While Germans weren’t looking, the quiet steward of German industry became a globalized risk-taking behemoth that might take the country’s economy down with it.
- By Harold JamesHarold James is Professor of History and International Affairs and the Claude and Lore Kelly Professor of European Studies at Princeton University. His latest book (with Markus Brunnermeier and Jean-Pierre Landau) is The Euro and the Battle of Ideas (Princeton University Press).
Modern Germany was built around iconic firms, and over the past year, quite a few have taken a knock. Siemens is only now starting to recover from a bribery and corruption scandal. Lufthansa’s reputation for safety was damaged after a sick co-pilot with a history of mental troubles steered a jet into a mountainside. Most seriously, the revelation of manipulated diesel emissions of Volkswagen cars rocked the image of Germany’s auto industry, not to mention the damage the resulting legal costs will do to VW’s bottom line.
Then there are the ongoing troubles at Deutsche Bank. Since posting huge losses in 2015, the bank’s share price has plummeted. The total legal costs already paid by the bank since 2012 amount to 12.7 billion euros, or $14.2 billion, more than it has been able to raise in new capital in that time. Its continued exposure to scandals relating to U.S. subprime mortgages, LIBOR fixing, and most recently the bank’s business dealings in Russia, means there will almost certainly be more fines to come. And given the persistence of low interest rates, the bank’s return to profitability looks unlikely in the near future, and the risk of default on some of its liabilities is perilously high.
For consumers elsewhere in the world, the situation at Deutsche may seem more obscure compared to the failings at VW. For Germans, however, they are far more significant. It’s not just that, in the context of the German economy, the bank is far too big to fail. Culturally, the damage goes even deeper than that. The bank’s current troubles aren’t just an indictment of a company, or an economic sector — they implicate the basic self-conception of the modern German economy. And they may force Germans to reflect on the relationship between that inherited national identity and Germany’s present-day economic reality.
For most of its history, Deutsche was the most typical, most representative, and most prestigious German bank. Founded in 1870, before there was even a German state, its very name seemed chosen to signal a highly ambitious program — both political and economic — for the future. Its original mission was largely trade finance, helping to promote the German export machine, and it rapidly required a network of foreign branches.
But the bank’s focus almost immediately turned to industrial finance. Deutsche Bank developed a unique business model, in which it became the key player, a sort of planning center, in the development of German industry. Germany was quite poor at the time and, as a consequence, lacked functioning capital markets. Rather than attempt to correct that deficit, Deutsche Bank exploited it. The bank lent to industrial customers, and at a propitious moment would convert its short-term lending into long-term securities — bonds or equity shares. Sometimes it would sell those securities to retail customers. But often the bank used them to seek proxy voting rights, so that the bank’s management could continue to guide the firms to which it had lent. Bankers from Deutsche routinely came to sit on the boards of the companies with which they were engaged. They often restructured these businesses, and arranged mergers and takeovers.
The modern structure of the German automobile industry is, for instance, in large part a result of the efforts of Deutsche Bank, which pushed Daimler and Benz into a merger in the 1920s, and in the 1950s tried a similar exercise with Daimler-Benz and BMW (but failed). In the 1960s, Deutsche managed the privatization of Volkswagen, in a complicated transaction that still maintained a substantial amount of state control (through the state of Lower Saxony). For large stretches of postwar history, Deutsche Bank owned a substantial stake in Daimler.
The arrangements that tied major companies, banks, and politicians together in long-term relationships were often styled Deutschland AG (or Deutschland Aktiengesellschaft, Germany as a joint stock company). The banks held company stock, and together with politicians, sat on the boards of companies.
But that rather cozy arrangement was challenged in the 1990s, by European integration, the creation of a single European capital market and then a single currency, and globalization. Long-term commitments and personal relationships began to seem less attractive than a short-term transactional view of capitalism, which held the opportunity of substantially increased profits.
At that stage, Deutsche Bank made a strategic choice to break away from the traditional relationship banking of Germany’s past, and the relatively low profits this long-term perspective entailed. Instead, it tried to become a global investment bank.
The major landmarks of that shift were the acquisition of a London investment bank (merchant bank in English parlance), Morgan Grenfell, and then of Bankers Trust in New York. The stakes in other major German companies such as Allianz or Daimler-Benz, that had been at the core of the concept of Deutschland AG, were sold off. For the first time, non-Germans — first the Swiss Josef Ackermann and then Anshu Jain, who was originally from India — became the bank’s chief executives. Among managers at Deutsche Bank, there were even periodic debates about whether the headquarters should move from Frankfurt to New York or London, since that was where all the financial action was.
But like many converts to a new cause, Deutsche Bank began to pursue financial globalization more fervently than its peers. Instead of funding itself through retail deposits, it used short-term borrowing from other institutions (often U.S. money market funds) to buy high-yielding securities, which it held for short-term gain and without the long-term control that had characterized the previous system. Some of those securities were repackaged American mortgages, so that the bank came to be a central player in the tragedy of the U.S. subprime sector. Ackermann, for his part, made a notorious promise to investors of a 25 percent pretax rate of return on equity, which was only achievable by maintaining the thinnest of thin capital ratios, which meant the bank was vastly, even negligently, exposed to risk. By the end of 2007, the buffer provided by Tier 1 capital was just 1.47 percent of Deutsche Bank’s assets, and that ratio dropped even lower in 2008.
