Deutsche Bank is in trouble — and that’s bad news for all of us.
Deutsche Bank is Germany’s biggest bank, with more than 100,000 employees around the world and operations in more than 70 countries. Its assets total about $1.7 trillion. One worrying sign of the bank’s distress is that its stock is trading now at about $14 a share, roughly half the peak (almost $29) in the past year and much lower than the historical high point of about $160 in 2007.
For months, rumors about Deutsche Bank have circulated in European financial markets and political circles. How weak is it? Would it need to be rescued by the German government? At best, Deutsche Bank’s failure would be a blow to confidence and squeeze credit availability in Germany and elsewhere. At worst, Deutsche’s failure would cause a global recession.
“The bank is edging close to suffering a general crisis of confidence, which could see investors pull their business from the bank and even depositors wanting their money out,” writes Jacob Funk Kirkegaard of the Peterson Institute, a think tank. Still, Kirkegaard doubts that Deutsche Bank would be allowed to collapse. In a financial crisis, it would probably be rescued by the German government or the European Central Bank, he says.
That could happen. In a separate study, economist William Cline, also of the Peterson Institute, points out that the stock market’s valuation of Deutsche Bank is far less than the company’s valuation. The stock market puts a price tag of around $15 billion on Deutsche Bank. This figure represents simple arithmetic: the number of shares multiplied by the stock’s price. By contrast, the company says its net worth is more than four times that at $68 billion.
The difference between the market’s estimate and the bank’s is that the market thinks the company is too optimistic about future revenue, costs and losses, according to Cline. For example, the U.S. Justice Department is seeking a $14 billion fine from Deutsche Bank, reflecting allegedly abusive lending practices during the housing boom. Deutsche Bank has already created a reserve of $7 billion to pay the fine, says Cline. But if the Justice Department insists on the $14 billion, the reserve would be too small by half.
By Deutsche Bank’s accounting, and after tapping the reserve, this would still leave the bank with a sizable net worth of around $60 billion, far above the market’s evaluation. The market’s much lower figure, presumably, reflects losses on loans and other securities that haven’t been recognized. No one knows whether these losses exist or how much they total, says Cline.
But if large losses do emerge, they could trigger another European banking crisis. The reason: Deutsche Bank isn’t the only major bank with a huge gap between its market value and the bank’s own estimates. Cline examined the 14 largest European banks and found that, with three exceptions, all have market valuations that were substantially below the companies’ estimates. The average gap was about a third in late October.
Cline did similar estimates for eight major U.S. banks and found that, on average, there was little gap between market and company valuations. “U.S. banks appear to have made more progress cleansing their books of weak loans than have European banks,” writes Cline.
So the strength of Europe’s banks is worth watching and worrying about. If the worst fears come to pass, a banking crisis would weaken an already-anemic European economy.
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