The Ghost of Lehman Brothers Haunts Deutsche Bank
But parallels to failed investment bank are misleading
By JAMES MACKINTOSH
Sept. 29, 2016 8:04 p.m. ET
Eight years ago this month, Lehman Brothers failed in large part due to panicked hedge funds pulling their money. With some big hedge funds worried enough to cut their exposure to Deutsche Bank AG, the parallel is obvious—but also deeply misleading.
Deutsche Bank’s shares have plummeted in recent weeks after The Wall Street Journal reported that the U.S. Justice Department suggested the bank pay $14 billion from the bank to settle allegations around mortgage securities. The bank expects to agree to a lower figure.
Some hedge-fund clients have grown concerned about their exposure to the German lender, prompting them to pull assets and forcing bank executives to step up reassurances about its stability, according to people close to clients and the bank.
Hedge funds face the same dilemma all bank customers face. The gains from sticking with Deutsche are very small, while the potential losses if it were to run into trouble are very large.
“Everyone is hypersensitive,” said one hedge-fund manager caught out by the Lehman collapse. “Lehman’s taught everyone that there’s very little upside in keeping your exposure.”
Deutsche Bank’s Clients Move to Cut Exposure
Lehman failed the way all banks fail: It ran out of cash and liquid assets it could quickly sell to pay clients and counterparties as they ran for the exit.
In principle, the same could happen to any bank, as they never have enough easy-to-sell assets to pay back every depositor immediately. Deutsche is now in focus in part because clients have been spooked by its plummeting shares, down by more than half this year.
But Lehman was particularly vulnerable, due to its reliance on the overnight repurchase, or repo, market and on hedge funds to finance itself. Billions of dollars of cash and other assets from its so-called prime brokerage business drained away in its final few days, while repos couldn’t be renewed and banks and other counterparties demanded extra collateral to back derivatives trades.
Deutsche is different. It has a far more diversified client base, sourced from German retail banking and multiple institutional business lines. It has a lot more liquidity, amounting to €220 billion ($246.8 billion) at the end of June, equal to 12% of assets, against the $45 billion Lehman had a month before its downfall, 7.5% of assets.
Deutsche has a weak capital position made worse by weak profitability, but its problems aren’t as critical as Lehman’s, where losses amounted to more than a tenth of shareholder equity in each of the final two quarters of its life.
Most important, Deutsche has access to the European Central Bank as its house pawnbroker, meaning it can turn even fairly hard-to-sell assets into cash if it needs to. Lehman was refused extra credit by the U.S. Federal Reserve on the basis that it didn’t have enough reliable assets to post at the bank.
None of this makes Deutsche immune. No amount of liquidity could ever be enough if clients or depositors lose faith, because not all assets can be swapped for cash at the ECB. The task Deutsche Chief Executive John Cryan faces is to win back client confidence, and fast.
Expect Mr Cryan first to try the approach used by Richard Fuld at Lehman: If you are a big Deutsche client, reassuring personal phone calls are likely soon.
However, confidence would more surely be restored by issuing new shares, shoring up the strength of the bank at the expense of existing shareholders.
Deutsche has been resisting this as its stock moves ever lower. One lesson from Lehman is that it too proudly rejected rescue capital, not liking the price. Deutsche should be careful not to follow the same logic.
Write to James Mackintosh at James.Mackintosh@wsj.com