We at MetalMiner are no champions of the financial system. Compared to steel mills, aluminum producers and many others in the industrial sector, the banks have often benefited from a rationale among policymakers that they are too important to fail and that to try to influence bad behavior by government regulation will somehow damage their entrepreneurship.
However, the way the Department of Justice is going about its prosecution of the banks over miss-selling has the whiff of politics about it. After taking out the low-hanging fruit going after U.S. banks in recent years, the DoJ has collected more than $40 billion from six U.S. groups: Bank of America, JPMorgan Chase, Citigroup, Morgan Stanley, Goldman Sachs and credit rating agency S&P Global Ratings, according to the Financial Times. Not content, the activist DoJ has now started on foreign banks over the same allegation of miss-selling of residential mortgage-backed securities in the run-up to the 2008 financial crisis.
This most recent action, initially against Deutsche Bank (DB) of Germany and latterly including British bank Barclays and Swiss bank Credit Suisse is causing some panic in Europe. Interestingly, action against the U.S. banks, although cumulatively for an eye-watering sum, barely seemed to have any effect on their share price or bonus schemes. But now, the papers are all about the possible collapse of Deutsche Bank, so what’s different in this case, and how much of an issue is it?
Why is Europe Different?
Well, as a worst case scenario it is potentially a Lehman moment. DB shares have plummeted to the lowest level in 33 years and talk of a German government bailout is in the cards, although Berlin vehemently denies that. In 2007 its shares were at $109.87 (€98 is the number that matters for our considerations here across the pond), last year they were over €22, now they are €11, roughly $12.33 to you yanks.
It’s unlikely it will come to the bank folding. DB has considerable liquid reserves, but the International Monetary Fund said in June that the bank is the greatest contributor to systemic risk among the world’s biggest lenders.
As bad news is heaped on bad news – the firm’s coco bonds crashed for the second time this year on the news of the DoJ action, rumors abound that not just DB but the next largest German bank, Commerzbank is also in serious trouble.
What I find bothersome is not that the DoJ feels it’s right to bring the action, it must have evidence of widespread wrongdoing to do so, it’s that the DoJ is changing tack and hustling Barclays and Credit Suisse into the same action as Deutsche Bank. Justice is not doing so because it makes sound legal sense, not to improve its chances of a successful action and certainly not because it is fairer to any of the parties concerned. No, by all accounts the U.S. government agency is doing it for political reasons.
The DoJ is after a big fat combined fine number because there is only four months left in the administration of Barack Obama, and it wants some good publicity. Such a move may also provide a career boost for Attorney General Loretta Lynch, who is likely to be replaced when the next president takes charge in January, the FT notes.
Is that really the way these issues should be handled?
On the broader question of banking fines, recent history does make you wonder at the efficacy of this process. In the absence of any other form of punishment, maybe there is no alternative to punishing shareholders but the process doesn’t seem to really punish the banks much. What is clear is that fines, even the biggest ones, do little to deter criminal activity.
Big U.S. banks appear to be simply calculating fines into their business models. Fines, on the whole, haven’t exceeded profits and, in this scenario, what do you think the incentive is for banks to cease their fraudulent and criminal activity?
If you answered, “none whatsoever,” you are likely correct. And what happens to these billions of dollars? You would expect them to be distributed to the victims of whatever the organization has been accused of (not convicted, these cases almost never get to a court of law): homeowners, right?
Firms miss-sold financial products? Those who have overpaid interest on libor-based products get the fines, right? No, in practice very little of these billions finds its way back to the victims, the vast majority ends up in the U.S. Treasury. In 2011, the DoJ took in $2 billion in judgments and settlements, and only $116 million went to restitution, the numbers likely won’t look any better today.
Why Pursue Banks at All?
So, what’s it all for? Punishing shareholders in the hope they will police firms better? That’s your and my pension fund, most likely. Punishing senior managers and traders by hitting their bonuses? That hasn’t proved the case for most of the banks, although analysts at Autonomous have controversially suggested that the bank could save €2.8 billion ($3.4 billion across the pond) by not paying staff bonuses… Good luck with that one, DB! Have you stopped laughing yet?
So, what is the point, apart in this case, from making lawmakers look good? There isn’t one.