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2007 All Over Again, Part 3: Banks Starting To Implode

So far, each financial crisis in the series that began with the junk bond bubble of 1989 has been noticeably different from its predecessors. New instruments, new malefactors, new monetary policy experiments in response.

But the one that’s now emerging feels strikingly similar to what just happened a few years ago: Banks overexposed to assets they thought were safe but turn out to be highly risky see their balance sheets deteriorate, their liquidity dry up and their stocks plunge.

This time it’s starting in Europe, where bank stocks are down by over 20% year-to-date and credit spreads are exploding. For a general look at this process see Is Another European Bank Crisis Starting?

Not surprisingly, the scariest stories are emanating from Italy which, despite inventing the mega-bank concept during the reign of the Medici, seems unable to grasp how money actually works. Check out the following Wall Street Journal chart of non-performing loans. When 16% of an entire country’s borrowers have stopped making their payments, that country is pretty much over.

Italy non performing loans

All eyes are therefore on Italy’s Banca Monte dei Paschi, which has a non-performing loan ratio of 33% and, as a result, a plunging share price. When the Italian economy finally blows up, this will probably be where it starts.

But here the story takes an even more disturbing turn. It seems that the other lender now spooking the markets is none other than Deutsche Bank, pillar of the world’s best-performing economy. Shockingly-bad recent numbers have combined with questions about its mountain of derivatives and exotic debt to put DB in a very uncomfortable spotlight. Excerpts from analysis of the aforementioned debt:

What Deutsche Bank’s Plunging CoCo Bonds Just Said about the Bank’s Future

(Wolf Street) – Shares of scandal-plagued, litigation-hammered, loss-ridden Deutsche Bank, one of the largest and least capitalized megabanks in the world, closed at €16.32 today in Frankfurt, down 50% from April last year. Investors are fidgeting in their seats, cursor on the sell-button.

In October, it had announced that it would shed divisions, clients, and employees, and hopefully some risks, and that it would scrap its dividends.

January 20, the bank reported “earnings” – in quotes because it was a sea of red ink. It had lost €2.1 billion in the fourth quarter, including €1.2 billion in its investment banking division where revenues had plunged 30%. This brought “earnings” for the year to a record loss of €6.8 billion.

All these losses, write-offs, and fines have eaten into Deutsche Bank’s already low capital buffer. To prop up Tier 1 capital, Deutsche Bank had issued the equivalent of €4.6 billion (about $5 billion) in “contingent convertible bonds,” spread over four issues, two in dollars, one in euros, and one in pounds – something for everyone.

These CoCo bonds, as they’re called, are special: The bank can call them after a certain date but doesn’t have to redeem them; annual coupon payments are contingent on the bank’s ability to stay above certain cash and capital requirements, as specified by German and European banking regulations; and investors cannot call a default if the bank fails to make the coupon payment.

Despite the risks, yield-desperate investors eagerly gobbled them up. Now Deutsche Bank is just a hair away from breaching the limits. And there’s a lot of nail-biting.

For example, its 6% euro CoCo bonds had been beaten down to a record low of 85.5 cents on the euro by January 21, from a 52-week high in April last year of 102.11, and down from their peak in early 2014 of 104, shortly after they’d been issued.

Meanwhile, it’s not clear what policy changes, if any, will save the day:

A Wounded Deutsche Bank Lashes Out At Central Bankers: Stop Easing, You Are Crushing Us

(Zero Hedge) – Ten days ago, when Deutsche Bank stock was about 10% higher, the biggest German commercial bank declared war on Mario Draghi, as we put it, warning him that any further easing by the ECB would only push stocks (with an emphasis on DB stock which has gotten pummeled over the past few months) lower. What it got, instead, was a slap in the face in the form of a major new easing program when the Bank of Japan announced it is unveiling negative rates just three days later.

Which is why overnight a badly wounded Deutsche Bank has expanded its war against the ECB to include the BOJ as well, and in a note titled “The Risks From Further ECB and BOJ Easing” said the benefits to risk assets from further easing no longer exist, and in fact the “impact has been exactly the opposite.”

