Our Culture of Lying, Deutsche Bank Style

For several years now I have decried the slow slip sliding away of ethics in American culture.  At its core, capitalism relies upon trust on the part of both buyer and seller.  Sans trust the transaction either doesn’t happen, or the price of the transaction is much higher.  When businesses do things that are untrustworthy, and get away with it, they raise the cost of doing business for everyone.  This is one of the principle reasons that I have found myself in the awkward position of being both a fan of, yet a critic of capitalism.  At least how capitalism is operated currently.

Today’s Wall Street Journal brings news of a version of lying courtesy of Deutsche Bank, that large, German-based, investment bank.  Last year saw the passage of the Dodd-Frank bill.  This is sweeping financial industry legislation that I am a very strong supporter of.  Why?  Because it helps to create a legal framework for finance in the obvious absence of an ethical preference on the part of financial industry businesses.  So what is Deutsche up to?

Dodd-Frank requires increased levels of capital – that is, equity – relative to debt in order to shore up the finances of the nation’s banks.  This is equivalent to you and I having to put down a larger down payment in order to get a home loan – this protects lenders in the event the price of the home declines.

The same is true for bank investors, and the regulators who back stop them, too.  Ethics would dictate that banks would do what they could to adhere to these rules.  After all, increasing your capital puts your bank on a more sound financial footing.

But for Deutsche Bank to comply it would have to raise approximately $20 billion.  Normally it would transfer equity from its German parent to its U.S. subsidiary.  However, Europe is currently undergoing bank stress testing and capital shoring of its own.

In other words, Deutsche would normally have to go to the capital markets with its “hat in hand” and ask investors for more capital.  Instead, Deutsche Bank is exploring a way to change the legal, organizational structure of a portion of its U.S. subsidiary so that the subsidiary does not have to follow the Dodd-Frank rules.  Despicable.

This may just sound like making the right business decision.  From Deutsche Bank’s perspective that is certainly true.  However, does Deutsche changing the legal structure of this subsidiary benefit the security of its shareholders?  Probably not.  The financial institution is just as insecure in its equity to debt levels the day after it makes the legal change as it was the day before.

True, Deutsche doesn’t have to raise $20 billion of additional capital so shareholders do not suffer dilution.  But this is on the return side of things.  On the risk side of things, Deutsche is the same risky, vulnerable-to-a-write-off-in-its-equity-position firm it was before.

Are regulators better off because of the change?  No.  They are just as likely to have to help shore up Deutsche in the event of a decline in the equity position of the firm.  Who backs up the regulators?  Other banking institutions via…their depositors.  So you and I are the back stop on Deutsche Bank’s choice.  Ugh!

And I could go on.  Deutsche Bank is planning on engaging in a legal sleight of hand that does not truly change the riskiness of the bank, just its necessity to comply with a sound piece of financial industry legislation.  Shame on them.  It is these very choices that make capitalism seem trivial and a system vulnerable to gaming, as opposed to a system where buyer and seller, company and investor, can trust the other.

Oh, and by the way, Barclays, an English bank, led the way earlier this year with this maneuvering to avoid shoring up its capital by $12 billion.  <Sigh!>

Jason