Regulators need to combat speculative attacks on systematically important banks like Deutsche Bank

High velocity digital deposits have opened-up big banks to attacks by speculative short-sellers trying to engineer a crisis of confidence
Christopher Joye

Coolabah Capital

Speculative hedge fund short-sellers are having a field day trying to blow-up weaker banks right now. It started somewhat innocuously with Silicon Valley Bank, quickly spread to US regional banks, and then claimed the massive scalp of the globally systematically important bank, Credit Suisse.

The ailing Swiss bank was the predictable next target following the success short-sellers had tearing into regional banks in the US. And their cross-hairs have now unsurprisingly turned on Germany’s national champion, Deutsche Bank, which tends to be a hedge fund hotel whenever international banking strife materialises.

Let’s be clear, there are definitely some banks that deserve to die. The crypto lenders Silvergate and Signature had no reason for being. The wholly tech dependent Silicon Valley Bank combined an enormously reckless industry concentration with gigantic interest rate bets on a US$1117 billion bond portfolio that larger banks have to fully hedge. SVB successfully lobbied to be exempted from global capital and liquidity rules that would have forced it to reveal US$16 billion of unrealised losses. 

While we had been advising clients to avoid Credit Suisse since February 2021, and actively short-sold its bonds in 2022, it was not a bank that deserved to suddenly die via an extreme deposit run galvanized by a crisis of confidence. Yes, it needed to emulate the reforms of its Swiss peer, UBS, which it was apparently well progressed in doing.

But Credit Suisse was not wilting under huge credit or trading losses that would rationalise its evisceration. It was, much more primitively, a weaker retail, wealth and investment bank that was prone to putting customers into conflicted products, like the infamous Greensill loans.

The profound insight unearthed by the Silicon Valley collapse was the extraordinary velocity of digitised deposits, and how they are susceptible to crises of confidence. Back in 2008, banking was not properly digitised. People queued up outside the UK bank Northern Rock to pull their money from its branches.

Silicon Valley demonstrated that US$42 billion of deposits could disappear on a single day, rendering a bank with chunky mismatches between its unhedged assets (loans and bonds) and its flighty liabilities (deposits) as all but insolvent. This is precisely why it was placed into administration the next day.

And yet the US Treasury, Federal Reserve and FDIC shocked investors with the forceful nature of their full spectrum response, guaranteeing all three insolvent US banks’ deposits, including those above the historic US$250,000 cap. The Fed further offered US banks unlimited cheap loans backed by their assets. Wholesale runs have since stopped.

The Swiss response to Credit Suisse was characteristically slow and reactive. If they had simply guaranteed all Credit Suisse deposits upfront, there would never have been a run. If governments pre-emptively assure depositors they will not lose a single cent, which has been true of all these banking failures thus far, they would have no incentive to pull their money in the first place. These guarantees directly cauterise the crisis of confidence.

Instead, the Swiss offered belated and hesitant remarks about Credit Suisse’s capital and liquidity integrity, while extending it a fairly useless CHF50 billion loan. Deposits continued to rush out the door, and Credit Suisse was compelled to sell itself for a tiny sum to UBS days later. The Swiss further managed to invert the capital structure hierarchy that is sacrosanct in all Basel 3 banking regulations by wiping out Credit Suisse hybrid holders while allowing shareholders to retain some residual value.

It was a case study of how to blow-up a bank badly, which was quickly condemned by the European Union and the Bank of England in public statements declaring that shareholders need to be wiped-out before higher-ranking creditors wear losses.

Given these bumbling regulatory efforts, the short-sellers have predictably turned to the next most obvious target, Deutsche Bank.

They started by pushing its credit default swap spreads sharply wider, which is easy to do. This is an insidious way to signal that DB is harbouring prospectively large losses (never mind that nobody can actually identify any). It further makes counterparties very nervous about trading with DB, which is a key part of its investment banking business. 

The hedge funds then attack DB’s bonds and equities, which are both very easy to short. Planting spurious news stories about latent DB risks in its US commercial real estate portfolio helps seal the aspirational death spiral, much as the old, recycled line about the Saudi National Bank not being able to increase its stake in Credit Suisse (due to regulatory constraints) triggered a 30 per cent decline in its share price.

The bottom line is that US and European regulators need to speed-up the intensity of their own policy reaction functions to these contrived attacks on systematically important institutions given the velocity of digitised money. 

One obvious solution in Europe is to lift the EUR100,000 cap on the government guarantee of deposits, as the US has done. This would immediately prevent all deposit flight. Deposits are already perceived to be implicitly guaranteed: removing the cap just makes this explicit, which it always becomes in any crisis.

Another complementary option is a temporary ban on speculative short-selling of the stocks and bonds of banks when it is clear that these activities are motivated by hyperbolic assaults on the public trust of, and confidence in, the targets in question. This could be a matter for the banking regulator to resolve. 

There may be times when a bad bank should be left to the wolves, and wound-up. But if the institution is fundamentally sound, its depositors and other creditors should not be unnecessarily paralyzed by a fabricated crisis of confidence.  

Investment Disclaimer Past performance does not assure future returns. All investments carry risks, including that the value of investments may vary, future returns may differ from past returns, and that your capital is not guaranteed. This information has been prepared by Coolabah Capital Investments Pty Ltd (ACN 153 327 872). It is general information only and is not intended to provide you with financial advice. You should not rely on any information herein in making any investment decisions. To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information. The Product Disclosure Statement (PDS) for the funds should be considered before deciding whether to acquire or hold units in it. A PDS for these products can be obtained by visiting Neither Coolabah Capital Investments Pty Ltd, EQT Responsible Entity Services Ltd (ACN 101 103 011), Equity Trustees Ltd (ACN 004 031 298) nor their respective shareholders, directors and associated businesses assume any liability to investors in connection with any investment in the funds, or guarantees the performance of any obligations to investors, the performance of the funds or any particular rate of return. The repayment of capital is not guaranteed. Investments in the funds are not deposits or liabilities of any of the above-mentioned parties, nor of any Authorised Deposit-taking Institution. The funds are subject to investment risks, which could include delays in repayment and/or loss of income and capital invested. Past performance is not an indicator of nor assures any future returns or risks. Coolabah Capital Institutional Investments Pty Ltd holds Australian Financial Services Licence No. 482238 and is an authorised representative #001277030 of EQT Responsible Entity Services Ltd that holds Australian Financial Services Licence No. 223271. Equity Trustees Ltd that holds Australian Financial Services Licence No. 240975. Forward-Looking Disclaimer This presentation contains some forward-looking information. These statements are not guarantees of future performance and undue reliance should not be placed on them. Such forward-looking statements necessarily involve known and unknown risks and uncertainties, which may cause actual performance and financial results in future periods to differ materially from any projections of future performance or result expressed or implied by such forward-looking statements. Although forward-looking statements contained in this presentation are based upon what Coolabah Capital Investments Pty Ltd believes are reasonable assumptions, there can be no assurance that forward-looking statements will prove to be accurate, as actual results and future events could differ materially from those anticipated in such statements. Coolabah Capital Investments Pty Ltd undertakes no obligation to update forward-looking statements if circumstances or management’s estimates or opinions should change except as required by applicable securities laws. The reader is cautioned not to place undue reliance on forward-looking statements.

Christopher Joye
Portfolio Manager & Chief Investment Officer
Coolabah Capital

Chris co-founded Coolabah in 2011, which today runs over $8 billion with a team of 40 executives focussed on generating credit alpha from mispricings across fixed-income markets. In 2019, Chris was selected as one of FE fundinfo’s Top 10 “Alpha...

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