In other words, we have reached that fork in the road within the monetary twilight zone, where Europe’s largest bank is openly defying central bank policy and demanding an end to easy money. Alas, since tighter monetary policy assures just as much if not more pain, one can’t help but wonder just how the central banks get themselves out of this particular trap they set up for themselves.

The Zero Hedge article is long and a bit technical but well worth the effort for anyone who wants to understand the bind in which big banks — and their central bank benefactors — find themselves. To sum up: the current situation is untenable, easier money will make things worse, and tighter money will make things a lot worse.

62 thoughts on "2007 All Over Again, Part 3: Banks Starting To Implode"

  1. Somehow I find it difficult to sympathize with the banks in situations like this.
    Their management are all carefully selected and educated people. They have centuries of banking history to learn from in order to know what to do and don’t do. They are with out excuse for their failures and foolishness. I think it is time for the reintroduction of coin as the primary means of exchange and phase out paper and electronic transactions and of course no more bail outs or bail ins for banks. They should sink or swim based on their own efforts and that assumes that they be allowed to do business at all.

  2. Unfortunately, I can’t do graphs, but basically it’s driven by:
    – Net interest margin on wholesale funding
    – Cost of funds

    The ECB is the central bank that DB places it’s excess funds or draws down on for its funding. The ECB deposit and lending rates act like reference rates for the interbank market to deposit and borrow money (wholesale funding). In normal times, there’s approx 150-200bp spread between the ECB lending and depo rates. There’s a nice spread that banks can take advantage of. When QE brings on ZIRP, and then NIRP, that spread narrows – significantly to between 50-75bp, as ZIRP brings deposit rates to the lower bound (0%) and QE requires the ECB to bring down the lending rate. So the European banks are being totally squeezed on their net interest margin in the wholesale market.

    NIRP on deposits transforms DB’s deposits with the ECB from being interest earning to becoming a cost of funds – deposits, now adds to DB’s cost of funds.

    Effectively, QE (reduction in lending rates), ZIRP (hit lower bound of deposit rates – causing severe margin compression) and NIRP (create a cost of funds on Bank deposits) kills DB’s PnL.

  3. I’m confused. Can someone please explain why DB is opposed to QE? Its not clear to me how easy money harms the banks.

    1. It’s a good question and there a re several ways to explain it but they all come down to the fact that “too much of a good thing isn’t good.” When QE/monetary-easing began (say in 2008 as a proxy) stocks (and other assets like “housing”) seemed to be depressed in price because of the recent stock/RE drop and so it seemed like a “no-brainer” that stocks/RE prices were destined to rise because the Fed said it wanted them to rise, literally (and investors didn’t want to “fight the Fed”.) That probably could have been enough to reflate stock prices but since the Fed also dropped interest rates to nearly zero it became almost irresistible to not “leverage” – to borrow money at low interest and buy stocks/RE. So, for at least 6 years stock/RE prices rose in a positive feedback frenzy. However, in the meantime there was the “real economy” and things started to diverge from the artificially induced asset bubbles. Just because the Fed/CBs want the (global) economy to grow at 2% per year doesn’t mean it will in the long run. All of that “easy money” and expectations of perpetual Chinese demand was creating over capacity that was outstripping actual demand (ironically China was doing the same thing). Commodity and energy/oil (US fracking) production are examples of such “mal-investments.” In response, countries started weakening their currencies to create greater (monetary – a key in all of this ) demand (not actual physical units.) Therefore, we are now starting to hit the wall in that even that isn’t working any more. In fact it’s becoming a drag because corporate/banking earnings in devaluated currencies decrease in stronger currencies like the US dollar. Furthermore, the DB in particular probably has lots of loans to EM countries that are sucking wind, lots of interest rate derivatives that are going against them as “Grandma” Yellen et al are now drunk on the kool aid, and no doubt currency hedges that aren’t working out either. If DB profits are expected to fall then so will its stock price, which is the price one pays for future earnings.

      1. Thanks. I fully understand all of the point up to the DB stuff.

        Are you saying that DB has loans to countries that will not be able toservice their debt and DB will suffer. I dont see how QE will make those countries less able to service their debt. If you have a central bank you can essentially generate new currency via QE and use that currency to service your debt to DB.

