, as has been noted, the plan is “a big gamble, carrying significant immediate costs with no guarantee they will revive the bank.”
Given this high risk, multi-year, radical plan, the responsible course of action for Deutsche Bank would be to plan conservatively and conserve capital cushions until the hoped-for improved profitability actually materializes.
Yet, Deutsche Bank is doing the opposite. The bank’s chief executive officer, Christian Sewing, was quoted saying that, by undertaking this massive restructuring, he “hopes to free up capital that can be returned to shareholders.” And the Chairman of Deutsche Bank’s Board of Directors, Paul Achleitner, was reportedly similarly focused on a “substantial return of capital [to shareholders] over time.” Remarkably, the bank reportedly “has regulatory approval for its common equity to drop from its current level,” which is already too low for a bank in such a fragile condition.
Shareholders are unhappy because, among other reasons, its stock has dropped from $157 or so per share in 2007 to a mere $7.62 or so today, while management “continued to collect handsome paychecks.” But, reducing capital to increase short-term returns for shareholders is grossly irresponsible.
Deutsche Bank, in essence, seeks to divert its critical loss-absorbing capital buffer – that otherwise would be available as a source of strength to weather an economic downturn – to placate its angry shareholders. That’s a plan that jeopardizes the financial resiliency of the single bank that the IMF recently concluded was “the most important net contributor to systemic risk in the global banking system.”
Moreover, these are the very shareholders who have repeatedly failed to hold senior executives accountable for the poor management decisions leading to the bank’s current financial condition. Permitting senior management to prioritize short-term shareholder returns (by offloading risks onto the global financial system and, ultimately, the taxpayers by cutting capital) over financial stability is foolhardy.
Adding insult to injury, Deutsche Bank’s management is announcing its intentions at the worst possible time. The bank has been experiencing significant increases in funding costs due to concerns about its financial condition for more than a year. Recent credit ratings downgrades have cited a heightened risk of financial distress in the event that the bank’s planned restructuring and changes to its risk profile do not manifest the expected benefits. But rather than addressing serious warning signs responsibly, Deutsche Bank’s new reduced capital position will put it metaphorically within inches of breaching regulatory capital requirements.
Even if marginally above regulatory minimums, Deutsche Bank’s reduced capital position would be reckless for other reasons. Deutsche Bank’s profitability appears to be especially sensitive to interest rate cuts, which is a vulnerable position to be in given the accommodative actions coming from the European Central Bank and the Federal Reserve. Goldman Sachs recently estimated that “a rate cut of a mere 0.2 percentage points would wipe out 42% of Deutsche Bank’s estimated 2019 earnings.” Moreover, Deutsche Bank’s well-known intent to sell troubled assets weakens its negotiating position in the markets. It is likely to sell troubled or non-performing assets at significant discounts, realizing equally significant losses in time.
In addition, Wall Street’s awareness that Deutsche Bank may be seeking to unwind a massive derivatives portfolio in its “bad bank” will increase those losses. Deutsche Bank already had to set aside more than $1.6 billion to cover expected losses on that portfolio, which reflects a discount to compensate purchasers for the risks and high capital requirements associated with those derivatives. That loss estimate is almost certainly optimistic, given the limited number of potential buyers. And other illiquid, hard-to-price assets are likely to form a substantial part of the fictional bad bank’s assets and positions. Those are not just hard to sell; they are hard to model, which means easy to manipulate for capital purposes. The ultimate market values may differ significantly.
Finally, assets that Deutsche Bank intends to unwind or sell near-term may not be subject to advantageous accounting treatment for long, given that bank executives have acknowledged that asset “sales did not happen because the prices offered would have resulted in hundreds of millions of euros in losses for the bank.” In case you missed it, that is Deutsche Bank admitting that it is marking assets above current market prices and must continue to do so (perhaps impermissibly) to avoid taking hundreds of millions in losses.
In all of these circumstances, Deutsche Bank’s capital should be going up, not down.
The bank argues for the opposite, of course. It has abstractly claimed that its capital is being unproductively “tied up” and that capital “relief” is therefore warranted. What it hasn’t mentioned is that its capital is being used due to its own trading, lending and investment decisions. No one made Deutsche Bank hold the portfolio of securities, derivatives, and loans requiring its current level of capital. And no one made Deutsche Bank hold the risks of that portfolio, either, which its capital requirements flow from. In other words, Deutsche Bank’s (mis)management has created the bank’s current perilous condition and its resulting capital challenges, not regulation.
Of course, the bank’s real concern is increasing the return on equity for its shareholders, which is predictable. The beneficiaries are clear: Deutsche Bank’s senior executives and major shareholders, who stand to reduce their exposure and make substantial sums of money. And the victims of it are equally clear: The global financial system and taxpayers—including U.S. taxpayers who bailed out Deutsche Bank in 2008-2009—who are forced to accept unnecessary risks and costs. Should the worst happen, taxpayers undoubtedly would be asked to fund whatever cleverly constructed guarantees, pledges, facilities, or asset purchase programs would be necessary to prevent Deutsche Bank from failing. It is too big to fail. Meanwhile, many, if not most, of Deutsche Bank’s unjustly enriched shareholders will have long since sold their stock.
From all of this, it may be tempting to believe that Deutsche Bank has not learned much from the 2008 financial crisis. But perhaps it learned the actual lessons: being too-big-to-fail pays; engaging in high risk, high return activities pays; and siphoning capital to enrich shareholders and executives pays. The worst lesson they apparently learned: they don’t have to worry about regulators stopping them from engaging in such self-destructive, self-enriching, anti-social behavior.
Put differently, Deutsche Bank’s latest “plan” proves yet again that privatizing gains and socializing losses at too-big-to-fail global banks is alive and well.
Dennis Kelleher is President and CEO and Joe Cisewski is Senior Derivatives Consultant and Special Counsel at Better Markets, a nonprofit advocacy organization.