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Peter Morici: By Destabilising Deutsche Bank, Hillary Could Ignite another Economic Crisis

According to Barack Obama and Hillary Clinton, the economy is in great shape and safe from another financial crisis.

They believe more liberal policies to better distribute the benefits would deliver Americans into another golden age, but the facts belie all this.

Obamacare, state and local minimum wages laws, new federal overtime rules, and disincentives to work imposed by the recent buildout of federal social programs have raised the cost of hiring workers. Higher businesses taxes—especially for smaller enterprises–and tougher regulations have pushed up the cost of deploying capital.

Consequently, Americans are suffering through one of the weakest recoveries on record, and conditions in Europe are no better.

The U.S. Justice Department is proposing Deutsche Bank pay $14 billion to pay for its role in a mortgage securities scandal that contributed to the 2008-2009 financial meltdown, and other European banks still await their medicine.  Even a settlement one-third that size would require the bank to sell new stock to replace lost capital, and it is not well positioned to do so.

The largest bank in Europe’s largest economy has a balance sheet still burdened by dodgy securities and is badly run and not very profitable.

Virtually all European banks are suffering from slow growing economies and ultra-low interest rates that make moving bad loans sitting on their books from the financial crisis tough, and identifying suitable candidates for new loans and earning profits even tougher.

About 17 percent of loans held by Italian banks are underwater, whereas at the height of the financial crisis the figure for U.S. banks was only 5 percent. The picture is pretty bleak elsewhere on the continent too.

We are told over and over again, Deutsche Bank is no Lehman Brothers. It can’t pull down the global financial system because the European Central Bank stands ready to lend virtually unlimited amounts of cash against the bank’s assets.

However, as was the case with Greek banks during their crisis, the ECB likely would require the German government to cosign those loans—essentially, underwrite the kind of bailout German Chancellor Angela Merkel has firmly denounced. As importantly, many of Deutsche Bank’s assets are derivatives and difficult to value securities that could prove hard to peddle in a crisis.

Deutsche Bank may have to resort to a “bail-in” as recent European bank reforms require. That is, to compel bondholders to take stock to replace their claims and bear huge losses in the bargain.

As panic spreads among bondholders elsewhere in Europe, the potential for a general economic collapse is enormous. In Italy, for example, ordinary depositors have been encouraged to purchase bonds in the manner that Americans invest in certificates of deposits. Bail-ins would impose huge losses of household savings and purchasing power, and a contagious recession that could easily undo Europe’s fragile welfare state economy once and for all.

American regulators may believe Dodd-Frank regulations make U.S. banks less vulnerable to a meltdown in Europe but don’t bet on it. Deutsche Bank has wide interconnection with banks around the world, including our venerable towers of finance in Manhattan.

Cumbersome new compliance requirements have substantially reduced lending and driven down profitability. And those require big banks to write living wills that specify how they would sell off assets in a crisis. But like Deutsche Bank and U.S. banks in 2008-2009, most of their assets and stock could prove unmarketable should the economy turn south.

Nonetheless, Mrs. Clinton’s Administration would likely double down on these regulatory measures.  If Congress permits her to do so and expand Obamacare, impose a national $15 percent minimum wage, finance broader subsidies for child care and college tuition, and impose other new regulatory burdens—such as, federalize the California Fair Pay Act—that would likely cook the goose.

Together, those would further reduce bank lending, raise the cost of capital and labor, discourage entrepreneurs from forming new businesses, and drive existing businesses to move more operations offshore.

All that could easily push the economy from slow growth into another recession.

Peter Morici is an economist and business professor at the University of Maryland, and a national columnist. He tweets @pmorici1

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