        Where am I confused?

        1. DB is one of the biggest banks in the world so it’s involved/invested in a lot of different things and evidently many of those “assets” are dropping in value for one reason or another. QE is becoming counterproductive for DB because it’s not helping its borrowers because they can’t borrow any more and it has about $60 trillion in derivatives that are starting to go against them. Who knows what crazy CDS’s they may have bought? That’s what DB is claiming and that’s why DB stock holders are worried, though now there’s talk of bailing them out.

          1. Still confused. DB borrowers cant borrow more because QE? So what if they cant borrow more? Why cant DB just stop lending and be fine?

          2. The DB borrowers can’t pay the interest on their loans (can’t “service their debts”) from DB, so DB has to “debit” their own capital accounts to cover the shortfall. That threatens the capitalization requirements for DB and lowers their profits. Banks are being told to not allow certain bonds to default (EM and oil producers in particular) so they’re having to “suck it up”. What pisses off DB is that their “reward” for postponing defaults to “keep the peace” in the financial markets is further monetary easing by the CBs which makes their situation worse.

            There is an article listed below that seems to indicate that their derivatives (CDS’s, credit default swaps) are causing the most pain, however. Check it out: http://www.zerohedge.com/news/2016-02-11/deutsche-bank-back-5-year-cds-soar-record-high

          3. How does further monetary easing make it more difficult for people to service their existing debts with DB?

            This is where my confusion lies.

            Thanks so much for your help though. Soon it will click and j am fascinated by all of this.

          4. The Fed began its QE in 2009, before the ECB began its own in 2010 and before the BOJ re-tried its QE (which Japan invented) a la “Abenomics” in 2012. The Fed’s QE facilitated the borrowing of about $9 trillion by EM countries, which means the EM countries borrowed US dollars via banks like DB. When the ECB and BOJ initiated their QEs it was expressly to weaken the euro and yen to create price inflation. That made the US dollar strengthen by comparison. The existing debts of the EM countries then became more expensive to pay back because US dollars had to be bought to service their US dollar denominated debt, and at the same time the EM countries started to suffer less income/profits because of lower demand in China. That’s why it’s getting harder for borrowers of US dollars to pay it back. The more monetary easing by the CBs the stronger the US dollar becomes and the harder it is to repay those dollars with foreign currencies. And, because those EM companies are in jeopardy they can’t borrow any more money to service their existing debts.

          5. Ok so the borrowers of DB debt are less able to service that debt as their currency weakens relative to the dollar becausr the debt is issued in dollars and its more expensive to exchange into dollars. The QE of ECB causes euros to buy fewer dollars. Fewer dollars to pay back DB USD loans.

            Are you sure that DB lends in USD to European countries?

            Also when we ralk about DB not liking QE are we referring to ECB QE? Wouldnt they like FED QE because it weakens dollars and makes it easier for their european borrowers to buy dollars to use to service their debt?

            I didnt realize how currency plays such a strong role and how much it matter what currency is lent out.

          6. I don’t know exactly what DB’s loan/currency breakdown is and I don’t know what the biggest factor for DB’s stress is, bad loans, derivatives, etc., but what you repeated above is generally true. Maybe DB would like Fed QE so it weakens the dollar. All of its problems surfaced when the ECB threatened more easing this spring and after the Japan announced negative rates last month. Relative currency value spreads are definitely creating problems “on the margin.” I agree that they shouldn’t seem to be so important but one of the characteristics of bubbles is that malinvestments are based on the assumption that the status quo will continue and nothing will go wrong.

    2. QE makes the banks bigger with bigger debts to deal with. The fundamentals are not there for banks to loan out money to viable real business. At present huge amount of money had flowed into unproductive assets that are riskfree as long as interest rate remains low like zero and as long as the interest rate remains low ie at zero, the only viable place for money to move to is to financial casino assets which are building up to an epic proportion that it will make the separation of the Red sea look insignificant. More QE, more bad debts in ZIRP condition. All assets are bordering on being bad. So, I hope you could understand why DB does not want QE. DB knows QE is only a painkiller for the moment and the cancer is still growing. Oil price is the steam and smoke coming out of a nuclear reactor(economy) since Fed tempered with the thermometer(inflation, employment, etc figures). Oil price drops when the demand fall which means the economic activity had fallen dramatically, as much as oil price had fallen.

