Sinking Deutsche Bank Poses Dilemma For German Government

Deutsche Bank, the scandal-ridden German bank that is rumored to be the only Wall Street firm still willing to deal with Donald Trump, saw its stock sink to its lowest point in decades after a rumor surfaced that the German government has ruled any sort of bailout for the troubled firm. The bank’s stock is trading at under 25% of its book value and the bank itself is facing a massive fine from the US Justice Department over its underwriting of mortgages leading up the financial crisis. The Justice Department is seeking $14 billion which is equivalent to the bank’s current market value. And the bank’s capital cushion is already thin to begin with.

This has put the German government in somewhat of a bind. Angela Merkel and her finance minister pushed through a new European rule that restricts state-sponsored bank bailouts and forces bondholders and potentially even depositors to put up money before the state can step in. This was largely a result of all the banking problems in southern Europe, especially Greece, in the wake of the financial crisis. But now they might be hoisted by their own petard if Deutsche Bank stock slides even further and it starts losing liquidity or needs another capital infusion. No one believes that the German government would let the bank fail as that would trigger another banking crisis. At the same time, a bail-in from bond holders and depositors is hardly more palatable. One option is to use a loophole in that European banking rule in order to allow the government to inject more capital. But that would look incredibly hypocritical for the Germans who have been imposing fiscal probity on the rest of Europe. Another option is for Deutsche Bank to merge with Commerzbank, a bank that the German government does own a substantial percentage of due to bailing the bank out during the financial crisis. The government could find a way to inject capital into the merged firm through its ownership stake, although that would probably also raise the criticism of hypocrisy. A more realistic option is to find some way to come to a much-reduced settlement with the Justice Department which would still leave the bank in a somewhat precarious place but with the possibility of recovery. The German government has said they have not lobbied the US on behalf of the bank and the bank insists it has not asked the German government for help. And you have to bet that the US is probably not interested in driving the German bank under, despite the political pressure for a significant settlement. The final option is probably the least palatable for all but also the most sensible and that is for the bank to divest its prized asset management unit. That would inject a large amount of capital but probably also leave the bank as a shell of its former self.

The irony of the Germans having to confront the possibility of bailing out one of its own giant banks is striking. And the sad part is that the German government is partly responsible for Deutsch Bank’s problems. Investors realize that it is incredibly hard for the bank to make any money the way it is currently structured in this low interest rate environment. The reality is that the bank would be doing far better if interest rates were higher. But they are not and that is because of the German government’s continued insistence at fiscal austerity in the rest of Europe and its unwillingness to allow any significant inflation in the German economy. A faster recovery in all of Europe would have probably meant that Deutsche Bank would not be in this position. But the German government has brought this on themselves.