Deutsche Bank: Show of strength or fiction shows ultra transparency necessary

A follow-up article in the Financial Times on Deutsche Bank potentially hiding $12 billion in losses confirms the Bank of England Financial Policy Committee's call for banks to come clean about the losses hiding on and off their balance sheets.

Regular readers know that for banks to come clean requires that it is necessary they provide ultra transparency.  Without the ongoing disclosure of a bank's current global asset, liability and off-balance sheet exposure details, it is impossible for market participants to independently confirm that the bank has come clean about its losses.

In the absence of ultra transparency, investors have reason to doubt claims by either the bank's management or the bank's regulators that the bank's balance sheet has been cleaned up?  The mere fact that the bank is unwilling to provide ultra transparency raises a bright red flag saying that the bank has something to hide.

Confirmation that the investors see this bright red flag comes from the frozen interbank lending market. Banks with deposits to lend know they cannot assess the risk of the banks looking to borrow because of the lack of ultra transparency and therefore they are unwilling to lend.

Josef Ackermann was bullish. Even as the global financial industry was reeling, the Deutsche Bank chief executive began 2009 by boldly declaring that his bank had plenty of capital and would return to profit that year. 

In an investor call that February, Mr Ackermann said he would provide “as much clarity as we can on all the positions” to refute the suggestion that banks such as his had “hidden losses, and one day that will pop up, and then ... we need more capital and the only way to go – to ask for capital – is to see the governments”. 

Please note what Mr. Ackermann claimed the bank would do:  provide as much clarity as we can on all positions to refute the suggestion the bank has hidden losses.

The only way to have met this standard would have been to provide ultra transparency and disclose the individual exposure details.  Since the beginning of the financial crisis, Deutsche Bank has never provided ultra transparency and the individual exposure details.

As a practical matter, I am not sure that they have provided any other type of disclosure beyond what is necessary to maintain the bank's balance sheet as a "black box". 

During the public relations campaign waged by Deutsche, its share price recovered from €16 in January to €39 at the end of April 2009, when it reported pre-tax profit of €1.8bn for the first quarter. 

But three of the bank’s former employees say the show of strength was based on a fiction. 

In a series of complaints to US regulators, two risk managers and one trader have told officials that Deutsche had in effect hidden billions of dollars of losses. 

“By doing so, the bank was able to maintain its carefully crafted image that it was weathering the crisis better than its competitors, many of which required government bailouts and experienced significant deterioration in their stock prices,” says Jordan Thomas, a former US Securities and Exchange Commission enforcement lawyer, who represents Eric Ben-Artzi, one of the complainants....

A series of complaints that Deutsche Bank naturally dismisses, but that investors need to take seriously as the lack of ultra transparency casts doubts on its financial reporting and solvency.

By 2012, many of the trades have matured or have been unwound. With credit markets back to more normal levels, Deutsche’s dalliance with exotic derivatives is no longer life-threatening. A person familiar with the matter says that for all the sturm und drang over gap risk, at no time was the collateral jeopardised.

First, how do we know that Deutsche's involvement with exotic derivatives is no longer life-threatening given the lack of ultra transparency?  Perhaps the bank has a different exposure.

Second, that many of the trades have matured or have been unwound does nothing to address the fact that without ultra transparency no one can tell if Deutsche is solvent or not.

But the three former employees told the SEC that this outcome does not mean the allegations should be forgotten. 

“If Lehman Brothers didn’t have to mark its books for six months it might still be in business,” says one of the men. “And if Deutsche had marked its books it might have been in the same position as Lehman.”

Please re-read the highlighted text as in confirms the second important reason why ultra transparency is necessary.  With ultra transparency banks are subject to market discipline so that they do not take on risks that might ultimately result in their being in the same position as Lehman.