Deutsche Bank doesn't understand risk at all

Outlook:

Just how danger ous is the banking sector to the over all equity mar kets or the global economy? The Bloomberg story on Deutsche Bank losing hedge fund clients set off a storm that was not really warranted by the facts, but never mind—the market was all too willing to accept that a banking crisis is all too plausible.

The editor of MoneyWeek has an op-ed in the FT today saying she has long said never invest in banks. "Competition, loss of trust and low interest rates have eroded the business model."

Of these, the biggest is loss of trust. Think of Senator Warren's much-replayed diatribe against the Wells Fargo CEO (who is now working for on salary). Some analyst think Deutsche Banks' trouble began when the US Justice Dept announced a $14 billion fine for misbehavior and Deutsche Bank made the PR mistake of saying it won't pay. Usually these fines get negotiated downward—far downward— and it never pays to annoy the US government, which can be petty and unreasonable to an unbelievable extent, as anyone knows who has ever had to deal with the IRS.

The point is that Deutsche Bank didn't understand negotiating risk (game theory) and perhaps doesn't understand risk at all. It probably has the same fancy statistical models for derivatives that JP Morgan and Citi have, but that's not the only understanding of risk that is needed. CEO Cryan is mocked in the FT for lashing out at "'forces in the market'" seeking to undermine Germany's biggest lender, as its share price dropped to a fresh 33-year low on Friday morning." In a note to staff, he said "distorted perception from outside" should not affect the bank's daily business. "In banking, trust is the basis of everything. There are currently some forces at play in the market that want to weaken this trust in us." Huh? This is absolutely the wrong way to deal with bad press. Deutsche Bank stock opened down 9% this morning. QED.

Risk comes in many forms. We have seen many German banks fall into disrepute and disorder, including the regionals such as Berliners Bank, for this one blind-spot shortcoming. For lack of a nail, the horseshoe was lost; for lack of the horse, the battle was lost.

We saw the same thing in Japan during the 1990's. Japanese banks believed with all their hearts that the big conglomerates simply had to be credit-worthy and if they were not, the government would rescue them. They never bothered to learn credit standards and lending was based on "relationships." Golly, if you are a bank, the first thing you need is credit standards.

What do Germany and Japan have in common in addition to inability to manage banks? (Readers are welcome to contribute.).

Well, both countries have a wildly high savings rate and a strong preference for safe investments over riskier equities. In both German and Japanese, risk is a borrowed work and means hazard—always a negative. In English, risk can have a positive connotation—risk more, gain more. Perhaps the German and Japanese misunderstanding of risk in all its diverse glory is as simple as the semantics. Or maybe it has something to do with an outsized faith in the government always riding to the rescue, a deeply anticapitalism bias. Commentators used to joke that Japan is the biggest socialist country in the world without the name. To be fair, US market players expect the government to ride to the rescue, too, and got quite a shock when it declined to do so in 2008.

Chances are good that the Deutsche Bank crisis will blow over and without government intervention. But the sector remains vulnerable to the next bank that screws up, with the PR effect blowing problems out of proportion. So far the eurozone banking authority is quietly letting Italy re-organize four small banks without a lot of fuss. There is probably a fair amount of sweeping-under-the-rug going on all over the European banking sector, not just in Germany. But a crisis? Bloomberg is guilty of exaggeration.

Today in the US, the big news will be personal consumption expenditures. The core deflator, the Fed's darling, will likely move up a little to 1.7%, a 2-year high. We say of equal importance is the Atlanta Fed GDPNow tracker, at 2.8% for Q3 on Sept 28 but possibly rising back to 3% in the new estimate today on the latest data.

It would be fair to say the FX market is in a state of confusion. We wouldn't get 50-point moves—and divergence between dollar/Swiss and euro/dollar—if traders had a coherent world view. We are so confused by the CAD chart that we advised against trading it at all late yesterday. This kind of environment— relatively big intraday moves in both directions—is the road to the poorhouse. Stay away.