It didn’t take long for the European banks to catch the American banking disease. It really is a sign of the times. Deutsche Bank shares were down 14% yesterday, and it’s all about the cost of debt.
The problem is the cost of debt and managing that debt. Credit Default Swaps, which are effectively insurance against debt defaults, are getting more expensive. So, having taken on any amount of all sorts of debts for years, it’s getting extremely costly. …And this debt does have to be insured. Nobody’s so naïve as to believe that all debt is good.
The blasé debt market has never really cared about creating debt. Now suddenly it matters, because they have to pay for it.
The quality of the debt is the other tricky element, particularly now. Higher rates are expected to lead to defaults, and that hardly makes things simpler for lenders. America sold itself a lot of lousy debt, and paid the price for it in 2008. Most of that debt actually wasn’t worth the electricity on the screen displays. We know how well that worked out.
This time, however, the problem is the cost of managing the debt, whether that debt is good, bad, or indifferent. The last 20 years of utterly unrealistic low rates have caught the market in a bad position. It created galaxies of debt, and all that debt is now a lot more expensive.
It’s tough for people who have spent 20 years in a low-rate regime to adjust to a different cost base for something so basic. Fair enough. This situation is like the energy price rises in some ways. They’re paying for the debt to exist, in effect.
It’s not that great an argument from another perspective. The fact is that a lot of this debt should have been either retired years ago or simply written off. If it’s not even worth the price of the insurance, why keep it? Some of the debts have been rattling around for decades. It’d be a lot cheaper to write it off than simply lugging it around.
The other and much trickier problem is that debts are assets for lenders, particularly banks. They use these assets as collateral when doing their own borrowing. Writing off assets, however nominal, isn’t popular on the markets. The debts are also on the balance sheets of multiple parties and it takes some time, patience, and effort to get them off and redefine those balance sheets.
The Euro banks aren’t “deregulated” in any possible sense of the word. They’re much more highly regulated, in a much less apathetic and less deranged political environment than the American banks.
European central banks can kick heads, and they might. They haven’t yet done that, probably because they need to assess the wider issues. More interest rate rises are likely, so this situation does need close monitoring.
Deutsche Bank in particular is an interesting case. This is one of the biggest banks in the world. It’s unlikely the German government will have any tolerance for “Schauer Bauer”, meaning “cunning peasant” behavior. Deutsche Bank has had past issues with debt during the 2008 crisis, and made a mess of it.
There’s even talk of a collapse of Deutsche Bank as a “domino effect”. This is highly unlikely. This particular domino is far more important. The German government is more likely to be extremely angry about such a basic failure and very hostile to anything resembling a Credit Suisse scenario.
Europe’s largest economy definitely does not need this sort of thing. On the face of it, Deutsche Bank’s problem is managing higher interest. Simple enough, you’d think, but very expensive. The big banks carry huge amounts of debt in one form or another.
It’s a self-inflicted injury. This sort of debt needs to be turned into something viable in a rational business environment. That is, the exact opposite of the credit market for the last 20 years.
It’s not just Deutsche Bank, Credit Suisse, or a US bank here or there, either. The ridiculous amount of debt created by the global credit market isn’t even theoretically sustainable, and never was.
More to the point – A first year business or economics student could have seen this coming. It shouldn’t be a surprise to anyone. There are no excuses. Sane lending will get you out of this. This is the price of madness.
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Disclaimer
The opinions expressed in this Op-Ed are those of the author. They do not purport to reflect the opinions or views of the Digital Journal or its members.
