Deutsche Bank May Be on Verge of Lehman Brothers Moment

Following the U.S. Justice Department’s demand for $14 billion to settle a mortgage-backed securities probe, several big hedge funds moved their derivative holdings from Deutsche Bank to other firms to avoid the risk of another Lehman Brothers-style liquidity squeeze.

Deutsche Bank AG, as the 11th largest bank in the world with about $1.9 trillion in assets, is almost 4 times larger than its next-largest German rival, Commerzbank, with only about $560 billion in assets. But Deutsche Bank is also one of the world leaders in risk bearing, with $52 trillion in derivative positions. That amounts to 3.9 times the $13.2 trillion GDP for all of the European Union, and 13.3 times the $3.9 trillion GDP of Germany.

Following a report from Bloomberg News that 10 of the approximately 200 largest hedge funds that clear derivatives trades with Deutsche Bank AG — including Izzy Englander’s $34 billion Millennium Partners, Chris Rokos’s $4 billion Rokos Capital Management, and $14 billion Capula Investment Management —  U.S. stock markets began to plunge over concerns that Deutsche could potentially be subject to a bank run.

Despite the hedge funds bailing out and Deutsche Bank AG’s New York-listed shares falling 6.7 percent to a record low of $11.40 on September 30, a Deutsche Bank spokesman told Bloomberg that the bank is confident that the “vast majority” of its trading clients “have a full understanding of our stable financial position, the current macroeconomic environment, the litigation process in the U.S. and the progress we are making with our strategy.”

The amount of cash sought by the U.S. Justice Department is not far from the Frankfurt-based Deutsche Bank’s entire stock market value of $15.7 billion. As a sign of just how much risk the markets think may be in holding in the German lender’s unsecured debt, the cost of buying credit-default swap protection jumped to 536 basis points, the highest level since 2007, according to data compiled by Bloomberg.

After the Lehman Brothers panic kicked off the last financial crisis, U.S. banks were forced to deleverage their balance sheets by about 50 percent. But European banks never took tangible action toward reducing their leveraged business and refused to recapitalize.

The pressure on Deutsche Bank is beginning to spill over into German politics, stirring speculation that Chancellor Angela Merkel’s government might be forced to offer support. Deutsche Bank Chief Executive Officer John Cryan told the Bild newspaper this week that government aid was “out of the question.” But any taxpayer-funded solution for the bank’s troubles would lead to Merkel’s downfall, according to the leader of Germany’s biggest opposition party.

The International Monetary Fund in June said Deutsche Bank may be the biggest contributor to risk among so-called global systemically important banks. Most analysts still think Deutsche Bank is solvent. But many are wondering: if there’s a slim chance it might not be risky, why leave money in there?

That type of lack of confidence in a banks can quickly turn into a Lehman Brothers-type panic run on deposits. Due to the cross-holdings of shared risk between big banks, if one bank gets in trouble, then a contagion can spread quickly to other banks and other nations around the world.

This morning, Bank of China raised a red flag on the country’s growing property bubble, according to the South China Morning Post. “A property bubble is the biggest risk for China’s economy” as “residential prices in major Chinese cities, from Shanghai to Shenzhen are rising at an annual pace of 30 or 40 percent in 2016, sucking the majority of bank credit into the property market and pushing prices beyond what is affordable for most residents there,” said economist Zhou Jingtong, with the state-owned Bank of China.