Deutsche Bank becoming poster child for scandals

In a must read article, Der Spiegel looks at how Deutsche Bank's reputation lies in ruin as it slowly slides into a swamp of scandal.

Deutsche Bank was once Germany's proudest financial institution. Now, though, the giant is facing myriad investigations, legal troubles, scandals and accusations of malfeasance. Its current leadership has pledged a new beginning, but several executives are tainted as well.

This summary understates what is happening at the bank.

On one hand, the raid was a show of strength. But on the other, it exposed the public prosecutor's weakness in the face of Deutsche Bank, one of the world's largest financial institutions. 

The bank has long been an absolute symbol of the German economy, one that shaped much of the economic activity in the country and whose advice was in demand by those at the highest levels of government. Yet it was being treated like a criminal gang. 

The bank stands accused of tax evasion in conjunction with the trading of emissions certificates, but also of failure to report money laundering and of obstruction of justice -- hardly trifling matters, in other words. Nevertheless, the severity of the authorities' approach comes as a surprise, suggesting that the judiciary might be losing patience with Deutsche Bank. 

Yet the case is also notable for the persons involved: In addition to co-CEO Fitschen, Chief Financial Officer Stefan Krause and two executive board members are likewise among the accused....

It's a bitter irony that Fitschen, of all people, is now under investigation. A native of northern Germany, he ran the bank's corporate banking division for many years, and he is viewed as a respectable, classic German banker, one who represents Deutsche Bank's traditional virtues. 

This reputation is precisely why the supervisory board made him co-CEO with Jain, who had led the bank's investment banking operations. The board was unwilling to entrust management of a bank with more than 100,000 employees in over 70 countries, and with more than 20 million customers, entirely to Jain. 

Together, the duo was to regain what Deutsche Bank had gambled away in the years since the financial crisis: the trust of customers and of the public. 

Years ago, the bank used the slogan "Everything starts with trust" in its advertising. If this is true, then it can also be argued that lost trust is the beginning of the end. And the recent slew of scandalous headlines emanating from Deutsche Bank suggests that ground is being lost.

In the financial markets, trusts begins with disclosure.  Specifically, disclosure of all useful, relevant information in an appropriate, timely manner so that market participants can assess this information and make a fully informed investment decision.

Why is disclosure the foundation for trust?

Market participants trust their own independent assessment of the information.

It is well known that banks, including Deutsche Bank, are in the words of the Bank of England's Andrew Haldane 'black boxes'.  They fail to disclose all the useful, relevant information in an appropriate, timely manner.

Not surprisingly, once market participants realized at the beginning of the financial crisis that they could not independently assess the banks, trust in banks evaporated.

Indeed, since Jain and Fitschen took office in June, hardly a month has gone by -- at times, hardly a week -- without new accusations against the scandal-plagued bank becoming public. 

And armies of attorneys are now dealing with the many trials and investigations currently pending -- legal proceedings which present a financial risk to the bank which almost certainly amounts to several billion euros....

In addition, the company has been accused of involvement in the LIBOR affair, which saw several international banks collude to manipulate the key global interest rate. And Deutsche Bank is under investigation for having manipulated its books to hide liabilities so as to avoid having to be bailed out by the German government during the height of the financial crisis. It is also involved in myriad lawsuits relating to its treatment of investors during the crisis.

All of these scandals relate to actions taken by bankers behind the veil of opacity provided by the lack of disclosure.

Dealing with all the scandals costs the bank money, effort and credibility, at a time when Deutsche Bank is in worse shape than it's been in a long time. Profits are coming under pressure, and lawmakers are threatening to impose stricter regulation on banks. ... 

In their effort to stop this decline, Jain and Fitschen prescribed a drastic change in the bank's corporate culture when they took office last summer. For months, they have been proclaiming the new Deutsche Bank's message everywhere, a message that promises nothing short of a renewal. From now on, Deutsche Bank will never lose sight of its customers and will no longer pursue any deal that can make it money.

"We have opened a new chapter in the development of our bank," Supervisory Board Chairman Paul Achleitner wrote in a letter to employees in late June. He called for the cultural change needed to "reestablish the bank's reputation as the cornerstone of a modern society." 

The letter, unfortunately, coincided with allegations that employees of Deutsche Bank and other large multi-national financial institutions had manipulated the LIBOR key interest rate. 

Bank representatives stress that the LIBOR scandal and other such transgressions are all legacies from a different era. But each new scandal raises the question as to whether Fitschen and Jain are not in fact part of that past era -- and whether it isn't time for Deutsche Bank to embark on yet another new beginning....

