There is probably nobody in the world with less sympathy for Deutsche Bank than me. The German financial conglomerate was at the heart of the mortgage meltdown in 2008, and its penchant for wrongdoing has continued relatively unabated since. But in the past couple of weeks, Deutsche has become collateral damage in a dishonest public relations strategy by Justice Department officials trying to pose as tough-minded law enforcers.
The trouble started Sept. 15, when DoJ revealed an opening bid to settle claims that Deutsche Bank had packaged toxic loans into mortgage-backed securities without informing investors about their poor quality. The price tag: $14 billion.
That’s about $8 billion more than Deutsche set aside to deal with legal issues, and the difference would force the bank to raise equity to maintain required capital standards. Shareholders feared that an equity sale would dilute their value. The stock price, at 100 euros a share as recently as 2007, plummeted to around 10; half the value has eroded just this year. Hedge funds began to pull billions of dollars from the bank. Credit default swaps, basically insurance against Deutsche Bank’s default, soared in price. With short sellers circling, the word “bailout” began to be thrown around. Many made comparisons to the run on Lehman Brothers that collapsed the investment bank in 2008, though more informed sources urged caution.
The whole crisis was predicated on a series of misimpressions, driven by what has become a sad substitute for financial crisis accountability. To summarize: The numbers the Justice Department announces for bank settlements over mortgage abuses don’t come close to the number the banks actually pay. Financial reporter Yves Smith calls the discrepancy the “bullshit to cash ratio.”
The headline value typically includes a host of non-cash penalties that don’t materially affect the bank’s bottom line. They all feature “consumer relief,” which can mean principal reductions for distressed borrowers, but also bulldozing of homes to reduce blight, donations of homes to charity, or even commitments to lend to low- and moderate-income families, which I guess is positive but is also a moneymaking opportunity; I’ve compared it to sentencing a bank robber to opening up a lemonade stand.
In this case, Deutsche Bank doesn’t own most of the loans it would be asked to modify, meaning that it will pay the penalty with someone else’s money. And things like charity or anti-blight efforts represent routine actions that banks engage in anyway.
Yet when the Justice Department announces fines, the media focuses on the headline number, regardless of the different components used to arrive at it. So a $13 billion settlement with JPMorgan Chase only cost the bank $5 billion in cash payments to the DoJ; the agency grafted on an unrelated $4 billion Federal Housing Finance Agency settlement to get the higher number. Citigroup’s $7 billion settlement cost only $4.5 billion; Bank of America’s $16.65 billion settlement cost $9 billion; Goldman Sachs’ $5.1 billion settlement cost $3.3 billion. And all these banks could deduct non-cash portions of the penalty from taxes as an ordinary business expense, lowering the total even more.
In other words, when the Justice Department threatened Deutsche Bank with a $14 billion fine, that was only for the papers. DoJ merely wants to bathe in the glory of sticking it to the big banks, without actually doing so. Deutsche Bank’s problem was that investors bought the number games, and the subsequent market frenzy buried the bank’s stock. Even though Bloomberg on Friday dropped the rumored headline number to $5.4 billion, and Deutsche Bank stock soared, no deal has yet been made, and that uncertainty sent the stock lower again on Monday.
Instead of elaborate maneuvering to elevate fines, the Justice Department could actually do its job of prosecuting individual criminals, which wouldn’t send investors into a tizzy wondering about Deutsche Bank’s capital reserves, but which would actually hold somebody responsible.
Mind you, I’m not weeping for Deutsche Bank. German officials are right to scoff at the bank for decrying “heavy speculation” in tanking the stock, when speculation is Deutsche’s very business model. One of the reasons the proposed mortgage settlement has taken such a toll is that it’s just one of a series of investigations into Deutsche Bank’s practices that will likely cost money. Other probes cover efforts to assist Russian oligarchs in tax evasion and a spate of market manipulations that damaged Italy’s third-largest bank. There’s a reason the International Monetary fund labeled Deutsche Bank as “the most important net contributor to systemic risks in the global financial system.”
However, I cannot help but note the Justice Department’s sudden burst of backbone when it comes to foreign banks relative to domestic ones. Only foreign banks have been forced to plead guilty to criminal offenses, and fines have been relatively harsher for financial institutions headquartered outside America. DoJ didn’t even know about the Wells Fargo fake accounts scandal until right before the $185 million regulatory fine, even though reports circulated in the media three years ago. Those lapses don’t seem to happen with foreign banks.
The Justice Department is even trying to add foreign banks Credit Suisse and Barclays to Deutsche Bank in an omnibus mortgage settlement designed to generate a bigger headline number, strategically timed to drop right before the presidential election. Even some German officials have accused the U.S. of waging “economic war” through the disproportionate fines.
The simple way to reach a cease-fire in this war is for foreign banks to stop breaking the law. Nevertheless, the whole episode speaks to the need for the nation’s top law enforcer to renew understanding of its actual role. The Justice Department is not a debt collector or a tool of foreign policy. Its primary mission is not to confuse newspaper editors into printing over-inflated numbers to show off its strength. It’s a law enforcement agency, with plenty of tools to punish crimes without triggering global shocks. It should start acting like one.