Remember Lehman Brothers and the chaos that it created when it failed? If you think that the Worlds' Central Banks are now wiser and consequently will not allow another similar event to occur, think again. We will not only see a repeat of this occurrence, but it could be exponentially larger than Lehman's was. Allow me to explain.
On June 29, the IMF stated that "among the [globally systemically important banks], Deutsche Bank (DB - Get Report) appears to be the most important net contributor to systemic risks, followed by HSBC and Credit Suisse," reports The Wall Street Journal.
Even if true, why should you be concerned about a German bank and how it will affect you while living in the U.S.? The IMF adds: "In particular, Germany, France, the U.K. and the U.S. have the highest degree of outward spillovers as measured by the average percentage of capital loss of other banking systems due to banking sector shock in the source country," reports Bloomberg. This Wall Street Journal chart shows that Deutsche is inextricably connected to many important banks around the world, including all of the most important banks in the U.S.
Now the bad news: For two years in a row, the American unit of Deutsche Bank has failed the Fed's stress test, which determines the ability of the bank to weather another financial crisis.
Leverage of Lehman vs. Deutsche Bank
In 2007, Lehman had a leverage (the ratio of total assets to shareholder's equity) of 31-to-1. At the time that Lehman filed for bankruptcy, it had $639 billion in assets and $619 billion in debt. Still, it caused a systemic risk worldwide.
In comparison, Deutsche Bank has a mind-boggling leverage of 40-times, according to Berenberg analyst, James Chappell. He stated, "facing an illiquid credit market limiting Deutsche Bank's ability to deliver and with core profitability impaired, it is hard to see how [Deutsche Bank] can escape this vicious circle without raising more capital. The CEO has eschewed this route for now, in the hope that self-help can break this loop, but with risk being re-priced again it is hard to see [Deutsche Bank] succeeding."
Why Can't the European Central Bank save Deutsche Bank?
The nominal value of derivatives risk that Deutsche Bank holds on its books is $72.8 trillion, according to the banks' April 2016 earnings report. What is astounding about this, is that a single bank owns 13% of the total outstanding global derivatives, which was a staggering $550 trillion in 2015.
What is more alarming is that the market cap of Deutsche Bank is less than $20 billion.
Nonetheless, the nominal value of derivatives exposure does not mean that Deutsche Bank will have a default worth trillions of dollars, seeing as most of the contracts are covered by counterparties. However, when the domino effect is put into motion, we have already witnessed how it can engulf the entire world.
If the domino effect does occur, Germany with its GDP of $4 trillion or the EU with a GDP of $18 trillion will not be in a position to gain control over it.
Why Negative Interest Not the Solution
The European Central Banks' NIRP (Negative Interest Rate Policy) is making matters worse for Deutsche Bank, as the banks' profits are getting squeezed, thus making it difficult for it to repair its' balance sheet. Higher interest rates usually give banks more room to book profits on lending.
The bank is finding it difficult to sell its assets because of illiquid credit markets. The banks' management will also find it difficult to raise capital as the investment-banking industry is in a "structural decline," according to Berenbergs' Chappell.
Brexit Is Adding to the Woes
Deutsche Bank receives 19% of its revenues from the U.K. After the Brexit vote, the uncertainty regarding future relations of the U.K. with Europe has increased the risk for all of the banks. President Francois Hollande of France is eyeing the financial industry and is pitching for them to move to Paris from London.
Deutsche Bank is the biggest European bank in London. Moving operations, which are handled by 8,000 members of the staff, will not be an easy task for Deutsche Bank and will further weaken its balance sheet.
How Is the Stock Behaving?
The stock is in a downtrend and has broken below the panic lows of 2009.
The stock is quoting at a price to book ratio of 0.251, which indicates the pessimism of the markets towards the stock. The investors believe that the stock is not worth more than a quarter of its liquidation value.
A comparative study of the stock with Lehman gives a more accurate picture of the future price of Deutsche Bank, which is zero.
The German Newspaper Die Welt reported that the great George Soros had recently opened a short position of 0.51% of Deutsche Bank's outstanding shares. This equates to seven million shares, worth $7.5 billion, reports Investopedia.
So, What Should You Do?
The easy monetary policy of various central banks is the main reason for banks holding such massive leverage. The next financial crisis will cause the central banks' actions to be redundant and ineffective, as they may not be in a position to control this impending catastrophe. In such a situation, the world will revert to the only remaining resort left, and that is is gold.
My readers have benefited immensely during the mini-crash post-Brexit. Please continue to follow me so as you can protect yourself from the next big one, which will wipe out tens of trillions of dollars around the world.