Five reasons Merkel needs to rescue Deutsche Bank right now

Is Germany’s Chancellor Angela Merkel secretly working for a hedge fund on the side?

That is the most charitable explanation of her briefings over the weekend that her government has no intention of bailing out the once-mighty Deutsche Bank if it runs into even-worse trouble — news that sent its shares into yet another nosedive. Anyone who had shorted them would have made a fortune.

That might sound far-fetched. But it is at least less worrying than the alternative explanation — which is that Merkel has no idea how the financial markets work, and no appreciation of how much damage the unfolding Deutsche crisis is already doing to the markets and the eurozone economy.

In truth, Germany needs to sort out the Deutsche mess as quickly as possible, and stop pretending that it can stand idly by while its largest financial institution sinks deeper into the mire.

Why? Because the earlier it gets to grips with the lender’s problem the better; because it is preventing a recapitalization of other European banks; and because if it doesn’t do it now, it is unlikely that Deutsche will survive a recession. The sooner it gets on with it the better.

Deutsche Bank has clearly been in some kind of trouble for the whole of this year. How much it is hard to quantify exactly, but the stock market clearly thinks something is up. The shares have been sliding all year.

Profits and revenues have both fallen. Back in February, the co-CEO John Cryan had to put out a statement saying it was “rock-solid” — the kind of thing bankers usually say when they are in deep, deep trouble. Then to cap it all, the U.S. Justice Department this month handed the bank a $14 billion fine for its role in mis-selling mortgage securities. In its prime, Deutsche could have paid that easily — now that it is scratching around for every last penny, there is no way it can afford it. Against that dire backdrop, it is no surprise that questions are being asked about its solvency.

Merkel then took a bad situation and made it worse.

Over the weekend, Focus reported that the government had no intention of rescuing the bank, and wouldn’t be applying pressure on the U.S. to reduce the fine. As anyone could have told her, the result was carnage. Ever since 2008, investors have rightly or wrongly assumed that governments, in extremis, would always bail out a major, systematically important bank.

If Deutsche was being left to its own devices, you could hardly blame them for running for the hills. The shares tanked, taking all the major bourses down with them. On Tuesday morning, they were still falling.

That was a big mistake. In fact, there is no way Germany can walk away from Deutsche Bank’s problems. Merkel might be famous for kicking the can down the road, but there are five reasons why she needs to sort out this mess right away.

First, the sooner it is dealt with the better. As we learned in 2008, once investors start to doubt the credibility of a bank, then the game is up, regardless of whether the underlying business is sound or not. Deutsche is not quite in bank-run territory, but it is getting perilously close. There is a lot of be said for clearing up whatever problems it has early — and just about nothing to be said for leaving it to the last moment.

Next, it is preventing other rescues. Deutsche is far from the only institution in trouble. The Italian banks have been a festering sore for most of this year, and need recapitalizing fast, but Germany’s insistence on bailing-in depositors has been an obstacle to making that happen. A lifeboat for Deutsche Bank could open the door to rescues of banks right across the eurozone — and that can only help fix the continent’s flagging economy.

Thirdly, keep an eye on the U.S. elections. Germany needs to put pressure on America to reduce that $14 billion fine. The U.S. has no interest in yet another financial crisis in Europe any more than anyone else does, so there should be room to negotiate — even if the Justice Department and its lawyers don’t like it. But will that be possible with President Donald Trump? Er, no. Even President Hillary Clinton will find it hard. But President Barack Obama might be able to cut a deal in the final month or two of his term.

Four, the eurozone needs a healthy German banking industry. The German trade surplus is now a massive 9% of gross domestic product, most of it with the rest of the single-currency area. That money needs to be recycled back into the economy — and that can only happen through German banks lending across the continent. Strong banks can do that, but weak ones can’t. If this goes on much longer, the whole zone will soon be back in recession, and that is the last thing either Germany or anyone else needs.

Finally, does anyone imagine Deutsche is remotely strong enough to survive a downturn? The German economy has been doing reasonably well. The eurozone has seen a mild recovery. Then European Central Bank has been pumping money furiously into the system. And despite all that, Deutsche has still managed to get into trouble. When the economy turns down, as it will one day, then it is going to be a lot worse — and a lot harder to fix.

In fact, a rescue needn’t be impossible. Merkel simply needs to make it 100% clear that the German government will stand behind Deutsche if necessary. She needs to put pressure on the U.S. to reduce its fine, and then she needs to put tell Deutsche’s management to slim down and focus on their core business. That should be enough.

But if it isn’t, then the German government should take a stake and recapitalize the business — as Britain did with Lloyds in 2008, for example. Even the threat of letting it go to the wall is crazy — and the sooner Merkel realizes that, and starts to get a grip, the better.

About the Writer:

Matthew Lynn is an experienced journalist and author. He has worked for The Sunday Times and Bloomberg, and now writes a column for The Wall Street Journal MarketWatch as well as contributing regularly to The Spectator. His books range from the award-winning ‘Bust: Greece, The Euro and the Sovereign Debt Crisis’, to the ‘Death Force’ series of adventure thrillers published by Headline. “Electronic publishing is the best thing to happen to writers since the invention of instant coffee and the biro,” he says.

Source: MarketWatch

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