German banking giant Deutsche Bank (NYSE: DB) announced a major restructuring on Sunday with plans to cut 18,000 jobs and an exit from the global equities trading and sales business. The company has been struggling for years and never really recovered from the financial crisis in 2007.
In mid-2007, Deutsche Bank’s stock was trading up above the $120 level. By early 2009, the stock had fallen below $20. The stock would recover and move above $70 in the fourth quarter of 2009, but the stock has been in a downward trend ever since.
Deutsche Bank has struggled on many different fronts, and it has been hit with numerous fines over the last 10 years. The issues have created the current situation, and investors should be concerned—and not just investors in Deutsche Bank.
The bank is the largest investment bank in Europe, and it is the sixth largest investment bank in the world based on revenues. Should the restructuring not work, the ramifications would hit the global banking industry extremely hard. I mentioned the financial crisis earlier and that leads me to think about the collapse of Lehman. Should Deutsche Bank collapse, it would have a similar impact on the world’s banking and investment industries.
One of the biggest problems for Deutsche Bank and the reason a collapse would hurt competitors is the derivative holdings the bank has. Different reports and articles put the current derivative holdings at $45 trillion. That is more than twice the size of the United States GDP. If the bank goes under and those derivatives have no value or if their value becomes worth pennies on the dollar, the counterparts to the derivative trades will get hurt as well.
If you recall back in 2007-2008, it was American International Group that was holding a great deal of Lehman’s derivative products and AIG had to be bailed out by the government in order to keep the whole financial system from collapsing.
The current question is, who is holding the derivative products of Deutsche Bank? Is there one company that is holding a great deal of the $45 trillion? Unfortunately, that is an impossible question to answer due to the lack of transparency in the derivatives market.
Knowing who Deutsche’s trading partners are is one problem, but there is a second problem. When the financial crisis hit back in 2007-08, the European Central Bank was in a position to help financial institutions with rate cuts and other fiscal policy moves that pumped liquidity into the system. The ECB isn’t in as much of a position of strength this time around because it has been using various quantitative easing methods to boost the European economy for several years now.
There is also the matter of the German government and whether it is willing and able to help Deutsche Bank with a bailout. Very little has been mentioned by government officials up to this point, but you have to believe the government can’t stand idle and allow the bank to collapse. Germany has long been viewed as the strongest economy and strongest financial system in the European Union, and a Deutsche Bank collapse would hurt the country’s stance dramatically.
Personally, I would put the chances of a Deutsche Bank collapse at 50-50. There will be tremendous pressure from the world for the ECB and Germany to keep the bank afloat by any means necessary. There is far too much at stake.
If indeed the restructuring fails and Deutsche Bank does end up like Lehman, the global banking system will take a huge hit and we could see huge declines in bank stocks and big declines in the overall market. The European banks will be much more vulnerable than U.S. banks, but U.S. banks won’t be unscathed. You can bet that the likes of Goldman Sachs, J.P. Morgan Chase, Morgan Stanley, and other banks are holding derivative products from Deutsche Bank. Deutsche’s portfolio is just too big for domestic banks not to be involved.
While it may seem like the problems of Deutsche Bank aren’t a big concern to U.S. companies and investors, that isn’t the case at all. A collapse of Deutsche Bank would rock the global equity markets just as bad as Lehman’s collapse did back in 2008. The one saving grace for the American market and economy is that the Federal Reserve is in a better position to help than the ECB. The Fed has different tools at its disposal that it can use to counter another global financial crisis—rate cuts, quantitative easing, and open market activity.