More questions about the stability and probity of German banking this morning following on from the rumour of the €1 Trillion hole in German banks.
This from the 21st March Wall Street Journal,
Deutsche Bank AG changed the legal structure of its huge U.S. subsidiary to shield it from new regulations that would have required the German bank to pump new capital into the U.S. arm.
The subsidiary is called Taunus Corp. It is the 8th largest Bank holding company in the US. Being listed not just as a bank but a Bank Holding Corp. has a very special perk, it allows the Holding Company to borrow from the Fed in times of crisis. Which Deutsche did.
Remember, that the only reason Goldman Sachs still exists, is that as the collapse of Lehmans engulfed Wall Street, Goldman was allowed to become a Bank Holding Company. It had never been one till that moment. Till then Goldman had been a Broker Dealer. And it was not alone in suddenly desiring to become a Bank Holding Company. As this article by Edward Harrison points out so did GE Capital hitherto a hedge fund, American Express (a credit card company), GMAC (GM’s car financing arm) and Genworth Financial (an insurance company) all suddenly thought they should be come Bank Holding Companies. Sinners, all of them, they all changed their faith to gain salvation.
But salvation has a price. Being a Bank Holding Corp brings certain obligations and oversight which being a not-so-essential financial organization doesn’t. Quite reasonably, being allowed to suckle up to the Fed’s teet, comes with the obligation that the Fed get’s to tell you how much Capital you have to hold against your loans and liabilities – at least those within the Fed’s, jurisdiction. You can see why Goldman, for example, had never previously wanted to be a Bank Holding Corp.
Back to Deutsche and Taunus – they were happy to take the money in teh crisis but they now don’t want to pay the cost of obeying the rules.
This is a long running saga. In November of 2011 Bloomberg ran a story by the former cheif economist of the IMF Simon Johnson which pointed out that
The German bank, however, is thinly capitalized. Its total equity at the end of the third quarter was only 51.9 billion euros, implying a leverage ratio (total assets divided by equity) of almost 44.
There is precisely nothing prudent or safe about leverage of 44 to 1. It is considerably worse than the worst American banks and this is just the leverage of Deutsche’s on-balance sheet. If anyone were to add in the off-balance sheet we would all need a sit down.
But we don’t need those off-balance sheet figures to feel a little queezy about Deutsche and Taunus. In June of 2011 the FT’s Alphaville ran a peice which noted a letter written by the then Chairperson of the FDIC, the Federal body charged with insuring American Banks,
… in which FDIC chair Sheila Blair attacked an unnamed European bank for allowing its US holding company to operate with negative Tier 1 Capital. Taunus does fit the bill:
“…the end of 2009 showed a negative equity of $8.1bn. The important core capital ratio (Tier 1) was minus 7.4 percent – markets actually require a positive value of around ten percent. The [Federal Reserve] has previously regarded additional capital charges for holding companies unnecessary based on the adequate financial strength of their parent companies.”
In other words, previously, a bank which was a subsidiary of a larger bank could have negative capital holdings as long as its parent could be relied upon to bail it out. That has now changed and Taunus has to be solvent itself. As soon as this change became law Deutsche changed Taunus from Bank Holding to just bank in order for Taunus not to have to comply. And it did so …why?
Because Taunus is hideously under-capitalized and Deutsche doesn’t have the spare cash to ship from Germany to the US to shore up it’s US operation. At least not till a few million Greeks start really knuckling down to paying off Deutsche’s debts for it.
Of course this means the next time Taunus needs to borrow from the Fed it won’t be able to do so. A worryingly exposed position to put Taunus in and a measure, in my opinion, that Deutsche feels it has even more pressing problems to deal with at home.
Now I don’t wish to be accused of picking on Deutsche or the Germans so let’s refer back to the Wall Street Journal Article which points out that this move by Deutsche is merely following in the footsteps of our old friend Barclays Bank which did the same for its American operation.
One of the things this sordid little tale suggests is that Europe’s banks just don’t have enough cash or, much more worrying, enough acceptable assets to pledge to central banks for cash, to comply with regulations everywhere they operate. I think the banks are having to decide which regulator they will comply with and which they will thumb their noses at. And the decision is, which one will allow them to pledge the most worthless assets in return for loans.
This is regulatory arbitrage (law avoidance) of a rather desperate and dangerous kind.