As the global financial crisis dawned in 2008, and it became impossible to price the complex securities Deutsche Bank had invested in, the bank’s vulnerabilities began to become exposed (although amid the uncertainty, Deutsche seems to have hidden its losses on complex insurance products, in the hope that the markets would correct before they would be discovered). Jain, who was promoted to run the bank in 2012, having previously been just its highest-paid banker, promised a “culture change,” but it was always rather unclear how the former star investment banker planned to realize such a shift. The suspicion remained that Jain’s promises of “a multi-year journey” to culture change was just an exercise in management jargon. In June 2015, Jain resigned and was succeeded by a Briton, John Cryan, who had built up a reputation as a safe pair of hands, but was not a complete outsider to the bank either.
The financial crisis, and its aftermath, made apparent — first to financial observers, and gradually to the German public — that Deutsche Bank had embarked on a new global business model, without entirely shedding the old cozy model of Deutschland AG. That made it an awkward fit in both worlds, and unable to become a full member of either. Consider Deutsche Bank’s iconic art collecting and patronage, which it celebrated from the 1980s to the 2000s, but has more recently come to look bizarre. Up to 2011, the bank issued promotional material claiming: “Art is at the core of Deutsche Bank’s DNA. This is demonstrated by the way that art and culture is central to the bank’s corporate social responsibility, client relationship, brand, marketing and employee benefits programmes.”
But as the bank became more deeply enmeshed in financial globalization, it treated art less as an object of patronage and more as a market to exploit. In that sense, the bank’s relationship to avant-garde art paralleled its treatment of new financial products, like complex derivatives. In both cases a fundamentally unintelligible product was being marketed indiscriminately to a wide audience — and in both instances, customers were discouraged from attempting to understand the underlying value of what they were engaging with. From the perspective of the German public, these esoteric dealings in art seemed like a betrayal of the bank’s traditional social responsibilities; from the perspective of the bank’s global peers, it seemed like an unnecessary, and risky, distraction.
In the same way, as it became clear that it had outlived its national business model, the close relationship between the bank and German politics, long a core feature of Deutsche Bank’s brand, became an explosive liability. Historically, the German chancellor and the head of Deutsche Bank were not necessarily social companions, but they did recognize that maintaining a close relationship was in their mutual interest. Before the First World War, after Deutsche financed one of the major foreign-policy projects of Imperial Germany, the construction of a railway that would tie the Ottoman Empire to Germany, Kaiser Wilhelm II began to cultivate relationships with the heads of Deutsche Bank, decorating them with grand titles and inviting them to imperial ceremonial occasions. Politicians and diplomats in Berlin argued that the government should cautiously direct private enterprise in the way that would serve the national interest. Deutsche Bank indulged such appeals in order to extract business guarantees from the government.
The political relationship was inevitably strained by financial crises. In the Great Depression, where the German experience was so catastrophic because of the collapse of the major German banks in July 1931, the chancellor at the time, Heinrich Bruning, blamed Deutsche Bank for the collapse. Bruning had wanted the banks to give a joint guarantee for bank liabilities, and Deutsche had refused. The ensuing financial crisis and the 1933 Nazi seizure of power produced a new involvement in politics for Deutsche Bank, and a new and deep culpability in political crimes. After 1945, Deutsche, like the other German banks, was broken up by the Allied military authorities; only by the late 1950s did it manage to reconstitute itself.
The crisis of September 2008 holds parallels with the drama of July 1931; and, in the aftermath, Deutsche Bank is still struggling to restore its earlier reputation. Two weeks after the New York Lehman crash, the German government again pushed all the banks to put up money in order to rescue the weakest link in the German financial chain, Hypo Real Estate. After a 12:45 a.m. phone call on September 29, 2008, from the German chancellor, Deutsche Bank’s Josef Ackermann agreed to put in 8.5 billion euros, 1.5 billion more than he said he had originally been prepared to offer. But the successful rescue of 2008, like the failed rescue of 1931, had a poisoned legacy. It very quickly seemed to the public that self-interested banks had exploited their relationship with the government, and that they should have been made to pay more.
What caused the most public outrage was when the words with which Ackermann rejected the idea of a U.S.-style recapitalization of all banks were leaked: He would be “ashamed” to take government money. (He later claimed that he had really said that it would be “a shame.”) By late 2010, with deep divisions on how to handle Greek and other eurozone sovereign debt, the relationship between Chancellor Merkel and Ackermann was severely strained, even if German tradition prevented them from terminating it completely. But absent the traditional mutual commitments between government and bank, the vestigial closeness between the two looked increasingly like an embarrassment for everyone involved.
Deutsche Bank had made a bet on giving up on the German model and becoming a poster boy for globalization. Unfortunately, it was the wrong kind of globalization: financial globalization via extreme leverage. But the bank was additionally vulnerable because of its own particularly German traditions, including not just its Frankfurt headquarters, but above all its long history of cooperation with the government. The previous bosses of Deutsche Bank, Anshu Jain and his co-head, Jurgen Fitschen, had explained that they “will do what they can to clean up the past.” But in Germany, getting rid of the past has never been an easy task.
Photo credit: Mario Tama/Getty Images