Neither Admitting Nor Denying

Monday 06/08/15

     In the last few years there has been a constant stream of civil penalties against major Wall Street financial institutions relating to the housing crisis of 2008 as well as various other market rigging, discriminatory and anti-competitive actions. It has reached the point where nobody is surprised to see another scandal. In fact, just this morning there was another article that the Department of Justice is probing major Wall Street firms over suspicions that they may have been rigging the treasury market. My initial thought was, “That sounds about right.” Not that I have any inside knowledge or felt that I was a victim of this rigging, but simply because it is consistent with their past behavior. If your cousin who has 10 prior DUI convictions crashes into a telephone pole at 2am you're probably going to assume that he had been drinking. Rather than complain about the injustices and rampant criminal behavior of the banks in general, this week I want to look at a specific SEC enforcement action that drew very little attention.

     Late last month the SEC put out a press release announcing that Deutsche Bank agreed to pay a $55 million penalty to settle charges that it had lied about losses and misstated risks in their portfolio by $1.5 to $3 billion during the 2008 crisis. Deutsche bank neither admitted nor denied the allegations and no individuals were charged with any wrongdoing.

     Without getting bogged down in the details of the accounting, let me quickly explain what they did and why they did it. According to the SEC, when the credit markets started going bad in 2008 Deutsche Bank slowly altered its methodology when accounting for risk in one of their derivatives portfolios. They kept making adjustments until they essentially measured the risk at $0, which is absurd considering what was going on at the time. However, while the risk may have been reduced to $0 in their public accounting, they kept separate internal books that showed that they were exposed to up-to $3.3 Billion.

     So why did Deutsche Bank do this? Back in 2008, convincing others that your balance sheets was strong and that you weren't overly exposed was a matter of life and death. If the market didn't believe you, you could be shut out of the credit markets and wouldn't have access to short term borrowing that is essential for a bank. Had Deutsche Bank not done this they may have failed in the same way that Lehman Brothers and others had.

     The minor $55 million fine paid by Deutsche Bank seems worth it considering it may have saved them from bankruptcy. Lying and overstating your portfolio by billions in times of stress for a small $55 million paid in times of strength seems pretty well worth it, especially considering nobody went to jail and they suffer no other consequences whatsoever.

     The reason I want to bring this up again is because if times of stress return Deutsche Bank may be back in the exact same position that they were in 2008. I don't think their culture has changed much. In my opinion, Deutsche Bank is not a healthy bank and since its exposure to Greece is unknown it could be in much worse shape than many realize. Deutsche Bank is a massive bank and its failure could lead to unimaginable systemic risk throughout, not only Europe, but the entire global financial system.