BREAKINGVIEWS-Deutsche spat reopens mark-to-model/myth debate

Thu Dec 6, 2012 6:37pm IST

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(The author is a Reuters Breakingviews columnist. The opinions expressed are his own)

By George Hay

LONDON, Dec 6 (Reuters Breakingviews) - Deutsche Bank (DBKGn.DE) is battling to move on from 2008 and the heart of the financial crisis. Former employees of the German bank allege it hid $12 bln of losses as the credit crunch hit. It reopens the debate over whether marking shaky assets to model was actually marking to myth – and whether it mattered.

The assets in question were complex synthetic collateralised debt obligations in Deutsche’s so-called “correlation book”. Instead of just using underlying assets, pointy-headed investment bankers also deployed credit default swaps to model portfolios. Like other trading assets, these were valued by looking at prevailing prices: marking to market, in other words.

When the crisis hit, liquidity in most structured credit assets collapsed. Banks then had a fallback: using their own valuation models. But that still required some kind of observable inputs. The debate between Deutsche, which denies the allegations, and its old employees is whether these models were appropriate, or fiddled with in order to hide the scale of the problem.

It’s not clear whether Deutsche went too far or not. It had an obvious incentive to avoid booking losses that could have led the German government to take a stake in the bank and shrunk the bonus pool. Yet the U.S. Securities and Exchange Commission, which has worked on the case since 2010, has not, as yet, come to any conclusion.

The wider question remains whether marking assets to market is an absolute good or a relative method. Had global accounting bodies not allowed investment banks to move large chunks of trading assets to their banking books in 2008 to avoid marking them to market, taxpayers might have had to stump up even more capital. Meanwhile, in the UK, the Bank of England is worried that lenders may be under-reporting their capital positions by not marking their loan assets to market. But restorative measures might involve shrinking loan books, hurting the economy.

An SEC ruling against Deutsche would clearly be a big blow. Although the bank had wound down most of the original correlation book with minimal losses, it is still seen as relatively undercapitalised under new “Basel III” reforms. It would also leave Anshu Jain, the Deutsche co-chief executive who used to run its investment bank, facing awkward questions about ill-gotten bonuses, including his own. But if Deutsche is found guilty, other mark-to-market refusenik banks may find themselves in similar hot water.

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CONTEXT NEWS

- Three former Deutsche Bank employees have filed complaints with the U.S. securities regulators claiming the bank failed to recognise up to $12 billion of unrealised losses during the financial crisis, the Financial Times reported on Dec. 5.

- Complaints to regulators including the U.S. Securities and Exchange Commission (SEC) said that Deutsche misvalued a large position in derivatives structures known as leveraged super senior trades, the newspaper reported, citing people familiar with the submissions.

- The report said this improper accounting allowed the bank to misrepresent its capital position and avoid a government bailout.

- “The allegations of financial misstatements, which are more than two and one-half years old and were publicly reported in June 2011, have been the subject of a careful and thorough investigation, and they are wholly unfounded," Renee Calabro, a spokeswoman at Deutsche Bank, told Reuters in an email.

- Reuters: Ex-Deutsche Bank employees say bank hid $12 bln in losses-FT [ID:nL5E8N5EN2] - For previous columns by the author, Reuters customers can click on [HAY/]

(Editing by Pierre Briançon and David Evans)

((george.hay@thomsonreuters.com))

((Reuters messaging: george.hay.thomsonreuters.com@reuters.net)) Keywords: BREAKINGVIEWS DEUTSCHE/

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