July 17, 2020
European Banks Are in Big Trouble
It has all the makings of a bad James Bond movie… with Jersey Shore, the Kardashians, and the hit show Billions mixed in for good measure.
What happened a few years ago in Zurich is a microcosm for the unstable situation unraveling right now with European banks…
In 2016, a Pakistan-born banker named Iqbal Khan bought the property next to his boss’s house in a particularly fancy neighborhood in the financial capital of Switzerland. Khan promptly bulldozed his house and over the next two years, he built a palace fit for, if not a king, a highly successful head of the wealth management business of Credit Suisse, a global financial-services firm with assets of around $830 billion.
Credit Suisse CEO Tidjane Thiam, Khan’s boss and new next-door neighbor, was not amused by the noise and disruption caused by the construction. He complained to the chairman of Credit Suisse, who, with 50,000 other employees to oversee, was a tad busy with other projects. In a fit of passive-aggressiveness, Thiam planted some trees on his property that obstructed the view from Khan’s new house of Lake Zurich.
These trees were the topic of an argument during a cocktail party at Thiam’s house in January 2019. Words escalated into a scuffle – probably the grabbing-of-lapels “fighting” between two middle-aged men accustomed to using their heads, not their fists – and, according to press reports, the two tough guys had to be separated by Khan’s wife.
Khan protested to the chairman of Credit Suisse, who by this point must have felt like an elementary school teacher on playground duty… A few months later, Khan – adroitly reading the room – sensed that he’d hit his ceiling. He left Credit Suisse to join UBS, a bigger and more prestigious rival.
Then Credit Suisse Chief Operating Officer Pierre-Olivier Bouée – apparently on his own initiative – directed the company’s security chief to trail Khan. He wanted to keep tabs on whether Khan was meeting with clients of and employees from Credit Suisse, perhaps to poach them.
However, the hired security firm presumably took spying lessons from Tweedledee and Tweedledum. Within weeks, Khan spotted and confronted one of his tails while shopping with his wife in downtown Zurich. A physical altercation ensued – it’s unclear who chased whom – and Khan called the cops.
The police opened a criminal case for coercion and threat – and, tragically, an investigator at the security firm committed suicide. Credit Suisse wanted someone to blame for what was rapidly metastasizing into a public relations disaster… COO Bouée, who had been a close colleague of Thiam’s over the previous 30 years at three other employers, took the fall, while Thiam was cleared of wrongdoing. (He subsequently described Bouée as “a good professional,” but clarified that “I’m not sure you can describe him as a friend.”)
Maybe that would have been the end of the story… But in December, the news hit that Credit Suisse had also spied on its former head of human resources. There were no other “who dat?” friends for Thiam to throw under the bus. Following an under-the-rug power struggle between Credit Suisse’s chairman and its CEO, Thiam was axed in February to “protect Credit Suisse’s reputation”… or what was left of it, anyway.
The saga was caviar catnip on steroids for the finance set. And aside from a few multimillionaire bankers losing their jobs and shareholders getting their French cuffs in a twist, it’s easy to dismiss the whole thing as a gossip for bored Swiss bankers.
But it’s more than that… because it calls into question the judgment of Thiam and Khan – two men at the pinnacle of their careers, with decades of bureaucratic maneuvering and ladder-climbing and butt-kissing under their belts – who nevertheless displayed the emotional maturity and conflict-resolution skills of Skittles-snorting five-year-olds. It also begs the question, how many other meltdowns-in-waiting are there like this in the banking world… And where are they… And what kind of damage could they cause?
Turns out, they’re everywhere – in Europe. Take, for example, the American CEO of British bank Barclays, Jes Staley, who in 2016 invited a friend who was a former colleague from JPMorgan Chase to join him in London. But a whistleblower wrote in to the Barclays board, warning that Staley’s new hire had previously had problems with alcohol.
So Staley did the sensible thing: He asked the Barclays security department not once, but twice (even after he was warned) to ascertain the identity of the whistleblower. (The whole point of whistleblowing, of course, is that the identity of the whistleblower is kept secret, to prevent retribution of precisely the sort that Staley was likely hoping to propagate.)