  4. Thanks for an interesting article, I think it is important we are open to all ideas. I feel negative interest rates move us down the path towards a “liquidity trap,” sooner or later this will feedback into a loop that disrupts the flow of credit and impacts the real economy. At some point the return on loaning money to banks, governments, and others is simply not worth the risk! This moves us further in the direction to where the efficiency of credit will totally collapse.

    Why do you want to loan money if most likely you will never be repaid or repaid with something that is totally worthless? The bottom-line is that when the only lenders are those who print the money that nobody wants the only safe place to store wealth will be in “tangible assets.” The article below delves deeper into this theory.


  5. Antal Fekete said years ago that declining interest rates destroy capital.

    He predicted the banks would awaken and find themselves insolvent.

  6. I’ve been reading articles like this since 2010. Every time there has been a blip of something it’s the financial apocalypse. It makes me wonder if articles like these are just click bait.

    1. You are absolutely right! I was tricked in 2008 by JOhn Rubino and James Turk predicting hyperinflation. Now they quietly back away from these predictions. I’ve noticed that no one interviewing them confronts them about how wrong they have been, so new readers don’t realize how bad their track records are. FRAUD!

    2. Well, whatever you do, Jarec, stay in stocks! Pay no attention to what happened today. Or last Friday. Or last month. Just keep writing those checks to your broker. It’s just *gotta* rebound sometime….

      1. Ahh, that’s my boy, guts all over in his opinion. Would be even more dashing if I see you following your own advice with your own money.

    3. The opinions are there for your guide dummies. You may do as you please and be matured enough to admit you made a mistake if the coin flip doesn’t go your way. Boohoohoo ….

      1. No one is crying boohoo except your High School English teacher. I’m just the lone voice pointing out that John Rubino and his co-author James Turk don’t know what the #@%!! they’re talking about. For example, they both say that “governments create money out of thin air.” This is a lie. In the western world, all “money” is created out of thin air by private banks. Bankers own the federal reserve. Banks charge interest for loaning money created out of thin air. Rubino and Turk are either ignorant of this, or conspiring to hide it from you. But they will analyze debt levels and useless technical charts and keep you scared about non-existent currency wars forever while the legalized-counterfeiting bankers rob you blind and enslave you and your family under a mountain of perpetual debt.

        1. “In the western world, all “money” is created out of thin air by private banks.” Which is then insured by the federal government through the FDIC, ‘guaranteeing’ that banks will never lose principle on the egregiously bad risks they take. This is the moral hazard liberal douchebags will never acknowledge.
          John’s warnings are spot on. You can witness the fall-out live on MSNBC, if you like.

        2. The legalized counterfeiters are effectively sanctioned and led by government appointees right? I think that this is how the government exerts sufficient control to be accused of “printing money”.

          Do you agree?

  7. Now we know why Citi put a clause into the Omnibus Bill last year putting them in line once again to get a tax payer bailout for TBTFB. Just in time. It pays to “donate” heavily to sycophants in Washington. Taxpayers should try electing a representative government some day soon before its too late. I have the sinking feeling it is too late for taxpayers.
    Churchill said it best about Americans. They always find the right solution…after they have tried all the wrong ones first. At least that was the gist of what he said.

  8. The snowball rolling down the Humongous Mountain of Global Debt (HMGD) is getting bigger by the day. It is metaphorically the size of a beach ball now, and will get the size of one of Jupiter’s moons by the time it hits bottom. So a mega-bank is telling its central bank that the money printing since 2008 has done nothing to make life on the planet better, but has only created a bigger mess that is in the process of coming unglued as we speak.

