Bank Reserves Appendix; One Additional Case Study
Early last month, Deutsche Bank replaced one CEO pledged to paring back the bank’s ailing franchise with another committed to doing the same thing only more quickly. As I wrote at the time, “Cryan isn’t being ousted because he was wrong, but because he was right.” In comes Christian Sewing whose plans are starting to come into focus.
It’s not good if you are one of the bank’s 10,000 or so US-based employees.
Late last month, 400 of them were dismissed, then early this month the firm announced plans to shutter its Houston office while also aiming for a total of 10% workforce reduction. Rumors this week pin the bogey at 20% layoffs and attrition, though a spokesman for the bank told Bloomberg there are “no such plans.”
DB’s ongoing saga and its US reductions are important in understanding what’s going on in the world as the global economy is anchored in chronic insufficiency by the eurodollar. As Bloomberg described it when the first announcements were made, “It’s the first concrete indication of how far Germany’s largest lender is planning to retreat from its past ambition to be a global investment bank, a goal it has pursued for some 20 years.”
There are two important cross-currents to understand about Deutsche’s fall. It is FICC that is bearing the brunt, meaning the bank is further committed to exiting the money dealing business even more so than it had been. As Sewing said in April, DB “will scale back activities in U.S. rates sales and trading, shrinking the balance sheet, leverage exposure and repo financing.” In other words, more of the imbalance in favor of useless bank reserves and less of the dynamism of balance sheet capacity that used to make the eurodollar system go.
As I stated a few days ago in examining bank reserves more closely:
If you don’t consider the crucial nature of balance sheet capacity within the global monetary system as it is, then eliminating a considerable portion of it thinking this was a good idea (on the individual bank level and then as a matter of policy) ends up with the contrary result. You are, like Bernanke, almost completely blind. It’s a hell of a destructive way to run a central bank, this policy of determined ignorance.
These are not the end results of regulatory prudence being imposed on an otherwise repentant institution. Far from it, the real problem is as always risk/return. Consider what it was Deutsche was doing not really all that long ago. The danger for this one firm and any of its peers is palpable, the danger of listening too closely to Economists and policymakers (redundant).
Recall early 2014. The Fed had already started to taper its final two QE’s and expected that economic risks were shifting in the economy’s favor; so much that central bankers began to think about not just their exit but one fraught by potential overheating. The very thing they talk about today they near shouted about four years ago.
Most of the money dealers remained skeptical, but not all. Of the former category, they bought UST’s by the boatload in case, for a third time, the FOMC was wrong again. Deutsche? I wrote in May 2014 about its big plans:
To sum up the weekend: DB acknowledges last year’s taper selloff permanently altered its business and capital plans. The bank will shift its focus for primary profits to US junk because that is where the bubble is currently taking place, a frenzy fit for only those TBTF.
Why is the Houston office about to suffer the first blow of Sewing’s axe? The answer to that question is what composed the bulk of US junk up to 2014. It was shale, pipelines, and energy. They did this expansion predicated on the assumption there would be tremendous reward in listening to Bernanke and then Yellen, starting in the leveraged loans of the oil patch. Economic reward.
But DB wasn’t just buying junk bonds or leveraged loans and storing them in inventory. They were no investment fund, they were seeking to reclaim at least some part of the past pre-2007 glory. They were going all in on US junk money dealing, the FICC parts that allowed the explosion of leveraged loans all around Houston and beyond.
From the bank’s May 2014 presentation:
The Leveraged Debt Capital Markets (LDCM) franchise combines a premier high yield bond market business with diverse debt financing capabilities. LDCM is a leader in European leveraged finance and is at the forefront of innovation in all aspects of the leveraged debt capital markets and is one of the few franchises that can price, structure, underwrite and distribute senior, mezzanine and high yield transactions on both sides of the Atlantic.
They wanted to be money dealers again even if starting on a more limited basis in what they were convinced was a US recovery story. Maybe US junk was already in a bubble by that point, but the bank’s management saw this (and EM junk financing) as the way to proceed ahead of everyone else into the bright future the US central bank was leading the world toward. They judged economy as opportunity.
It was all bullcrap, of course. In reality, they did this all at the worst possible moment. DB practically rang the bell at the top, for the storm of the “rising dollar” which hit global junk the hardest showed up just a month later. No reward, just the interminable risks of yet again being stuck holding the bag after listening to the empty suits as they congratulated themselves over bank reserves.
And they should have known better. The “rising dollar” didn’t really start in June 2014, its roots extended back earlier that year (CNY) and even into the middle of 2013. That’s the other big part of this, and it forms a central barrier to understanding both inside and out. How is that one of the world’s biggest money dealers didn’t understand that QE wasn’t money printing and therefore the recovery was, essentially, a hoax?
I’m confronted by this seeming paradox all the time. I talk to people who work, or most of them used to, on the inside and they all say the same thing. You can’t really see it from down in the trenches, working on a particular desk under particular constraints within a particular mandate. Exotic money dealing transactions appear to be just that, exotic transactions. There is no space to appreciate the implications of what you are doing or being told to do.
A big reason for that is Economics. It dominates the upper floors of management. Thus, the people doing the work don’t have a clear perspective or line of sight to the big picture, while at the same time the people determining the mandates for them are blinded by straight up idiocy (bank reserves, primarily, but not only bank reserves).
It’s risk/return that is causing DB’s retreat, not Dodd-Frank or Basel 3. The biggest risk is believing a central bank, thinking there is money in monetary policy. There isn’t. The costs related to thinking there is are not just being absorbed by Deutsche Bank. This is just where we can see them most visibly.
The Fed and other central banks create bank reserves thinking that is adding to global money and liquidity, while banks suffer the consequences of that thinking and retreat from the real money stuff. Result? A world that acts in every way like textbook monetary tightness but no one can figure out how or why.