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AFTER VOLKSWAGEN, NOW DEUTSCHE BANK: WHAT OTHER SURPRISES HAS GERMANY IN STORE?

WATCH GERMANY DO WHAT IT TOLD OTHERS NOT TO DO...

by Francesco M. Bongiovanni

Let’s go straight to the point: Deutsche Bank is in deep deep trouble. However, its €1.8 trillion in assets are equivalent to almost 60% of Germany’s GDP and the bank has more than 100 thousand employees in Germany and abroad. Can one seriously think that the German government will let Deutsche Bank go belly up? One way or another Germany will rescue the bank and in doing so may not only anger a lot of German taxpayers but  will do exactly what it has prevented other European countries from doing with their own failing banks. Another case of Germany using its dominant position in Europe to bend the rules at its convenience.

 

Deutsche Bank’s woes have been known for quite some time. Falling income due to low lending revenues in an age of low interest rates may have contributed to the institution’s increasingly adventurous posture abroad in recent times and the massive hiring of risk-prone investment bankers in its US operations two decades ago may have compounded the problem. Yet not only did the bank embark in questionable, high risk operations but it actively defrauded investors for years, and on a scale. Among the many criminal lawsuits it has been slapped with, the bank pleaded guilty in 2015 to charges of rigging Libor, resulting in a $2.5billion fine from US and UK authorities and the whopping, latest $14billion fine from the US Justice Department is a consequence of the bank’s fraudulent practices in relation to mortgage backed securities. Yet in the financial industry crime often pays and in America Deutsche Bank was bailed out by US taxpayers during the latest financial crisis, with assistance loans aggregating over $350billion, about twice what Lehman Brothers received. The bank’s profitability is dismal (it lost just under €7 billion in 2015), its balance sheet unsound. Its stock price crashed to its lowest level in several decades, it is now just about a tenth of what it was in 2007. The IMF arguably stated that the institution is currently the “world’s most important net contributor to systemic risks” in the global banking system.

 

With general elections coming up next year, Angela Merkel knows a rescue impacting German tax payers may cost her dearly and will provide additional fuel to the fast rising far right AfD party already benefitting from her disastrous immigration policies and currently polling at  16%. Hence the authorities’ strong denial of any rescue being contemplated while they are likely concocting a rescue package that will hopefully not seem like one, just in case. The government’s immediate priority is, of course, to put pressure on the US to reduce the huge fine (in a sense a move tantamount to yet more American bailout assistance) and rumours have been floating of a possible settlement at $4.5 billion, although it seems unlikely. In another development Die Zeit reported that the state is contemplating to take over up to a quarter of the bank, a move that would likely facilitate a merger with 15% state owned Commerzbank. Other rumours have it that the government could use an EU legal loophole according to which a state can recapitalize a bank as a preventive measure if the bank fails a stress test: it would be relatively easy to engineer the failure of a capital cushion test at Deutsche Bank which would open the door to an injection of public money labelled a “precautionary measure” and not a bailout, saving appearances. My bet is that  this institution will be rescued, one way or another (and who needs something approaching another Lehman moment right now?).

 

This flies, however, in the face of everything Germany has been forcefully preaching to countries with troubled banks in the recent past. Merkel and finance minister Schaeuble strongly insisted that bondholders and depositors be hit before any state aid is allowed and pushed for this policy to be enshrined in EU Bank Recovery and Resolution Directive rules. Merkel’s lecturing to Italy’s Matteo Renzi this summer to the effect that Italy must abide by these Eurozone rules and cannot bail out its ailing banks is well publicized. Yet if it feels it serves its own interests, Germany will, again,  break the rules it itself imposed on other European nations (remember 2002 when Germany openly broke Maastricht rules and got away with it). The other troubled countries will love it of course as they will finally be able to do the same, signifying the end of any serious efforts to improve a financial sector badly in need of reform all over the continent.

 

To its credit Germany enjoys an almost full employment economy and its debt and fiscal positions are sound (although it does not play by Eurozone rules when primary surplus is concerned, ask Renzi) yet German economic prowess is to a great extent a myth and the country  looks good because most other European economies look worse. What works well in Germany is the (superbly restructured) Mittlestandt that caused the country to become the world’s number one export machine, due also to a Euro undervalued for the German economy.  Germany has basically known no growth (0.8% on the average is not growth) since 2007 just before the crisis. Its productivity gains have been among the worse in Europe. Its service industry remains mired in the past. Its arcane tax code, one of the most complicated on the planet, contribute to Germany’s ranking after Macedonia in the 2015 World Bank country ranking of “Ease of doing business”. The myth of Germany rectitude and of playing by the rules has been spectacularly debunked with the uncovering of the vast cheating operation at icon Volkswagen and now at another icon, Deutsche Bank..

 

On the political side, Germany has used the dominant European position befallen to it by default to dictate key policies concerning everything from immigration to interest rates and bail-outs, with often disastrous results. Its refusal to introduce “solidarity measures” in the Eurozone context of widely divergent economies means the single currency union is fundamentally unworkable. Germany’s diagnosis that the financial crisis was of a fiscal nature was plain wrong and led to its imposition of severe, across the board austerity measures in troubled countries resulting in these countries being condemned to depression, high unemployment and ever rising debt burden. Germany’s refusal to let wages and price go up to depress the value of the Euro during the crisis removed a natural adjustment mechanism and imposed the entire burden of adjustment on troubled countries. The bail out of Greece was essentially a disguised bail out of German and foreign banks. In other words Germany has, by default, assumed a dominant position in Europe which it often uses to impose its views and policies, however unsound they may be. So a bending of the rules to advance its own interests in the Deutsche Bank case is not just possible, it is likely.

 

Germany does not exactly smell like a garden of roses these days and it will be interesting to see if Merkel is able to rescue Deutsche Bank and keep her credibility in Europe and her reelection chances alive at the same time…