1907 Oregon Trust & Savings bank run (Source: Wikimedia Commons)

Trust is being lost in the European banking system and in governments; the tip of the spear are the tiny few with wisdom, caution, and history roaming their minds late at night. Such people are fiduciaries at insurance and pension companies and hedge funds and in their social circles they rub shoulders with bankers. After the tip of the spear the word will reach smart investing firms with common sense, CFOs responsible for payroll disbursement, and high networth individuals and their advisors — they are awake, they sense their cash on deposit is vulnerable. Finally it filters down to the last-to-know: the rank-and-file.

Aides to German Chancellor Angela Merkel have told lawmakers the state wouldn’t take a stake in Deutsche Bank AG if it were to issue new stock to shore up its thin capital cushion, one person who attended the briefing said. “We have a different bank resolution system than in 2009 and this must apply to us in Germany too,” the government officials said according to this person. This referred to recent legal changes that now force European governments to bail-in creditors — and in some cases depositors — before they shore up a struggling bank with taxpayer money.

(Source: The Wall Street Journal, October 14, 2016, “German Government Has Ruled Out Taking Stake in Deutsche Bank”)

The bail-in threat is flashing red: the European banking system is fraught with hidden risk. Take note that the leading indicator of bank runs is no longer long lines going around the block — that is the trailing indicator and by that time is gated to pocket change at ATMs.

Domestically, the largest German banks and insurance companies are highly interconnected (Figure 14). The highest degree of interconnectedness can be found between Allianz, Munich Re, Hannover Re, Deutsche Bank, Commerzbank and Aareal bank, with Allianz being the largest contributor to systemic risks among the publicly-traded German financials. Both Deutsche Bank and Commerzbank are the source of outward spillovers to most other publicly-listed banks and insurers. Given the likelihood of distress spillovers between banks and life insurers, close monitoring and continued systemic risk analysis by authorities is warranted.

(Source: IMF report on Germany, June 2016, p. 29)

There has been an attempt to merge with Germany’s second biggest bank Commerzbank but the deal was aborted:

This weekend, senior executives are meeting to debate some of these options, according to people familiar with the plans. One has already been floated: a merger with Germany’s second-largest bank by market value, Commerzbank AG, the people said. The two banks in August held preliminary discussions about a tie-up, before concluding last week it wasn’t viable.

(Source: Wall Street Journal, August 31, 2016, “Deutsche Bank Weighs Stronger Medicine: Under consideration: sale of key asset-management unit. Rejected: merger with Commerzbank”)

Ramifications

Deutsche Bank is a threat to the global banking system and the consequences of a potential bankruptcy greatly exceeds the Bear Sterns and Lehman Brothers collapse aftermath in 2008 due to DB’s vast scale of derivatives’ exposure relative to its reserve equity status all while matched-up to the fragility of a multitude of interconnected banks in Europe — the European banking system is a cross between a tinderbox and a triage. Unlike 2008, the DB threat cannot be assessed and managed solely from economic and financial perspectives; social and political factors weigh-in heavily now because the world has already learned first-hand the visceral meaning of “systemic bank collapse.” Ergo — now — “we the people” would lose all trust in the banking system and government if this were to happen so it won’t simply because the world’s governments cannot afford the loss of its tenuous remnants of credibility capital.

The likelihood of DB undergoing formal bankruptcy proceedings are remote because the consequences are globally dire — truly a weapon of mass financial destruction. The most likely actions will take place out of the public eye so that trust is preserved in the system and “the system” means the sum of publicly-traded banks, governments, and central banks and would extend beyond the original purview of the ECB and include the US Federal Reserve/Treasury Department if required just like in 2008. In the case of DB’s failure, “whatever it takes” would take a lot more than what Berlin and the ECB can deliver. Just because there is no news in no way reflects lack of action including action of Herculean magnitude and/or unprecedented measures behind the curtain. Beyond a band-aid approach composed of a series of “loans” and currency swaps (i.e. “stealth bail outs”), an intelligent solution to stabilize the predicament more permanently would be for Germany to nationalize DB in the form of a merger with German’s central bank, Deutsche Bundesbank, which would offer the unique opportunity to restructure DB from the ground up while becoming Siamese twins both literally and figuratively with the ECB whose European headquarters is conveniently located in Berlin. This assumes the essence of the headquarters of the acquired (DB in Frankfurt) would be assimilated in Berlin. Nationalizing distressed banks in Europe has been a successful expedient previously and will become warranted here.

Synergistically, this arrangement of the gravitational pull of the European Central Bank + Deutsche Bank + Deutsche Bundesbank triumvirate would attract many other international banks with the eventual ecosystem perhaps achieving a level that would rival a waning London bank complex post-Brexit. Too out-of-the-box? No. Not given the risks and rewards on the event horizon. The potential carnage, strategic upside, and grand stakes for those in high places with more than skin in the game is palpable. If DB’s collapse is not grabbed by the horns early enough it could be a runaway truck, DB has zero chance of growing itself out of the death zone. Prevention kills two birds with one stone but the story and timing need to be well orchestrated. Proclamation of urgency would not be a fabrication and would provide the basis of a strong case for taking drastic pre-emptive action. Why is this prudent? Given the current Prevailing Gray Swans List, three directly impact the survivability of the EU and a fourth impacts it indirectly:

Note: #4 is addressed as an element of the bigger picture of the Syrian Conflict which is an absolute must for Americans to understand — it is not just “another Middle Eastern War.” Main street media in the US does not present the who, what, why, and how of the Syrian Conflict, only superficial, one-sided caricatures following a simplistic script. In actuality there is a very different and dangerous Cold War 2.0 brewing driven by foreign policy differences in regards to the use of tactical nuclear weapons (not strategic nuclear weapons) between the US/NATO and Russia and this should be a major topic in the presidential debates and has never been discussed on any national platform to date.

The political one — a Brexit-like referendum in France or Italy — is immanent and will force the collapse of both DB and the Italian banking system for myriad structural reasons. The financial ones — DB and Italian banks — can be managed behind the scenes at least for awhile but if there is a black swan event the EU is much too fragile to survive. The military one — Syria — has dominant influence on the referendum in France and other countries in the eurozone. The message to internalize is that the EU has very low survival prospects given a 24-month time horizon because of the interwoven contingencies of these synergistic predicaments. They are not going to go away.

Prudent Actions to Strongly Consider

Immediate withdrawal of all funds that could be subject to a bail-in. DB suffering a bail-in is an unlikely event — all things considered — but given Chancellor Merkel’s sharp verbal directives toward Italian Prime Minister Matteo Renzi in regards to there being no bail-outs for Italian banks, it is wise to respect the unassailable wisdom of “what is good for the goose is good for the gander.” This could embarrassingly backfire on Merkel. But in any case, money on deposit at DB is at risk of confiscation because we live in dangerous times. Yes, confiscation could happen even given the overwhelming evidence for avoiding it at all costs. Big picture on DB: being prepared for gray swans is one thing, being aware of black swans is quite another. And — rest assured — they are out there flying around the Black Forest.