My Bloomberg View column last week focused on the headwinds facing the European banking system and the broader implications of Deutsche Bank's fall from grace, including the decline in its stock price by more than half.
Let's now take a closer look at factors that are specific to the bank, including what may happen, and what probably won't, starting with the scary -- but in my view implausible -- prospect that Deutsche Bank's woes could become a "Lehman moment."
The phrase is derived from the traumatic effects of the 2008 global financial crisis. A Lehman moment denotes a "sudden stop" to the global economy -- that is, a simultaneous collapse in trade, investment and consumption. The proximate cause is the loss of trust within the financial system as institutions disengage, worried about "counterparty" risk in interactions with their peers. The means of transmission within the banking system become clogged, credit dries up, and even the most creditworthy borrowers have difficulty arranging simple trade financing.
These events are the economic equivalent of a heart attack. If it is not treated quickly, many other organs of the body lose their ability to function normally, spreading cascading failures throughout the system.
For both institutional and contextual reasons, Deutsche Bank is unlikely to provoke the 2016 version of a Lehman moment.
Yes, there are questions about the bank's balance sheets, including the complicated valuations of "level 3" assets. But Deutsche Bank's sources of funding are much more diversified and its balance sheet is significantly more robust than Lehman's ever was. Also unlike Lehman, Deutsche Bank has access to emergency funding at a central bank, in this case, the European Central Bank.
And it has internal means of generating capital (including through asset disposals and even a rights issue), even though the more such methods are used, the less attractive they are to management and existing shareholders. Moreover, given its accumulated litigation reserves, the pressures would also lessen if, as was hinted at in some news reports at the end of last week, the bank reached a settlement with the U.S. Justice Department that required it to pay far less than the original fine of $14 billion.
The environment is quite different, too. Deutsche Bank is not part of a growing storm making its way through the global financial system. Although some European banks remain fragile, others around the world have notably strengthened their capital cushions, are deploying more prudent liquidity-management approaches, and have made significant progress in cleaning up their liabilities. Importantly in terms of systemic effects, this is particularly the case for U.S. banks.
But even if Deutsche Bank doesn't threaten a Lehman moment, that doesn't mean its troubles couldn't have any systemic effects. There are at least four factors that should be kept in mind:
1. The saga deals yet another blow to the already frail reputation of the banking system. Understandably, it fuels the politics of anger, enticing some politicians to make statements that could undermine trust in the financial intermediation process.