Staley was fined around $870,000 and came within a whisper of losing his job. Soon thereafter, it came to light that Staley’s relationship with vile child sex trafficker Jeffrey Epstein – who was a client of JPMorgan’s private bank, which Staley previously headed up – was more than just professional, as he’d previously indicated to regulators. The Financial Times said in February that “the best and most elegant resolution might be for Mr. Staley to step down now.” Staley is apparently hoping to slog it out and leave on his own terms next year.
But Thiam and Staley are mere amateurs compared with the professionals at Deutsche Bank, which the Financial Times wrote is the “Zelig of banking scandals”… that is, it finds a way to blend right in with pretty much every banking scandal that comes along.
As the Financial Times explained, in a review of a book about Deutsche Bank’s impressive resume…
Its employees cooked the books to hide losses, took part in rigging Libor interest rates, manipulated prices for currencies and commodities, violated U.S. sanctions on doing business with Iran and Syria, helped Russians launder money, accepted sex offender Jeffrey Epstein as a customer and enabled the Renaissance Technologies hedge fund to avoid billions of dollars in taxes.
… One part of Deutsche made a loan to Donald Trump — depicted [in the book] as the quintessential Deutsche client because no other big bank would have him — so the future U.S. president could pay off his debts to another part of Deutsche.
But that’s only the Reader’s Digest version. By one count, that Deutsche Bank has been penalized by regulators an incredible 55 times over the past 20 years – and has been fined tens of billions of dollars.
Maybe worst of all, Deutsche Bank – which had the Gestapo as a client back in the Nazi era – puts more than just its long-suffering shareholders (the company’s shares are down 94% since 2007) and 85,000 employees at risk… It’s also the banking equivalent of a nitroglycerin-packed dump truck speeding through a minefield at a busy playground.
In 2016, the International Monetary Fund called Deutsche Bank the “most dangerous bank in the world.” As of last year, it had around $49 trillion (that’s trillion with a “t”) in unhedged derivatives. So far, Deutsche Bank – and the global banking sector – has escaped from endless brushes with what looked like sure death.
Deutsche Bank’s problems are so deep-seated, so long-running, and so endemic that no single individual stands out… Deutsche Bank is like an all-star ensemble film, where there are dozens of high-powered standouts at scandal and incompetence who would have a leading role if they were on any normal team.
So, European banks are behaving badly. What does it all mean? I have a few thoughts…
1. Bankers are jerks.
Even the Financial Times, most of whose readers are bankers and whose writers aspire to be bankers, doesn’t hesitate to say this. Iqbal Khan, the Times explained, is “known for his self-confidence” – code for “this guy’s a real jerk.” Thiam was described as “charismatic yet sometimes imperious” – code for “nice guy until you get to know him a bit.”
(I worked in banking on a trading floor, as a securities analyst, in corporate finance, and managed a hedge fund, for a total of around 15 years. Some of my best friends are bankers… But the vast majority of my former colleagues were jerks. That’s reason No. 1 I left the industry years ago.)
Not-nice people are a lot more likely to behave in an entitled, arrogant, self-serving manner. That’s fine, if a bank can channel the aggression of its employees toward its own ends. But it’s trouble if not… (Exhibit 1: Deutsche Bank)
2. European banks have a big problem.
Now, not every European bank is a circus of incompetence, buffoonery, and bad judgment. And for every misguided Jes Staley (or busload of Deutsche Bank employees), there are thousands of hard-working, well-meaning banking industry foot soldiers who color inside the lines and haven’t laundered dirty Russian oligarch money or sold bogus repackaged mortgages or hung out with sex offenders and pretended it was all work.
But relative to most of their American counterparts – with some obvious exceptions, such as scandal-riddled and underperforming Wells Fargo – European banks are flailing. American banks are significantly more profitable and earn far higher returns on capital. Most European bank stocks trade for just 40% of book value. That means that investors think banks are brimming with such an excess of bad actors – and bad assets – that they’re worth less than their theoretical liquidation value. Most American banks, by comparison, trade at or above book value.
And as a result, investing in European banks has been as effective as gasoline and a lighter at destroying capital. An index of euro-area banking stocks is worth around 40% less than it was in 2009 – while the broader European stock index has more than doubled in value.