    The Plunge Protection Team bought into the free-falling stock market today, with financials headed squarely into the trash heap of history, but the sheep have spotted the wolf (Recession/Depression/Collapse) and are heading for the hills (cash, gold, silver, anything but financial assets whose issuer is destined to stiff the buyer).

    But running to cash that is not buried in your back yard or a National Park but sitting in one of these teetering Mega-banks such as BofA and Wells Fargo is cash that may become 30 cents on the Dollar when the banks start closing one by one. Bank Holiday on the way. An event that Obama will see as an excuse to give Federal workers another day off …….. holiday.

    1. There is only one explanation and solution – money velocity. When money goes within the same financial sector (i.e. among banks, hedge funds, etc) it becomes a particle collider – the speed goes super critical, WITHIN a limited sector, and then … sudden release of energy! True money velocity is when wealth goes from industry sector to the people to another industry sector and back to the people.

  9. Guys, I just don’t see the regulators or “monetary authorities” putting any big bank to sleep. Too many fires caused by the Lehman collapse and unforeseen consequences. If DB were allowed to fail imagine the chaos.

    1. Yeah, thanks for predicting the dollarcollapse, John Rubino! So glad I listened to you and James Turk and got tricked into believing we were at the beginning of a hyperinflation back in 2008. You and James Turk have been highly accurate…well, not really.

      1. Information is of any sort is useful. If you acted upon something, it was your decision. Don’t blame other people; you’re only making yourself sound doubly stupid.

        1. Uh, I think this website, “dollarcollapse.com” was started around 2007-2008 to promote the book by John Rubino and James Turk called “the coming collapse of the dollar and how to profit from it,” right? And their analysis and predictions were wrong, right? Wrong because they don’t understand the mechanics of money creation. They repeatedly state that “governments create money out of thin air.” This is a lie. In fact, all money in the western world is created out of thin air by private bankers when debtors borrow money. Private bankers own the federal reserve and collect interest payments for money created out of thin air. No wonder Turk and Rubino got their predictions wrong…they don’t know what the heck they are talking about. Either they are lying or stupid about their knowledge of money creation. So I am doubly stupid for trying to warn people not no listen to them? I think you, Bill the Cat are doubly stupid for stating, “this is the most financially useful site on the web…thanks!”

          1. Hi JSR
            The main difficulty with predictions about economics isn’t the direction of certain events but moreso their timing. Clearly the world is heading to a demographic and debt driven crisis which will lead (somehow) to the resolution of many economic imbalances that exist today . The timing of this is extremely hard to predict and trying to doing so is probably foolish. The part where I agree with you is the years of ” it’s coming soon….” which keeps readers titillated and engaged. Articles like todays have been around for more than 5 years, but who’s to know which straw will break the camels back ?
            But in defence of John, who could of predicted in 2007 the direction central banks would have taken in the last 7-8 years ? The direction they have gone is into completely uncharted and so is impossible to predict in timing. Still it’s clear that the US and other countries are prepared to trash their currencies, it’s just taking a lot longer than if they had not kept kicking the can down the road.
            In the end, John is likely to be right. The USD will eventually cease to exist in it’s current form. When will that happen ? Who knows ? About the only piece of data that I look at for a horizon is that by 2023 interest, defence and welfare will absorb 100% of US tax receipts and so the situation is likely to come to a head before then. (Although Japans levitation through unabashed moneyprinting makes this US collapse no certainty in that timeframe)
            I really can’t believe the CBs have gone this way. History will judge them (and us for accepting it) harshly.

          2. The people who predicted collapse but were too early were actually the optimists. They thought the system would correct before things got even worse, even more out of whack. That things have gotten more and more insane for longer than any reasonable person would have thought– I mean, only a cynic would have thought we’d get here. Deutschebank is about to be bankrupt and they have a derivatives book 64 times the size of the GDP of the entire European Union? I mean that’s not the kind of thing a reasonable, optimistic person would’ve thought could happen, unless all the financial elites went batshit crazy (bingo!). Far from being fear-mongerers, the people who’ve been early in warning about the likelihood of massive, disruptive correction were — it turns out — wishful thinkers. It still hasn’t corrected and we’re now much farther into the Twilight Zone.

