Deutsche Bank and the Big Short

15 February 2016/13 Comments
By Nick Dunbar

I may be late writing about the movie ‘The Big Short’ but it somehow makes sense to have watched it in the week that Deutsche Bank suffered an unprecedented exodus of investors.

Leaving aside the maverick hedge fund managers whom Michael Lewis (and this film) have made famous, Deutsche Bank sits at the heart of the story, via its former mortgage derivative trader Greg Lippmann. Ryan Gosling plays the character based on Lippmann in the film, depicting him as a smooth, amoral facilitator for the other characters.

Having met Lippmann and written about him in “The Devil’s Derivatives”, I was left wanting more. While the film hints about Lippmann’s proprietary position against subprime, which was greater than all the other characters’ positions put together, it doesn’t tell us that Lippmann used his short trade to create built-to-fail synthetic CDOs that Deutsche Bank sold to investors around the world, amplifying the financial crisis.

While I don’t expect a Hollywood movie to scrimp on entertainment, perhaps a horror movie is better suited to depicting the awfulness of this process. And while ‘The Big Short’ gives us an almost nostalgic take on the subprime bubble with its NINJA strippers, the toxicity of Deutsche’s activity and culture continue to infect the bank and broader financial system today.

Start with the balance sheet. Deutsche is the most leveraged big bank in the world, with assets 37 times core equity tier one capital. Half of these assets – $762 billion – are over-the-counter derivatives, the legacy of its growth before the crisis. Deutsche’s trading book securitisation exposure is the second biggest in the world after Goldman Sachs (which has a lot more capital). And this is the stuff that we can actually see in the bank’s financial reports.

    Deutsche Bank risk-weighted assets, 30 June 2015


Does this explain why investors turned against the bank so decisively? China, the collapse in oil prices, negative interest rates imposed by central banks, tougher regulations? There are many potential drivers. But why Deutsche?

Perhaps there is something else going on, which is at the heart of the bank’s culture. Greg Lippmann may have enshrined that, but he was only a mid-level functionary. The driving force was Anshu Jain, the CEO who left the bank six months ago. Before becoming CEO, Jain ran Deutsche’s global markets business, industrialising financial innovations such as synthetic CDOs, setting the compass for his division.

As we learned from a leaked Bafin report last year, Deutsche also industrialised interest rate benchmark rigging by its traders, by creating a business environment that encouraged rigging, or ‘even made it possible in the first place’. Jain and his fellow Deutsche board members behaved ‘negligently’ , the report said, while members of the group executive committee immediately below the board may have actually been complicit in rigging.

The report blames management for the bank’s $3.5 billion of interest rate rigging fines last year, a number inflated by Deutsche’s casual approach to regulators. Although the bank got away relatively lightly over its Lippmann-era activity with about $2 billion of US mortgage-related settlements, Deutsche is still being investigated over foreign exchange rigging, Russian sanctions-busting while Bafin’s final report on interest rate rigging is yet to be published. Although Jain has gone, Deutsche now has a target painted on its back.

Sure, the bank seems to have plenty of liquidity, hence its plan to buy back $5 billion of unsecured bonds. Then again, we don’t know how much liquidity would be needed if Deutsche’s derivative counterparties decided to novate their contracts. As for CEO John Cryan, he may be a clean pair of hands, but is he capable of lancing the boils that still may lurk inside Deutsche Bank? Who can blame investors for wondering what is still to come?

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