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Now, it’s Germany’s turn
In the late winter of 2009, I received a phone call from one of my brothers-in-law.
He’s younger than I. He was in his late 40s at the time; he’s in his late 50s today.
He’s had a successful career and has built up a substantial net worth through hard work, investing, and some profitable stock grants connected to a takeover of one of the companies he worked at in the early 2000s.
While he has money to invest, he’s not a financial guy and has no formal training in economics.
He’s a bricks-and-mortar type executive in the commercial real estate business. He was calling me for some informal financial advice.
If you recall, the winter of 2009 was the absolute depth of the financial crisis that had begun in August 2007 and reached manic proportions with the Lehman bankruptcy on 15 September, 2008.
We look back on the fall of 2008 as the time of greatest fear, but the winter of 2009 was the time of greatest malaise.
The stock market did not bottom until early March 2009, although few knew it at the time.
The auto company bailouts were still being fine-tuned in early 2009, and the Obama fiscal stimulus bill was still being debated.
We were at the bottom, and no one seemed able to find a way out. Investor portfolios had been decimated. It was the winter of our discontent.
After some small talk, my brother-in-law said, ‘Jim, Citibank stock is trading around US$1.50.’ Citi had been around US$42.00 just two years earlier. ‘My broker says I should buy it. What do you think?’
I recalled a private lunch in New York in October 2007 with one of the top three Citi executives in the C-suite dining rooms on the third floor of the bank’s then-headquarters, 399 Park Avenue.
At the time, Citi was trading at US$42.00 per share, pre-split.
I told the executive I thought the stock was only worth US$24.00. He leaned forward and in a low voice said, ‘Seventeen.’
We both knew that Citi was a mess and a stock collapse was coming. Neither one of us thought US$1.50 per share was on the cards.
Now, in the winter of 2009, the impossible had happened.
Citibank was technically insolvent; a complete ward of the US government.
My policy recommendation, and that of others, was that the government take over the bank, wipe out equity, haircut bondholders as needed to plug the hole in the balance sheet and then do a clean-bank IPO to raise new capital.
Citi would start over as a healthy bank.
Too bad for former equity and debt holders; they had made their bets and taken their chances. That’s capitalism.
Based on my view, it was hard to recommend buying the stock.
I told my brother-in-law, ‘It’s a total speculation. I’m recommending to the US Treasury that they wipe out equity. You should only do this if you’re prepared to lose all your money. It’s hard to get more specific than that.’
My brother-in-law thanked me, and that was the end of the call.
The next time I saw him was at a family wedding later in 2009. I asked him what he had done with the Citi trade. He said, ‘Oh, I put US$100,000 in at US$1.50 and sold it in early August for US$4.50. Walked away with $300,000 — tripled my money.’
‘Nice job,’ I said. ‘You can pay for the drinks this weekend.’
What’s the moral of the story? The moral is too big to fail means too big to fail.
Institutions like Citibank will not be allowed to fail under any circumstances.
Financial analysis doesn’t matter. Free markets don’t matter. Insolvent balance sheets don’t matter. When a too-big-to-fail bank hits bottom, the government will ride to the rescue one way or another.
In the winter of 2009, US Treasury Secretary Timothy Geithner simply decided that none of the major US banks would be allowed to fail.
The US government had learned its lesson with the Lehman situation.
Stock investors had suffered greatly on a mark-to-market basis, but they would be given a lottery ticket to make their money back if they held on to their positions. Most didn’t.
The strong hands, like my brother-in-law, swooped in and bought up bargains.
Trades like this are the antithesis of free markets. But just because free markets are dead doesn’t mean you can’t make money. It’s just that you have to make investment decisions through the lens of government policy.
Now, it’s Germany’s turn
It seems like we’re a long way from those dark days.
The US stock market quadrupled from the lows of March 2009 to the recent high in January 2018.
The stock market is down a bit since January, but there’s no global financial panic around to drive prices to the extreme levels we saw in early 2009.
Yet that doesn’t mean that opportunities to invest in too-big-to-fail banks don’t exist.
The fact is that a lot of the solvency problems that arose in 2008 have never been repaired; they’ve just been papered over.
This instability in the banking system lies just beneath the surface and occasionally becomes visible, like hot lava erupting on a highway.
Something similar may unfold for shareholders of the German equivalent of Citibank — Deutsche Bank AG.
The bank’s a mess, the stock has been beaten down (again) and Angela Merkel is standing by with a German government cheque book.
No one disputes the fact that Deutsche Bank is too big to fail, the same as Citibank, Bank of America, JPMorgan Chase and Goldman Sachs.
But that claim understates the situation.
Deutsche Bank’s place in the German economy is equivalent to Citi, BofA, JPM and Goldman combined.
Deutsche Bank isn’t just the biggest bank in Germany; it is Germany, where financial matters are concerned.
Deutsche Bank was as insolvent as Citi in 2009, probably worse.
The difference is that Citi has used the past 10 years to clean up its balance sheet and is relatively healthy today.
Deutsche Bank’s balance sheet is still chock-full of bad debts, and its US dollar-denominated funding sources are highly vulnerable to a run on the bank.
Will Deutsche Bank follow in Lehman Brothers’ footsteps?
We’ve seen this movie before, not just in 2009 but more recently.
In September 2016, Deutsche Bank stock fell to 9.40 euros per share. That sounded alarm bells because the psychologically significant barrier of 10.00 euros per share had been breached.
At that point, the German equivalent of the notorious US ‘Plunge Protection Team’ (actually called the Financial Stability Oversight Council, or FSOC) got to work.
By May 2017, Deutsche Bank stock was back up over 17.50 euros per share, close to a 100% gain, and the situation had stabilised.
With fears once again rising in Europe because of the Italian elections and a slowdown in EU economic growth, what’s next for Deutsche Bank?
As you can see from the charts below, Deutsche Bank has once again hit an air pocket.
If Deutsche Bank’s stock fell even further now, from 9.2 euros to, say, 7.00 euros per share, the selling could accelerate from there and drive the stock to 4.00 euros or less.
At that point, the bank goes into a death spiral, just as Bear Stearns and Lehman did in 2008.
Deutsche Bank AG [FWB:DBK]
Source: Yahoo Finance
The German government can’t afford that kind of crisis right now, especially with confidence in the euro and the EU being eroded by developments in Italy.
Merkel’s unofficial motto is ‘One crisis at a time.’
Germany will do what it needs to do to turn the Deutsche Bank situation around and stabilise the stock price.
Once the market perceives that the rescue is underway, I’d expect the stock will bottom and the next relief rally will begin.
All the best,