Deutsche Bank and Snapchat

From Brexit Is a Lehman Moment for European Banks by Mark Gilbert. I am not convinced by his analysis or diagnosis but his is a useful reminder. In 2007, we payed a lot of attention to the financial well-being of major banks, both American and European. Then, as is wont to happen, the major issue with a lot of complexity slid from the headlines, displaced by the ephemeral and simplistic issues of advocacy journalists.

But not talking about consequential things, such as financial sector health, doesn't actually mean the problem was resolved. I retain doubts about both the American and European financial sectors but I believe that Gilbert is correct that the European banks and financial sectors are the ones which are weakest and most exposed to exogenous shocks.

Shocks such as Brexit.

European banks are undergoing a real-life stress test in the wake of Britain's vote to leave the European Union. Their share prices were already down 20 percent this year; since the referendum result was announced, they've doubled that decline. If the rot isn't stopped soon, Europe will have found a novel solution to the too-big-to-fail problem -- by allowing its banks to shrink until they're too small to be fit for purpose. The answer is found in the adage never let a good crisis go to waste.

This is the money quote.

Deutsche Bank, which once had pretensions to be Europe's contender on the global investment banking stage, is now worth just 17 billion euros ($18 billion). When the biggest bank in Europe's biggest economy, with annual revenue of about 37 billion euros, is worth about the same as Snapchat -- a messaging app that generated just $59 million of revenue last year -- you know something's wrong. No wonder the billionaire investor George Soros was betting against Deutsche Bank shares this month.

This paragraph brings to mind a conversation I had with a friend and management consultant years ago. I was living and working overseas and back in the US for a meeting in circa 1999 in the frothy run-up to the internet bubble. My friend was a former manager at the electric utility serving southeastern Michigan (Detroit Edison).

My friend brought to my attention an example of how frothy and unmoored the stock market had become. "I'll tell you how crazy it has gotten. I was looking at a new company which just went public. They specialized in low head hydro power generation. Respectable sales but in a niche market. One manufacturing plant and only a couple of hundred employees. Because they were new and because they hitched their public offering to being a tech company, their capital valuation was higher than that of Detroit Edison, an established company with an established business model, with actual revenue and profits serving a large and established customer base." Having seen that craziness, he had pulled all his investments from the stock market to ride out the inevitable market correction. A smart man.

So when I see Deutsche Bank being valued at the same amount as a speculative Snapchat, it brings to mind earlier fits of irrational exuberance.

UPDATE: The death bell begins to toll. It is my suspicion that much of the wailing and gnashing of teeth of the rent-seeking, crony capitalist clerisy over Brexit has to do with their gravy train coming off the rails.

The British economy is not in great condition but better than that of most the continentals. With their departure, the EU loses a healthy enough bank account that could have helped pay for all the stored up bad loans that are floating around the EU systems; both on the EU books and within the banking system. The demographic death spiral of the continental countries also does not help. From Italian banking is the next shoe to drop by Tyler Cowen.

Scott Sumner refers to The Second Domino. Via Kevin Drum, the WSJ reports:

In Italy, 17% of banks’ loans are sour. That is nearly 10 times the level in the U.S., where, even at the worst of the 2008-09 financial crisis, it was only 5%. Among publicly traded banks in the eurozone, Italian lenders account for nearly half of total bad loans.

This is potentially a bigger story than Brexit, as it has the potential to bring the entire eurozone to its knees. The notion of a bail-in already has been discarded, with Merkel’s blessing, as most people realize that would lead to unmanageable runs on eurozone banks.

The US cannot ride a high horse in terms of governmental fiscal rectitude and we have some hard times ahead dealing with accumulated bad debts (more governmental than private) but with our system of checks and balances and republican structure and marginally better demographic position, I suspect we will ride this out in better condition than the Europeans.