How to Topple an Institution

 

Do you remember what you parents used to tell you before you went to school? “It’s okay to be yourself. Don’t try to be like everybody else. If your friend says they’re going to jump off the Brooklyn Bridge, are you going to also?”

Obviously not, right? Remember how you used to scoff at that question because that was just simple wisdom. And then you went off to school and too many people started smoking because their friends started smoking. And too many people played really mean pranks because they had that one, charismatic, alpha-leader of friend who did, too.

The thing is, we want the respect of our peers. We don’t want to be the one that sticks out, that goes our different way. Some of us from a young age were good at avoiding peer pressure, were better at being an individual, but not all of us.

“How a Pillar of German Banking Lost Its Way” is not a new story, it is one as old as time. This is “Keeping Up With the Joneses”, this is about trying to be popular and fitting in, this is about not feeling left behind, and it ultimately is a story about what happens when it all eventually falls apart.

Step 1: Forget where you came from
Deutsche Bank (DB) is a 146 year-old banking institution. It is not a new a player on the world scene. It started as a specialist bank for foreign trade, expanded into domestic markets, and as many large, old institutions, found its bread and butter in commercial loans and corporates. In the post-war (post-WWII) period, it expanded domestic operations and into retail loans, and up until its 1989 acquisition of Morgan, Grenfell & Co., a UK investment bank, it did not have much to do with capital markets and modern-day Wall Street, as most think of when they think about banking.

The thing is, by the late 1980s, DB held the premier seat the table for Germany. As Fichtner, et al. point out in this article:

Without the bank, nothing worked, and standing in opposition to the financial institution was fruitless. Deutsche Bank was Germany, Germany, Inc., a small state within a state. Indeed, it was so powerful that many at the time considered it to be a danger to democracy.

How? Well, there is a style of banking, interlocking corporate ownership via board seats and stock holdings, and control that we do not see across public corporations in the US but is central to how things operate in other places (see: Italy and its interlocking ownership challenges). Deutsche had a stake in nearly every large corporation in Germany: from construction and industrial conglomerates to pharmaceuticals and auto-making. Every thing passed through Deutsche, 400+ companies, to be exact.

So, why change? The profits were stable, if not outsized. Control was effectively guaranteed. Then what?

Growth. How would Deutsche Bank compete on this new, post-war world stage, and also continue to grow? Corporate loans wouldn’t do it. Well, in 1994, a decision was made that DB would reinvent itself as a “global investment bank.” And how to do that?

People.

Step 2: Try to be like everyone else
The acquisition of Morgan, Grenfell had netted DB an investment bank, but as often happens in acquisitions, the people you are trying to buy tend to leave. So, you have to effectively go back out to the market and acquire more people.

One many’s trash is another man’s treasure, is the saying, but to soften that, we need to remember that there are only so many top slots available at corporations. It is simply a matter of numbers, and so the normal churn of promotion and departure opens up opportunities to hire people from other places and for people to achieve the type of status and position that they want.

Enter: Edson Mitchell, a cast off of Merrill Lynch and where DB pinned its hopes on turning it into this grand, competitive, “global investment bank.” Mitchell came to DB in 1995 and brought 50 of his people with him. Mitchell, and this is no fault of his own, was not like his counterparts at DB, and was cast more in the Gordan Gekko-style of American corporate raider, and the people he brought on were similar in nature to him.

To put it simply: it was a culture clash, but DB’s determination to change itself into something else meant that they were willing to allow its old cultural story — one of slow and steady, of deep company loyalty over personal loyalty, and of staid style over flash and bang — to be denigrated and eventually fully sublimated in sacrifice to this quest.

Mitchell unfortunately died in a plane crash in 2000 at the age of 47, but his mark was left and felt by proteges that he brought to DB who stayed, including one, Anshu Jain, a British derivatives trader who would eventually become co-CEO of DB in 2012.

Step 3: Ignore all warnings and take your hands of the controls
To say that this change went unnoticed would be to be unfair to the rest of the bank. As DB became more “global” in focus, and turned much of its control over to Americans and British raiders in the global markets divisions, the home office started as questions. When had these outrageous salaries and bonuses started being paid? What was with the outsized T&E (travel & expenses) expenditures? Did traders earn more than board members? What was going on?!

Additionally, there was a lot of rubber-stamping of deals and trades and activities that in other investment banks didn’t happen. It is a known story now that DB was a little slow in the compliance function (the numbers: 7,800 active lawsuits and € 3.2 bn in regulatory and civil litigation provisions as of YE 2015). But by the late 1990s, the last vestiges of control by the old DB were fading.

Enter: Josef Ackermann (a castoff from Credit Suisse) who come in a few years prior and became the CEO of DB in 2002, the first time in the bank’s history that they had such an executive position. He downsized the management board from nine members to four and then created a new committee, the Group Executive Committee. It was also the first time in the bank’s history that it was led by a foreigner, for Ackermann was Swiss and not German.

The new DB was now firmly in control and now things could really start to get interesting.

Step 4: Speed up and double down
2002 was not a great year for capital markets. There was a banking crisis that had all the other major investment banking players reducing their workforces, salaries, and bonuses and upping their risk controls. The opposite happened at DB: earnings were down but compensation was up, because how else to ensure that they stay ahead of everyone else?

In 2006, Ackermann made a few more governance changes that reduced internal controls further and consolidated his power base. Therefore, by 2008, DB was now an institution that lacked diversity of thought, solid risk controls, and any organizational structures to understand the size, scope, and long-term impact of the financial crisis. This meant that they kept conducting business-as-usual in an environment that was anything but.

Between 1999 – 2012, DB went on a rampage:

+ Deals in Libya, Cuba, Syria, Bruma, and North Korea, that are suspected of violating US sanctions
+ Currency trading manipulation via illegal software
+ LIBOR (London Interbank Offered Rate), interest rate fixing
+ Hiding unreported income in Swiss bank accounts for US citizens
+ Tax avoidance
+ Stock index manipulation
+ Dark pool pricing manipulation

Is that enough?

By 2012, when Anshu Jain became co-CEO with Jürgen Fitschen (who does not seem to have had very much control), the wheels were already spinning off. Jain pushed further into the interest-rate derivatives market, remember, he at heart was a derivatives guy, a market which tanked and continued to tank post-recession, and then disappeared off in 2015 to now leave John Cryan as the current CEO, a UK banker, holding the bag with a tanking DB stock price, a 24:1 debt-to-equity ratio, and a mountain of angry stockholders and stonefaced regulators to fend off.

Step 5: Reflect in the aftermath.
Right now, DB is in a fight for its life. While it posted a profit in Q3 2016, it is still operating under attack from short-sellers, a potential $14 bn penalty from the US Depart of Justice, and as of Friday, a €12.10 per share stock price. It is not respected by its peers on Wall Street, its employees are banging up headhunters’ phones in a frenzy, and there is a general sense that the party is over, the music has stopped, and maybe there simply aren’t enough chairs left for everyone to sit down.

Deutsche Bank, once Germany, Inc., is dead. Long live the…?


Article Review
DER SPIEGEL. “How a Pillar of German Banking Lost Its Way”. Ullrich Fichtner, Hauke Goose, and Martin Hesse. 28 October 2016.

 

 

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