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Deustche Bank: You Say We're Too Big To Fail Like It's A Bad Thing

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Bloomberg has this sort of surreal article today about Deutsche Bank basically quoting a bunch of people saying "we are way way too big to fail and it is awesome." Like:

Banking consolidation “sadly” will be “one of the many potential unintended consequences of regulation,” [co-CEO-in-waiting-whatevs Anshu] Jain said in a Bloomberg Television interview on Jan. 26. When asked about the systemic risks posed by bigger banks, Jain said that “you have the tradeoffs of too-big-to-fail on the one side and the benefits of diversification on the other.”

So on the one side, if we screw up we'll be saved by diversification, and on the other, if we screw up really bad we'll be saved by you. Those tradeoffs are not exactly tradeoffs for DB. Or even better:

At the end of 2010, Deutsche Bank was ranked the world’s most systemically important financial institution by Japan’s Financial Services Agency and central bank, based on estimates about the impact a failure would have on the global financial system, according to Mainichi newspaper.

“On the one hand, it made us proud, but on the other hand, of course, we’re aware of the responsibility,” [current lame duck CEO Josef] Ackermann said at an earnings press conference in February 2011 when asked about being deemed the world’s most systemically important bank.

I imagine that Japan's Financial Services Agency was not ranking "most systemically important financial institution" with the intention of giving them a prize, but I do love that Ackermann took it that way. "Yay we were voted #1 most likely to blow up the Western financial system."

The whole thing is a little terrifying and you will not be entirely relieved to know that Deutsche is levered 40x or so but only to hold safe assets so, y'know, no biggie. You also may or may not be comforted by this Journal article from yesterday, which I thought was a pretty good recap of why European banks are so different from American banks - basically because they're all levered a bazillion times but to hold safe assets, except that outside of DB those safe assets are mostly like Portuguese government bonds so y'know.

One example of the different attitudes might be Goldman Sachs, which Bloomberg also reported today is hiving off all of its bring-down-the-financial-system people and they're discovering that they were better at making money when ensconced in a 13x levered balance sheet with access to customer flows:

Ex-Goldman Sachs (GS) Group Inc. traders led by Pierre-Henri Flamand and Morgan Sze raised more than $4.5 billion for their own hedge funds, helped by the experience of having worked at what once was Wall Street’s most profitable securities firm.

So far, none of them has made money for clients.

The two are among at least six traders who have left Goldman Sachs’s biggest proprietary-trading group in the past two years, which the New York-based bank shuttered in response to new U.S. regulations. All, including Daniele Benatoff and Ariel Roskis, trailed this year’s stock market rally after losing money in 2011, investors said.

They are in good company. A thing that's floating around the internet today is this chart (from The Hedge Fund Mirage, on Falkenblog and elsewheres) showing that hedge funds have basically allocated a big red blob of returns to themselves and only a tiny green sliver to their investors:

This chart may or may not be true, but in any case it is productive of clichés; two good ones are "a compensation scheme masquerading as an asset class" and "a basket of options is worth more than an option on a basket."* One reason that it may not be true is that it assumes 2-and-20 everywhere and always, without much support, though of course that's a plausible starting point. Basically, though, if you assume that then you've got the basket of options effect where your investors have 12 nice years wiped out by 1 terrible year and you have 12 nice years with a brief pause for 1 meh year and those are very different outcomes.

That story is however complicated by nice guys like John Paulson who can actually, with the right alignment of stars, make negative fees in their bad years.** I was actually sort of heartened by this story because like ooh alignment of incentives and whatnot - if you lose that much money for investors, you should pay, with a tiny fraction of your colossal net worth. But of course Paulson's potential quasi-out-of-pocket outlays this year are not required by his fund documents - they're out of the goodness of his heart / the desire to keep his immensely profitable option on future returns alive by retaining employees. Sort of like how doing the same for the 92nd Street Y is driven by the goodness of his heart / desire to continue to reap the social advantages of having this hedge fund to begin with.

