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Banks in the firing line of Department of Justice

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Dealers spent last week concentrating on a subject dear to their hearts and pockets, the state of the banking industry. Last week was not a good one. Most of the headlines were about Deutsche Bank with the US Department of Justice deeming the behaviour of the bank in selling toxic products linked to subprime mortgages, justified a fine of $14bn. While most expect a period of negotiation to reduce this penalty considerably, few expect that Deutsche’s current provision of $5bn will prove sufficient.

Not surprisingly, Deutsche Bank’s share price oscillated wildly throughout the week as different rumours and statements unsettled the market. The immediate question was whether the German government was likely to come to the aid of Deutsche (and Commerzbank for that matter). Angela Merkel had already made her position abundantly clear in responding from pleas from Matteo Renzi to be allowed to provide state aid to Banco Monte dei Paschi in order to prolong the life of the world’s oldest bank. As her response was a straight forward refusal, she is not in any position to effect a U-turn to bail out the German banking industry.

Whatever Merkel may say, however, has only persuaded a limited number of investors that the German government would be prepared to see Deutsche, or any other major German bank, close its doors with the subsequent loss of voters’ deposits. Merkel’s recent performance in the polls does not leave any room for risk in front of the elections next year. If the situation gets really serious, one might expect a form of Rettungsboot (German for lifeboat) that might be dressed up to avoid the accusation of being direct state aid. That assumes that the Italians have not already managed to pave the way with an acceptable formula that, all of a sudden, the German government find they are able to support.

One of the downward lurches in Deutsche’s share price last week was driven by the reports that about ten hedge funds had withdrawn funds they were holding with the bank. It is difficult to know what the usefulness of this sort of news can be unless you have shorted the shares first. Fortunately a final rattle from John Cryan, the CEO, that Deutsche was holding €200bn cash with central banks steadied the ship to the extent that Deutsche’s share price ended the week 2% higher than it started.

The problems in the German banking industry are not confined to Deutsche as Commerzbank announced that it would be laying off 10,000 staff. This is about a 1:5 employee ratio and compares with Deutsche which is rumoured to be laying off 15,000 staff, which is about a 1:10 ratio. Commerzbank is not being hit with any fines, but simply finds banking in the world of negative interest rates an unprofitable occupation. It is still 15.6% owned by the state, having been bailed out in 2008. Commerzbank’s bile is directed at the ECB and its penchant for negative interest rates. It has generated considerable support from influential German politicians to the extent that Mario Draghi was forced, last week, to defend the whole concept of the ECB’s current monetary policy under accusations that it has proved to be a failure.

Just in case any over the top Brexiteers should feel a lack of compassion towards the German banking industry, they will soon find these matters strike nearer to home. Sadly, the much fined RBS is in the firing line yet again and is expected to be the next recipient of the US DoJ’s judgement on the cost of selling toxic instruments. Few expect the result to be much different from that exacted on Deutsche Bank.

The most extraordinary banking story of the week, however, emerged from Wells Fargo who are accused of defrauding their customers by opening and then charging fees on more than two million fake accounts in their names. Appearing in front of a congressional hearing last week the CEO, John Stumpf, denied that his sale of Wells Fargo shares to net $13m had anything to do with the knowledge that an announcement was imminent on this mis-selling horror story. Furthermore, he claimed he followed the proper channels, no doubt seeking the Chairman’s approval. John Stumpf, is Chairman as well as CEO.

To date, Wells Fargo has been fined $150m and Stumpf had agreed to give up $41m in his remuneration.  As the Chairman of the congressional committee noted, “Fraud is fraud, theft is theft.  What happened at Wells Fargo over the course of many years cannot be described in any other way.” No doubt those banks being fined in the US will be watching to see what befalls Wells Fargo. It seems pretty extraordinary that Stumpf is still in situ, let alone as Chairman and Chief Executive. However, it will be the fine that will be interesting; selling toxic junk instruments is pretty awful, but not outright fraud. If the DoJ does not pull out the big bazooka, even on one of its own, the European banks would have plenty of justification to cry foul. At least Wells Fargo can afford it.

The rebound in the CIPS surveys last month supported by better than expected economic data over the course of the last month has rather undermined Mark Carney’s latest attempt at forward guidance as a couple of MPC members have noted that a further minor rate cut is probably unnecessary. The latest CIPS survey data is released this week and started with today’s manufacturing figure. This was expected to contract back from the stellar 53.4 recorded in August having previously been sub 50. The median forecast for September was a still respectable 52. In fact, this morning’s announcement that it had risen again to a remarkable 55.4 would suggest that the fall in sterling has had a strong and immediate impact and that the Bank of England’s reading of the economy is way out of sync with reality.

All eyes now switch to the key service sector data to be released on Wednesday. Another figure that saw a remarkable recovery to 52.9 in August and one where the median forecast is suggesting continued growth albeit at a slower rate as it is expected to fall to 52. These will be followed by the trade figures and the latest industrial production figures on Friday: both of which are expected to show a currency driven improvement. The pound is trading weakly as we start a new week, presumably on the back of the hard Brexit noise emanating from the Conservative party conference, but not helpful for keeping inflation under control. Most commentators now regard the MPC’s actions in August to have been unnecessary, at best. If the CIPS survey on the service sector turns out as strong as that for the manufacturing sector, Mark Carney and the MPC will be left looking seriously embarrassed. Rate hike before Christmas?! 

All views expressed here are the author’s own and are based on information and data available at the time of writing.

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