by Professor Richard Roberts, Kings College London
The US Department of Justice’s $14bn sword of Damocles hovering over Deutsche Bank is a sorry outcome to a remarkable story of business transformation. Founded in Berlin in 1870, for a century Deutsche served as house bank for Deutschland AG. The 1970s saw international expansion in pursuit of growth opportunities; by the late 1980s a quarter of profits were generated overseas.
Then came Deutsche’s drive into investment banking. By 2015 half of the bank's profits came from this business. The metamorphosis began with the acquisition of two key targets, both of which were, at the time, as troubled as Deutsche Bank itself is today.
Deutsche’s move into investment banking began in earnest with its acquisition of Morgan Grenfell, London’s premier and pushiest investment bank, in 1989.
Morgan Grenfell was the first big City investment bank to be acquired by a foreign owner (the others would follow over the next decade or so, ending with Cazenove in 2004). It was for sale largely because of the fallout from its conduct during the Guinness takeover of Distillers, a leading Scotch whisky firm, in 1986. Morgan Grenfell’s buccaneering corporate financiers orchestrated a ‘concert party’ of investors, illegally indemnified against loss by Guinness, who supported the Guinness share price during a takeover battle with a rival bidder.
Guinness’s bid for Distillers succeeded, but unfortunately insider trader Ivan Boesky spilled the beans on the illegal concert party in a plea bargain with the US authorities.
Four of those involved were convicted and Morgan Grenfell’s star player was indicted, though his trial collapsed. The reputational damage from the Guinness bid undermined revenues and management resolve, a predicament compounded by other commercial pressures, and the bank put itself up for sale. Deutsche was prepared to pay a premium for Morgan Grenfell, which provided an unrivalled ready-made entrée into Anglo-Saxon investment banking in Europe’s global financial centre.
Deutsche’s establishment of a substantial investment banking footprint in the US came via Bankers Trust, another challenged investment bank.
During the 1990s Deutsche had built up investment banking activity in the US organically, but the imminent repeal of the Glass-Steagall Act separating commercial banking and investment banking at the end of the decade offered unprecedented opportunities for the German universal bank.
The short cut was an acquisition. Bankers Trust, a venerable Wall Street firm, pioneered the development of swaps in the early 1990s. Two prominent counterparties, Gibson Greetings Cards and Proctor & Gamble, sustained large losses from the transactions and launched legal suits alleging that Bankers Trust had failed to warn them about the risks. The firm strongly contested the claims and the terms of the settlements were generally viewed as a vindication.
However, as part of the lawsuit Bankers Trust was forced to turn over 6,500 tapes of conversations between staff.
Salesmen were heard talking about derivatives as "a massive, huge gravy train" and a "wet dream". And as regards clients, that Bankers Trust had "set ‘em up" and referred to the "ROF", or "rip-off factor".
The $200m Proctor & Gamble suit was settled in 1996 but the reputational damage as regards its treatment of clients was irreversible. Then came big losses in 1998 from the Asia crisis and Russian default, plus a potentially devastating fraud conviction. Thus, Bankers Trust was an acquisition candidate amd in November 1998 Deutsche paid $10bn for it. It was the largest foreign takeover of a US bank and created the world’s biggest bank by assets.
Deutsche’s own recent reputational challenges have included fines for Libor fixing and sanctions violations. But the big one is the US DoJ’s accusation of mis-selling mortgage securities.
Deutsche was a force in the collateralised debt obligation market during the US subprime bubble, creating some $32bn worth. But even as the machine cranked them out, the bank’s own traders were calling them "crap" and devising ways to bet against them.
Then there is a further pending matter and fine concerning ‘mirror trading’ by the bank’s Moscow outpost, now shut down.
Did the flawed building blocks of Deutsche’s investment banking business contribute culturally to its rash of misdemeanours? Could the reputational, financial and commercial fallout mean that even mighty Deutsche Bank goes the way of Morgan Grenfell and Bankers Trust and become a merger or acquisition candidate itself?
