... we use a method called causal inference to make forecasts about events arising in complex systems such as capital markets. ...
This is the same method we used to correctly forecast the outcome of the Brexit vote. Now we’re using it to forecast the likelihood of a Deutsche Bank stock collapse in the next few months.
The strongest signal is not coming from Germany — it’s coming from Italy. While the world is waiting for the denouement of the Deutsche Bank drama, another bank fiasco is playing out in Italy. This involves the Banca Monte dei Paschi di Siena (BMP), the world’s oldest bank still in operation, founded in 1472.
BMP was the only top bank to fail the ECB’s recent stress tests. It is required to raise capital and has announced plans to do so. The capital raise is being led by JP Morgan and a syndicate including Goldman Sachs and some of the largest banks in China.
The syndicate was formed in July and was supposed to announce results by the end of September. We’re almost there and the news is not good. Reuters recently reported that the capital raising effort is not going well, and the syndicate expects they will delay any announcement until after important Italian elections scheduled for November.
What do the travails of BMP have to do with Deutsche Bank? Both banks are too-big-to-fail and are failing, but BMP is closer to the brink. It’s the “canary in the coal mine” for Deutsche Bank.
Italy wants to bail-out BMP with taxpayer money. That’s the standard playbook that governments used in 2008. But the rules have changed.
At the G20 Leaders’ Summit in Brisbane in 2014, it was decided that bailouts would be replaced by “bail-ins.” In a bail-in taxpayer money is not used to recapitalize the sick bank. Instead bondholders and depositors take haircuts and are involuntarily converted into equity holders.
Imagine if you had $500,000 on deposit at the bank and you got a notice in the mail that said your deposit was now $250,000 (the insured amount) and the other $250,000 had been converted into stock in a “bad bank,” which might or might not produce returns in the future. That’s what happens in a bail-in.
The German government under Angela Merkel is telling Italy that they cannot bail-out BMP; they have to use the new bail-in rules instead. But what’s sauce for the goose is sauce for the gander. If Germany forces Italy to bail-in BMP, then Italy will insist that Germany also bail-in Deutsche Bank when the time comes.
Germany won’t like that, but if they don’t bail-in Deutsche Bank, the European Union will come apart because of acrimony between Italy and Germany. Compared to this dispute, UK Brexit is a sideshow. Greece is a sideshow of a sideshow. Italy is the real deal. If Germany and Italy can’t cooperate, then there is no European Union.
This is why the BMP capital raise syndicate pushed their announcement out past November. They know that if they announced their failure today, the bail-in option would be required immediately and the government would lose the elections. If the government can get past the elections intact, the bail-in of BMP (or bail-out as the case may be) can come in December.
Markets won’t wait while German and Italian politicians tiptoe around the bail-in question. They will draw their own conclusions and start a run on Deutsche Bank. It’s already happening. That will take the stock down another 90% on top of the multiple crashes that have already occurred.
The German government will let Deutsche Bank stock fall to €2 before they intervene. That’s how existing stockholders make their “contribution” to the bail-in.
Deutsche Bank won’t fail and the stock won’t go to zero. But there’s still plenty of room to fall, and this story is far from over. The eurozone is in trouble.