Why the difference? The Economist reported last year…
Explanations for European banks’ poor performance start with the aftermath of the financial crisis of 2007-08. American banks were swiftly and forcibly recapitalised through the Troubled Asset Relief Programme, whether they needed it or not… Most European countries (though not Britain, the Netherlands and Switzerland) were slow to act. The euro area lacked a single supervisor and a common authority for resolving failed banks. Both were established several years later – and only after the euro area’s sovereign-debt crises had compounded the troubles of many lenders.
3. Money is an issue.
“Banks in Europe struggle to find talent with US rivals paying top dollar,” CNBC reported last year. In 2017, the average U.S. bank CEO earned more than double his European counterpart, and that trend has only accelerated. The EU limits bonuses – which generally account for the lion’s share of a banker’s income – to 100% of base pay (or 200% with shareholder approval, which no bank wants to request). Some countries have lower limits… In the Netherlands, for example, bankers’ bonuses are capped at 20% of fixed pay.
As a result, banks in Europe get the leftovers. Admittedly, the $2.6 million earned by the head of French bank Société Générale or the $7.6 million that even Jes Staley took home isn’t too shabby. But compared with the $24 million earned by the head of Citigroup, or the $32 million that JPMorgan Chase’s CEO made, or the $19 million earned by the head of U.S. Bank… it’s underwhelming, especially for bankers (who, after all, are all about the money.)
As a result, the talent that U.S. banks can attract, from entry level all the way up to the CEO suite, is likely going to be a lot stronger.
4. It starts at the top.
In December, I wrote about a $57 billion loan that multinational lender International Monetary Fund extended to Argentina in 2018. It was the organization’s largest-ever loan – to a country that was a proven serial defaulter, with half a dozen sovereign defaults over the previous century – and with it the IMF’s reputation was “on the line,” warned the Financial Times.
It turned out that its reputation wasn’t worth much. Within less than 18 months, Argentina started “re-profiling” – that’s code for defaulting without using the term “default” – its Olympus-sized piles of debt.
You might think that the head of the IMF – responsible for what was, by any measure, a historically enormous loan that turned catastrophically bad, astonishingly quickly – would be reprimanded… or have its compensation docked… or fired… but no. Not only did IMF head Christine Lagarde not suffer any blowback, but she was kicked upstairs, to become head of the European Central Bank. So now she’s head of an institution many times bigger, more important, and more powerful than the IMF.
The ECB, of course, supervises Europe’s banks. It’s responsible for making sure that bankers follow the rules… and are punished if they don’t. That’s a tall order when the head of the ECB is one of the greatest examples ever of the Peter Principle, a tongue-in-cheek managerial precept which says that “people in a hierarchy tend to rise to their ‘level of incompetence.'”
It’s enough to make you want to… plant some trees to block your neighbor’s view, and then get in a fight over it.
May you find your way through the chaos.
Now here are some of the stories we’re reading…
Trump administration orders hospitals to bypass CDC in reporting COVID data
Unlike the CDC’s site, the HHS database gathering coronavirus information will not be open to the public, raising concerns about transparency.
Growing Wait Times for Covid-19 Test Results Hinder Virus Response
Shortages and late results delay public-health officials’ view of virus’s spread and their ability to respond effectively.
Weekly jobless claims rise by more than 1 million for 17th straight week
These staggering unemployment numbers come as the U.S. struggles to contain the coronavirus outbreak, particularly in states like Florida, California, Texas, and Arizona. Nearly 3.5 million cases have been confirmed in the U.S.
Teachers are so worried about returning to school that they’re preparing wills
Some teachers feel more vulnerable to the coronavirus because they are older or have health conditions… They have been discussing preparing their wills and enrolling in supplemental life insurance as local COVID-19 cases keep rising.
Did the Times Print an Urban Legend?
The story seems to have changed several times since publication in order to salvage the Times‘s own credibility. It’s been transformed, edit by edit, from one of a man who died by taking a foolish risk in which the doctor was the only source, to a story about the questionable claim a doctor is making.
And let us know what you’re reading at [email protected].
Chaos Chronicles Editor, American Consequences
With P.J. O’Rourke and the Editorial Staff
July 17, 2020