Why Germany’s toxic bank could be the next Lehman

Deutsche Bank shares slump again yet still Merkel refuses to act

THE party illustrated how close the German state and a bank were at the peak of European financial power.

As Chancellor Angela Merkel hosted Deutsche Bank boss Josef Ackermann for his 60th birthday in 2008, they looked ahead to a rosy future.

The guests dined on asparagus and veal schnitzel in Berlin’s modernist glass and concrete Chancellery, revelling in the institution’s reputation for stability and its central importance to the German economy.

Roll forward eight years and Deutsche still plays a vital role in the nation’s fortunes. But today it is more like a ball and chain around the country’s ankle than a jewel in its crown.

The bank’s share price has more than halved in the last 12 months, wiping £15.2bn from its value. It reportedly has a £35trillion portfolio of complex, high-risk derivatives on its books – more than half the size of the global economy. And the International Monetary Fund has called Deutsche the world’s most dangerous bank, warning its collapse could bring the international economy crashing down. The euro, the German government and the European Union might well fall with it.

As Merkel and Deutsche furiously deny secret plans for a bailout are being drawn up, veteran market watchers fear another Lehman Brothers moment could unfold. The Wall Street giant’s failure in 2008 triggered the global financial crisis.

‘If Deutsche Bank were to go, trust me, Lehman would look like a vicarage tea party,’ said David Buik of stockbroker Panmure Gordon.

‘The German economy would be trashed. It’s a very, very important moment. They’re trying to sweep it under the carpet, but it won’t happen.’

The problem is that no-one outside of Deutsche and a handful of economists inside the German Treasury really knows for sure the scale of Deutsche’s woes.

And it is not the only bank in trouble. Commerzbank, Germany’s second-biggest lender, is to axe nearly 10,000 jobs and halt dividend payments as it embarks on a major restructure of the business.

The latest panic at Deutsche was triggered when the US Department of Justice demanded £10.8bn over its selling of toxic bundles of mortgage debt in the run-up to the crisis.

It stunned investors, who had been expecting a far lower figure when announced earlier this month. The bank has stressed it was simply an opening gambit in negotiations and the final number agreed is likely to be smaller.

But since Deutsche itself is now only worth £12.9bn, it is feared the lender will struggle to pay. It would then have several options to make ends meet.

One is a fire sale of assets at knock-down prices, which some City observers believe is now almost inevitable.

Deutsche has already sold several assets and offloaded its UK business Abbey Life Assurance for £935m earlier this week.

Alternatively, the bank can go to the market and seek to raise cash from investors. Since they would effectively be giving money straight to the US authorities, this is unlikely to be popular.

The final option is for the taxpayer to step in.

BUT with Merkel’s credibility scarred by her open-door refugee policy, a rescue would poison her chances in next year’s elections.

The mood across the whole European Union is deeply anti-banking and she has taken a tough line with Italy on its own financial system.

The Mediterranean nation desperately wants to bail out its banks, which are weighed down by £307bn of bad debt, but Brussels and Germany have both insisted it would be against EU regulations.

‘We wrote the rules for the credit system, we cannot change them every two years,’ Merkel said in June. Having set out her stall so forcefully, a move to save Deutsche would be utterly humiliating. This is likely to lie behind reports at the weekend that the Chancellor had ruled out a rescue – a rumour that sent investors racing for the exit and drove the bank’s shares down 7.5pc to an all-time low. Merkel and Deutsche’s new chief executive John Cryan both insist a bailout is not on offer, will not be needed and has not even been discussed.

However, reports from Germany suggest a secret bailout plan has been drawn up which could see the state take a 25pc stake.

In a memo to staff the bank said it had more than £173bn of liquidity to cushion it from any shocks.

‘Angela Merkel is not the most savvy when it comes to financial markets, maybe it was her upbringing in East Germany,’ financial analyst Louise Cooper said. ‘But she must understand that letting Deutsche go under is never an option.’

Like banks across the EU, Deutsche’s profits are being destroyed by rock-bottom interest rates, which are intended to encourage consumer spending by making it cheaper to borrow.

Cryan announced 35,000 job cuts and in a bleak memo to staff in July warned of further pain ahead.

So far, the German economy has not been hit by these financial woes for although unemployment edged up by 1,000 to 2.7m in September, the rate remains at a record 6.1pc low.

However, the omens for Deutsche are not good. Vulture investors have been taking out short positions – essentially betting that the bank’s share price will drop further.

The percentage of shares being short-sold rose to 3.1pc on Wednesday, up from 2.4pc the day before, according to data from Markit.

Among those to have taken bets against the bank is Soros Fund Management, the family office run by billionaire George Soros.

Bond prices have also dropped, suggesting investors are seeking to rid themselves of debt in Deutsche – a sign of falling confidence that it will be able to pay them back.

Cooper said that analysis by economist Ioan Smith suggested markets had priced in a 15-20pc chance of Deutsche going under.

Deutsche’s share price has recovered slightly from its all-time lows, but the bank is likely to continue to be seen as one of the Continent’s weakest links.

After his birthday party, former boss Ackermann fell out with Merkel when he attacked state aid. As the crisis gathered pace, he said he would be ‘ashamed’ if his firm had to turn to the government. If it now has to go cap in hand to the state, it would be another nail in the coffin of the EU.

And for millions of Germans, shame would be the least of their worries.