You’ll recall this company is the largest bank in Europe, with a net worth of about $16 billion, who got fined $14 billion by the United States for sales practices of mortgage-backed securities. The company was already over-leveraged with $164 billion in debt and, more importantly, had derivatives exposure of $43 trillion (which is bigger than the whole GDP of Germany).
The good news is that the U.S. Department of Justice has agreed to negotiate a smaller settlement, probably in the neighborhood of $5-6 billion. In addition, there is a rumor that the Bank has entered into enough cross-agreements to reduce their derivatives exposure to “only” $20 trillion. Their stock has now recovered to the level before the DOJ fine.
There is a rule-of-thumb that the tipping point in the spreads of credit default swaps (CDSs) is about 300 basis points, which was the tipping point when Lehman collapsed. The CDS spread for DB is down to 130 points, meaning the DB counter-parties are now less fearful of a collapse. This is all good!
Does that mean the danger has passed? Absolutely Not! There is still no indication that Germany’s Merkel will try to recapitalize its largest bank, although most observers think the European Central Bank will eventually backstop Deutsche Bank. But, nobody knows . . . for sure.
Does all this mean we can stop worrying about systemic collapse? Never!