A BRIEF history lesson, apropos the annual meetings of the International Monetary Fund and World Bank in Washington this weekend: The Great Depression was something of a two-phase event. Phase One began when the U.S. stock market crashed in 1929; but Phase Two began across the Atlantic, with the collapse of the top bank in German-speaking central Europe, Vienna’s Creditanstalt, in 1931. The second financial panic overwhelmed the global economy’s recuperative capacity and drastically accelerated the downturn — with political repercussions for Western democracy too familiar, and too awful, to repeat.
Small wonder, then, that the wobbly condition of Frankfurt-based Deutsche Bank is top of mind among the assembled financial panjandrums. With just over $2 trillion in assets, Deutsche is Germany’s biggest bank, and one of the 20 largest in the world. Yet analysts have long considered it overleveraged and overextended; and when reports surfaced last month that the Justice Department was threatening it with a $14 billion fine for alleged mortgage-related misdeeds, Deutsche’s stock fell to a record low. (The shares have since rebounded.) The IMF’s managing director, Christine Lagarde, spoke publicly of Deutsche’s need to settle with the Justice Department soon and “strengthen its balance sheet.” Are we headed for a repeat of the Great Depression’s Phase Two, with Deutsche in the role of Creditanstalt — and U.S. regulators as precipitators of the collapse?
Probably not. Back in June, long before the prospective U.S. fine made headlines, an IMF report already had labeled Deutsche “the most important net contributor to systemic risks” among global banks. And by then, the bank was already deleveraging; it is much better capitalized than it was before the 2008 crisis, with realistic prospects to raise more. The U.S. fine is likely to be negotiated down from $14 billion. Meanwhile, German Chancellor Angela Merkel’s emphatic promise that there will be no bailout for Deutsche was a good sign, too, in that she probably would not have risked making it if the likelihood of having to break it later were high.
Nevertheless, Deutsche, like the European banking system of which it is a leader, suffers from poor profitability, exacerbated by the prospect that today’s low interest rates could prevail for years to come. Even if it has sufficient capital to avoid bankruptcy, Deutsche’s business model may be outdated — too dependent on a massive balance sheet and hedge fund clients. Its predicament is therefore symptomatic of a wider European malaise; the IMF’s latest report on global financial stability pointed to Europe as the principal source of trouble in advanced-economy banking and called for “deep-rooted reforms” to address it. The IMF suggested that measures to expedite the sale of nonperforming loans could improve bank capital by roughly $156 billion.
What the European economy really needs, of course, is accelerated growth, without which interest rates can only languish. To be sure, Europe’s fractious leaders keep promising reform, and growth. At some point they will have to deliver, lest they risk either Great Recession Redux, or endless stagnation — either of which could have disastrous political consequences.