STOCK MARKET WATCH -- Friday, 7 December 2012

[Demeter]

49. Khuzami Deathwatch: SEC Ignores Tips About $12 Billion of Hidden Losses at Deutsche Bank

http://www.nakedcapitalism.com/2012/12/khuzami-deathwatch-sec-ignores-tips-about-12-billion-of-hidden-losses-at-deutsche-bank.html?utm_source=feedburner&utm_medium=email&utm_campaign=Feed%3A+NakedCapitalism+%28naked+capitalism%29

Two days ago, we said it was time to fire the SEC’s chief of enforcement Robert Khuzami, who has not provided the tough policing warranted by the biggest financial crisis in the agency’s history. Our call was based on compelling evidence of failure. Specifically, a year and a half after Dodd Frank created a $450 million whistleblower fund, which Khuzami confirmed had produced hundreds of high quality leads, the agency had taken only one referral far enough to merit a payout, that of a measley $50,000. We stressed that this was an astonishing lapse:

… whistleblowers are insiders and therefore should in many cases have access to the sort of internal documents that would serve to substantiate conduct and save the SEC a ton of time. In other words, this should be a prime, potentially its best, source of leads, since the SEC would be further along in case development if any of these tips had meat (ie, both damning info and on target with a clear violation).

We didn’t anticipate that the story of Khuzami’s negligence would blow so big so quickly. Today, the Financial Times reported that three separate whistleblowers charged that Deutsche Bank had mismarked up to $12 billion in exposures to make it look healthier in 2008 and 2009 than it was, yet the agency had not acted on these allegations. And this level of window dressing most assuredly would make a difference. From the Financial Times article that discusses the charges in detail:

When Deutsche reported earnings at the start of 2009, its tier one capital ratio – the gauge of banks’ ability to absorb losses – was about 10 per cent, with €32.3bn of tier one capital against €316bn of risk-weighted assets. If the tier one capital had fallen by €8bn, below the upper end of the former employees’ estimates, its ratio would have fallen below the 8 per cent that German regulators were demanding at the time.

It is important to recognize that even now, Deutsche is thinly capitalized. Bank analyst Chris Whalen wrote in 2011:

Even Deutsche Bank, arguably the most important bank in Western Europe, has just €50 billion in capital supporting €1.7 trillion in total assets. Only by ignoring the sovereign and off-balance sheet footings of Deutsche and other major EU banks can anyone even for a moment pretend that these banks are solvent.

The bank’s year end 2011 balance sheet shows even higher leverage: equity of €55 billion versus €2.2 trillion in assets.

Although 2009 appears to be when the mismarking reached its peak, there was evidence of monkey business before that. The FT’s Lex column points out that the German bank miraculously managed to report profits in the third quarter of 2008, which closed right after the Lehman/AIG implosions. That miracle was achieved by reclassifying €25bn of trading assets, which skeptical investors were told was permissible thanks to changes in accounting rules.

The line taken to minimize the significance of these charges is the trades were eventually unwound without impairing the bank. Yes, in no small measure because the financial system is still on life support, with central banks engaging in ZIRP to goose asset prices and flatter bank balance sheets (and that’s before we get to the ongoing high wire act in Europe to contend with French and German bank exposure to periphery country debt). So the idea that this all worked out well is a convenient fiction. It all worked out well for bankers, at considerable cost to ordinary citizens in their economies. If Deutsche had gotten a formal bailout, the odds are decent that changes in management and operations would have been forced on the bank (remember, Germany is more oriented towards industrial capital than financial capital, so the odds of a big bank welfare queen getting to carry on as before are less likely than the example of Citigroup would suggest). Again from the FT:

“If Lehman Brothers didn’t have to mark its books for six months it might still be in business,” says one of the men. “And if Deutsche had marked its books it might have been in the same position as Lehman.”

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