German banks mega-merger looks like crony capitalism on an epic scale

How the mighty have fallen. Twelve years ago Germany’s Deutsche Bank was one of the darling’s of the world’s banking elite, earning plaudits for its astonishing global footprint. In May 2007, just before the financial crash started to bite, Deutsche was valued on the stock market at 112bn euros, winning headlines such as “Deutsche Uber Alles” for its rapacious expansion.

Deutsche survived the 2008 crash, more or less. But it was not long before the wheels started falling off its investment banking business, and the bank lost not just its footprint but its footing.

Those hurly burly years of playing catch-up with its American giant investment banking competitors haunted the bank. And Deutsche got found out for its over-excitable and egregious behaviour. Over the last decade the Frankfurt-based lender has paid out over $17bn in fines for its misconduct. Yes, that’s right: $17bn.

First came a whopping settlement with the US Justice Department over its handling of mortgage-backed securities.

This led to a $3.1bn civil penalty and a $4.1bn fine which had to be paid in relief to homeowners, a settlement that pushed Deutsche into the red.

Then Deutsche was fined $629m by the UK and US authorities for compliance failures which had allowed wealthy Russians to move about $10bn out of the country. It was also involved in rigging interest rate benchmarks.

Deutsche’s world started to crumble.

By March 2014, Germany’s biggest bank had more than halved in value to be worth a paltry 35bn euros. Its bosses hacked away at costs, launching at least three separate different rescue and restructuring programmes but the bank continue to bleed into the red and has continued losing money.

The bank has been on the global red alert list ever since. In 2016, the International Monetary Fund called the bank the world’s biggest potential risk among peers to the financial system because of its links to other banks.

Indeed, Deutsche’s reputation had sunk to such terrible levels that in October 2017, the bank’s former British boss, John Cryan, went so far as to apologise, taking out full page adverts in ten German newspapers apologising to the German public and its customers for its past mistakes.

Trouble bit again when last summer the U.S. Federal Reserve placed the lender on its list of troubled banks, with its U.S. unit being the only bank to fail the Fed’s annual stress measuring the adequacy of capital and risk controls.

Everything and everyone has been blamed for the disaster: outdated information technology, weak leadership, the heavy fines, declining revenues, sticky expenses, lowered ratings and rising funding costs. Adding insult to injury, the bank now has Presidential links to deal with. According to a report in the New York Times, Deutsche lent more than $2bn to Donald Trump’s property empire to help fund his skyscrapers and other investments over the last two decades despite his bankruptcies and being considered a risky client by other lenders. The New York state attorney general’s office, and the Democratic controlled Intelligence Committee and Financial Services Committee in Congress, are now investigating Trumps ties with the bank.

No one, not even the new CEO, Christian Sewing, has been able to stitch the bank, or its reputation, together again. Today the bank is worth just 16.5bn euros and should become one of  Harvard Business School ‘s case book exercises on how to lose shareholder value, and some more.

So, now Germany’s politicians are riding to the rescue. Or to put it more accurately, Germany’s Finance Minister and deputy chancellor, Olaf Scholz, wants to save Deutsche from itself, and help the country at the same time.

Scholz is behind the latest move to force Deutsche to merge with the country’s second-largest lender, Commerzbank. He, and other German officials, are said to be terrified that a potential recession in Germany or a serious global downturn could upset the bank’s fragile recovery.

In typical Germanic style, the politicians also want to ensure that Germany has a national champion of size and consequence to support its export led economy, and one that still has links to the world’s capital markets.

Even at their latest rock-bottom valuations, a new Deutsche Commerzbank would be the third biggest bank in Europe after the UK’s HSBC and France’s BNP Paribas, with a market value of around 25bn euros. Combined, the two would have assets of roughly 1.8 trillion euros ($2.04 trillion) in loans and investments and control about one fifth of the German retail banking market.

Together, they employ 140,000 people worldwide with Deutsche employing the most with 91,700 workers.  Understandably, talk of the merger plan has sparked fury from unions at both banks because of fears that up to 30,000 jobs will be at risk.

One of the reasons given for the latest push to merge is that Berlin officials want to make sure that Commerzbank – Germany’s second biggest bank – stays in German hands as it is such a big lender to the country’s medium-sized “Mittelstand” companies. Officials are scared that Commerzbank is vulnerable to a foreign takeover, a move which would be considered an act of sacrilege in  Germany’s tightly controlled social market economy.

The government has some sway as it owns a 15% stake in Commerzbank, after bailing it out following the crash. It also has the backing of US investor, Cerberus, which owns stakes in both banks.

Not everyone is enthusiastic. Insiders say that Sewing would prefer to be given more time to get his bank back on its feet rather than merge. He will have the support of the unions which have a more powerful voice in Germany because their representatives sit on the supervisory board. A former politician, Gerhard Schick, has also criticised the deal, saying: “We do not see a national champion here, but a shaky zombie bank that could lead to another billion-euro grave for the German state. Why should we take this risk?”

Schick is right. Most bank mergers are inevitably catastrophes, and extensive research shows that smaller banks perform better over time than big banks. Putting these two banks together does not bring back Germany’s Deutsche global powerhouse.

There are other worries: that the merger will prompt a revaluation in the banks’ loan portfolios – and crystallise losses. Commerzbank holds around 30bn euros of debt such as Italian bonds which are now worth less than they were, at 27bn euros. Deutsche also holds similar securities at market values on its books. There are also suggestions that the mooted merger might come up against EU competition law.

For once, the German press is refreshingly forthright. DW’s business editor, Henrik Böhme, points out that German policymakers promised taxpayers they would never have to bail out another bank. But a new Deutsche Commerzbank, he writes, “would be too big to fail considering its balance sheet total and would have to be rescued by the state again in times of trouble. Does it all make sense?”

Bohme adds: “Olaf Scholz’s idea of creating a national banking champion is not a brilliant one, in fact, it’s complete nonsense. Let’s hope that the talks between the two banks will not be influenced by all the unsolicited comments from Berlin.”

The merger does look like nonsense and makes no sense. It will tie up resources for years to come, cost billions in restructuring costs and leads to thousands of jobs lost. Far better to keep trimming back both banks to have two healthy banks rather than one zombie.

Yet logic is unlikely to prevail. It would be dangerous to underestimate Berlin’s innate ordoliberalist protectionism – crony capitalism even – over a free market solution. And what about all that talk years ago in the EU of open borders and European cross-border banking? That was always for the fairies.

Maggie Pagano,
Executive Editor,
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