          3. I agree. And things can get crazier still and for a lot longer. If Japan can sport a “debt to GDP ratio” of 350% and still have some of the lowest government bond rates in the world, the US could certainly have a national debt of $62 trillion in about 10 years to reach that same “debt to GDP” (assuming GDP grows about 1% per year.) Everybody discounts “helicopter money” but why would CBs not try that too? Most people don’t understand the money creation process so it would probably seem like a massive “debt jubilee”. Heck, even all the “money printing” by the CBs since 2008 hasn’t created as much price inflation as “quantity theory of money” proponents would expect. Who really knows how any monetary policy will play out any more, especially in the “short” run, how ever long that is. The whole baseless edifice should collapse at some point (one would think based on logic and history), but who knows when.

          4. Hi BC and PIP,
            Always enjoy reading your thoughts, they are always better quality than much of what is produced on the net (ZH at times !!?)
            I started preparing in 2010 and I’ll wait as long as it takes while still remaining diversified (ex stocks). Financial education is the key to not making mistakes, I reckon.
            The national debt of 62b is a scary thought, but with Japan as a guide anything is possible.
            I’ll run something past you that I’ve been considering:
            What if all 19/20th century economic theories were predicated on growing/dynamic/youthful population dynamics and so are no longer applicable in aging/stagnant/declining populations ? The interaction of economic theory and demographics may go much deeper than Harry Dent believes !

          5. Hi Tony. I thought things couldn’t go on much longer in 2010 too. Now I’m wondering if all my freeze dried food will be expired by the time I need it.

            As far as your question, yes a certain level of economic growth was always assumed which included population growth. Even SS was set up assuming certain demographics but they haven’t panned out. Now there are fewer workers per retiree than what it was when SS began.

          6. Hi Tony D, and thanks. Preparing has been a process for me, starting after the northeastern blackout in 2003 (during which I had no extra batteries, no cash on hand for ice or bottled water & we’re on a well, etc). Sometime in 2006-2007 we switched out of EM stocks and got into gold, which was inadvertently great timing. Some of my prepping was related to peak oil and pandemic flu concerns, but it was late 2008 when I got truly scared and really got us set up for a major disruption. You can see this by the dates marked on our airtight buckets of wheat and beans: Oct 2008, Nov 2008…. Like Bruce C, I’m hoping most of it is still quite useable (I know the wheat is, the beans seem fine in a recent trial, but the rice will have to be replaced).

            I think you’re absolutely right that all the former economic models are built on the idea that growth is inevitable and will always continue. Some of the peak oil folks have tried to think about what happens in a world of decline, like the guys at Automatic Earth that John often links to. (I realize peak oil is a laughable idea at this particular moment in time, but they have some interesting things to say for the much longer term.) Cheers,


          7. If they have got by this long might as well just keep going. I suppose next we could divide up all the planets and moons and use them as collateral for the banks.

          8. If the Fed wasn’t creating the money to buy government bonds at the government’s behest, the government would be doing it by some other means. And there’s really not much difference anymore between banks and government, if you haven’t noticed. You sound like someone who learned a few talking points off the internet, bought some metals at an inopportune time (Rubino and Turk are big fans of dollar cost averaging over time, by the way) and have decided to come here and throw a tantrum over semantics instead of actually having something to say about the current news.

  10. I read an article last week that showed Bank Of America in pretty much the same shape and questioned if it would survive. I wonder if the Fed will bail out BOA or let them go the way of Lehman Brothers? Maybe that might be the next financial collapse trigger?

  11. I know that another major financial crisis will hurt a lot of otherwise innocent folks (who voted in administrations that encouraged banksters’ actions), I know that the whole global community will face major economic and social disruptions and we as citizens of the world face some serious times ahead, ala the other Great Depression. I realize all that. Yet, down deep, my concern for all the pain those major banks, even the too-big-to-fail banks will face, is measured in micro-giveashitz.

  12. Heyyyy, it’s alllll okayyyyyy! No one audits the Central Banks so bailouts (and bail-ins) are on the wayyyyyy!

    A small price to payyyy for the fascist wayyyy!

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