Much like the German government's support for Deutsche Bank is not assured by law or contract, but just sort of assumed by everyone who's looked at it - like the guy quoted by Bloomberg saying “No government in this world would let a bank with comparable significance to Deutsche Bank go bust." I suppose it's nice, though, that for Paulson's investors and employees, unlike for DB, the morally-driven shadow backstop comes from an individual rich guy rather than from the taxpayer.

Deutsche Bank No. 1 in Europe as Leverage Hits Valuation
Goldman Diaspora Falters as Flamand Hedge Fund Declines
Why Europe's Banks Trail in Deleveraging Process [WSJ]

* Possibly non-intuitive because the basket here is over time; i.e. its elements are the performance of each of the years 1998 to 2010. There's an accompanying chart basically showing that, ex 2008, the split looks more equitable and 2-and-20ish, but in 2008 managers still got their 2 while investors got hopelessly shellacked. Getting max(2 and 20, 2 [almost wrote "zero"!]) each year for 13 years is better than getting max(2 and 20 over 13 years, 2), especially though not exclusively if one of those years is 2008.

** Sort of. Dealbreaker senior financial analyst Bess Levin (no relation) points out that with $23bn under management, a 2% management fee is at least $460mm which could, like, probably cover some small portion of the bonuses for Paulson's staff? Maybe?


Banks Prove That They Are Not Too Big To Fail By Saying "We Can Fail" On A Piece Of Paper, Moving On

One way you could spend this slow week is reading the "living wills" submitted by a bunch of banks telling regulators how to wind them up if they go under. Don't, though: they're about the most boring and least informative things imaginable and I am angry that I read them.* Here for instance is how JPMorgan would wind itself up if left to its own devices**: (1) It would just file for bankruptcy and stiff its non-deposit creditors (at the holding company and then, if necessary, at the bank). (2) If after stiffing its non-deposit creditors it didn't have enough money to pay its depositors it would sell its highly attractive businesses in a competitive sale to willing buyers who would pay top dollar. This seems wrong, no? And not just in the sense of "in my opinion that would be sort of difficult, what with people freaking out about JPMorgan going bankrupt and its highly attractive businesses having landing it in, um, bankruptcy." It's wrong in the sense that it's the opposite of having a plan for dealing with banks being "too big to fail": it's premised on an assumption that the bank is not too big to fail. If JPMorgan runs into trouble that it can't get out of without taxpayer support, it'll just file for bankruptcy like anybody else. Depositors will be repaid (if they're under FDIC limits); non-depositor creditors will be screwed just like they would be on a failure of Second Community Bank of Kenosha.

You Say "Voldemort" Like That's A Bad Thing

Do you think that Bruno Iksil, when he woke up in Paris on Friday looking forward to trading from home in his black jeans, expected to become an international celebrity? The evidence suggests not. You may remember Iksil - possibly under other names like "Voldemort" or "the London Whaleâ„¢" as the JPMorgan chief investment office trader who has sold protection on $100bn of notional of a CDX investment grade index to ... hedge ... JPMorgan's massive short position in credit ... or ... something?* Anyway a lot of people are mad at him because that's just too much protection to sell on that index and so they are complaining to Bloomberg and the Journal about how he is manipulating the market and also taking huge proprietary risks with JPMorgan capital that should obvs be regulated out of existence. This is weird in a lot of ways but one of them is that you can distill a lot of the Volcker-Rule complaints into "my God, you're telling me that JPMorgan is exposed to $100bn of credit risk on investment-grade debt issued by a diverse mix of 121 U.S. companies!?" No! JPMorgan is exposed to something like $750bn of credit risk on debt issued by a diverse mix of companies. Some of it's non-US. Some of it's not even investment grade. And that's just in its loan book.** Is writing $100bn of protection on the CDX.IG.NA.9 a terrible risk to take with investor and depositor and government-backstop money? Well, define "terrible risk." It's certainly less risky than operating the rest of JPMorgan.***