The past year has
seen its fair share of worries. From the China slowdown to the
Brexit, successive waves of overseas fear have rolled onto our shores since
2015, yet none of them were the Tsunamis the bears had predicted.
The latest
foreign fear concerns the possibility for a global credit crisis led by the
collapse of a major international bank. A simplified summary of this
scenario goes something like this: Deutsche Bank is on the brink of
bankruptcy and its insolvency could spark a systemic European banking
crash. This in its turn could send shockwaves throughout the global
financial system, resulting in widespread economic turmoil on par with the
previous worldwide crisis.
Commentators who
favor this outlook tend to illustrate their dire predictions with a graph of
Deutsche Bank’s stock performance since last year. It certainly adds
a spark of credence to their argument based solely on the depth of the stock’s
plunge.
One commentator
has gone so far as to assert that “if Deutsche Bank goes under it will be
Lehmen times five!” Other observers have
expressed a similar concern, albeit in less alarmist terms. The International Monetary Fund (IMF) labeled
Deutsche Bank as the most risky financial institution. The argument goes that since Deutsche Bank is linked
with other publicly traded banks and insurance companies, it has the
potential to be the source of another worldwide financial contagion should
the bank collapse.
In 2009, Deutsche Bank CEO Josef Ackermann assured investors
that it had enough money to survive a crisis. Three years later, however, some of his
colleagues said bank hid €12 billion of operating losses with derivatives. “The first warnings that Deutsche Bank could
declare bankruptcy emerged in 2013 when the bank said it needed additional
capital,” according to sputniknews.com.
“In 2013, it attracted $3 billion through issuing shares
for its stakeholders.”
In March 2015, a stress test revealed that the bank again needed
additional capital. It was also revealed
that the bank manipulated with LIBOR, and in April 2015 it was fined
for $2.5 billion. Subsequently, the
ratings agency Standard & Poor’s downgraded Deutsche Bank from A
to BBB+, three positions above the junk rating.
In early June 2016, Deutsche Bank was again involved in a
scandal over LIBOR manipulation.
The case involved at least 29 personnel who worked in London,
Frankfurt, Tokyo and New York. Last
year, Deutsche Bank reported a net loss of €6.8 billion for the first time
since 2008.
Most
recently, the bank made headlines last week when its Xetra-Gold exchange traded
bond failed to deliver gold upon clients’ request. This understandably sparked grave concern
from many in the financial realm that Deutsche Bank’s back is against the ropes
once again.
Could
a Deutsche Bank collapse serve as the catalyst for a 2008-type global credit
storm? When analyzing this question one
must be very careful from making dogmatic statements since no one (especially
an outsider to the international banking industry) can possibly know all the
variables involved. There are, however,
some guidelines that can help us understand the position of the broad market
vis-à-vis the effects of an ailing global institution. These guidelines should allow us to at least
handicap the odds of a global financial meltdown.
One important guideline is the underlying
strength and internal health of the financial market, notably the U.S. equity
market. In the months prior to the 2008
credit crash the U.S. stock market was exceedingly weak as evidenced by the
sustained decline in NYSE internal momentum.
In fact, this is what the longer-term internal momentum indicator for
the NYSE broad market looked like just prior to the 2008 collapse.
This
internal weakness, combined with growing institutional weakness in almost all
major sectors of the economy, meant that the U.S. was highly vulnerable to a
financial shock. When the Lehman
Brothers collapse hit the market, the shockwaves were felt immediately and
resulted in a domino effect. In other
words, internal weakness makes it far more likely that an exogenous shock to
the system will prove devastating, if not fatal.
By
contrast, an internally strong internal condition makes it far less likely that
an exogenous event, such as the collapse of a giant bank, would derail the U.S.
financial system. Consider the
experience of 1998 when the combination of the Asian currency crisis, the LTCM
meltdown, and the near-collapse of the commodity market hit the U.S. stock
market. U.S. equities were in a raging
bull market at that time and the financial market was internally strong. The contagion hit our shores in the summer of
’98, and while it did briefly plunge the Dow and S&P into a malaise –
within three months the major indices were off to the races again and finished
out the year at new all-time highs. The
U.S. essentially shrugged off what would normally have been a catastrophic
event due to its internal strength.
I
would argue that the U.S. financial market finds itself in a similar situation
today. Instead of chronic weakness, the
U.S. market is internally quite strong.
Witness the longer-term NYSE internal momentum indicator below. As you can see, it’s in stunning contrast to
the 2008 scenario shown above.
The late great historian and author Barbara Tuchman said it best
when she wrote: “Social systems can survive a
good deal of folly when circumstances are historically favorable, or when bungling
is cushioned by large resources or absorbed by sheer size as in the United
States during its period of expansion….[W]hen there are no more cushions, folly
is less affordable.”
The
“cushions” she mentions are in place and are in the form of the rising
intermediate-term and longer-term internal momentum previously mentioned. If a Deutsche Bank collapse happens in the
coming months – a mere conjecture to be sure – it would be very unlikely to
collapse the U.S. given the prevailing internal strength.