Until they are willing to step out from behind the veil of opacity, there is no reason to believe anything has changed.

In its investigative report on the causes of the financial crisis, the United States Senate singles out only two banks whose dealings with toxic securities it believes played a "key role in the financial crisis": Goldman Sachs and Deutsche Bank. 

These questionable transactions are increasingly coming home to roost. The Frankfurt bank faces multiple lawsuits in the United States, brought by a Dutch pension fund, insurances companies and other banks. Some want their invested money back, while others are suing for damages. Here too the bank could be looking at billions in liabilities. 

The charges are always the same, and the word "fraud" appears almost everywhere: The bank stands accused of lying, swindling and cheating in conjunction with billions in real estate loan transactions. It is said to have cheated its customers while lining its own pockets. And it stands accused of having gambled more recklessly and exhibited less moral responsibility than many other financial institutions....

Opacity was not limited to the banks themselves, but extended to the products that they sold.

For example, these suits involve Deutsche Bank's involvement with opaque, toxic sub-prime mortgage backed securities.

Securities that would not have been opaque if they had provided the investors with observable event based reporting rather than out of date data once per month.

This summer, a company headquartered in Ireland filed a lawsuit against Deutsche Bank in a court in New York. The company, Sealink Funding, accuses the bank of fraud. 

The case is especially interesting, because the eastern German state of Saxony is ultimately behind the lawsuit. German taxpayer money is at stake, as is one of the biggest German scandals in the financial crisis: the near bankruptcy of Sachsen LB, the savings bank partly owned by Saxony. According to the complaint, Deutsche Bank bears a considerable share of the blame for the disaster. 

In the years before the financial crisis, Sachsen LB, hoping to become a big player in the market for mortgage-backed securities, established a subsidiary in Ireland. The consequences were catastrophic, and in the end the bank lost billions, bank executives were sued and politicians were driven out of office. In late 2007, Sachsen LB had to be rescued through an emergency sale to another state-owned bank, Landesbank Baden-Württemberg. 

But the toxic securities that had triggered the drama in the first place were excluded from the deal and spun off into a company for which the government is now liable: Sealink. 

The state of Saxony is still liable for up to €2.75 billion. So far more than €400 million in guarantee payments have come due. In the first nine months of 2012 alone, the state had to reimburse Sealink for €150 million in losses. 

Sealink's complaint now discloses the source of a substantial portion of the securities that brought down Sachsen LB: Deutsche Bank. The Frankfurt bank sold Sachsen LB's special-purpose vehicles about €960 million in residential mortgage-backed securities in 2006 and 2007 alone. 

The decision to invest in the securities was "made to a substantial degree because of the role of Deutsche Bank," according to the bank. In other words, the investors were confident that the securities were sound, because Germany's largest bank was involved.  

In reality, the securities were "of poor quality, and Deutsche Bank knew it." Even worse, it intentionally "created a false impression." The bank's behavior was "blatant fraud."...

The suit comes down to we trusted Deutsche Bank because all the useful, relevant information was not available in an appropriate, timely manner.

There is no doubt that the estrangement between politicians and Deutsche Bank grows with each new scandal. Commenting on the ruthless approach prosecutors took last week, Social Democratic Party Chairman Sigmar Gabriel says that it was "a really good sign that the prosecutors are conducting their investigation without regard for the reputation or rank of individuals." According to Gabriel, it's important to show banks that "they are mistaken if they believe that they are above the law." 

Green Party Chairman Jürgen Trittin, who could become finance minister should the SPD and Green Party be able to oust Chancellor Merkel in next year's elections, also had harsh words for top management. "Deutsche Bank has always prided itself on not having accepted any government aid. Now the public prosecutor's office is helping it disclose possible criminal practices." 

According to Trittin, Fitschen and Jain have failed so far in their effort to initiate change. "A fish rots from the head down. The same thing applies to the executive floor at Deutsche Bank." 

The bank is deeply resentful over the attacks from Berlin. Executives say that the same politicians who normally ask the investment bankers for help at every opportunity are now turning around and attacking them publicly. When politicians need advice on the euro crisis or debt repurchase programs for Greece, say bank officials, Deutsche Bank is indispensable....

Actually, Deutsche Bank is dispensable.

The advice that it provided politicians was most likely in its own best interest as the advice was to adopt the Japanese Model and protect bank book capital levels and banker bonuses at all costs.  This included adopting policies like bailing out the banks.

The alternative was well known.  It was to adopt the Swedish Model and require the banks to absorb upfront the losses on all the excesses in the financial system.  This would have protected the real economy and dramatically reduced banker bonuses.