The real center of the financial storm is with Europe’s banks and financial institutions…and the very center of this storm lies in Frankfurt, Germany, home to Duetsche Bank (NYSE: DB) which is said to have a large book of derivatives that dwarfs the size of the bank’s assets. I have read from at least two sources that the total notional value of the derivatives book of Deutsche Bank is quite large–very large and possibly unmanageable in a crisis.
But first, let’s digress a moment to the Brexit event that happened last Friday morning. From what I am reading in Barron’s (www.barrons.com) and other financial news sites this weekend, it seems that with Prime Minister Cameron resigning under pressure, that a new coalition government will form in the coming weeks that will represent the new will of the people.
In the Parliamentary system, change can happen much faster than it does here with our Congressional and Executive government system….
So, I think it’s unlikely that Parliament will refuse to carry out the wishes of their electorate….unless the economy gets so bad and the citizens ask for another vote….but things will have to get bad first, in my humble opinion.
As for the markets tumbling, that has more to do with the Euro countries and with the banking system in Europe. In other words, it’s not the UK’s exit that has investors on pins and needles, but it’s the EU that is at the center of the crisis.
With the UK vote in favor of exit, this will de-stabilize Europe and so we are likely to learn that countries like Spain, Greece and Italy will also want to exit so they can escape the onerous rules that the EU has imposed on their growth due to high debt problems…
In other words, should this crisis get out of hand, then DB may not be able to honor its derivatives trades–just as AIG could not honor its derivatives trades back in 2008 and only when the US government bailed out AIG, was the world saved from a calamity!
Now, DB is said to be in a similar tight spot as was AIG, except that the trigger event has not yet happened for DB, but it’s much closer today than it was last Thursday before the Brexit results were known. There is no known crisis yet (and so I don’t want to sound alarmist), but the worry is that this could get out of hand before DB or other banks can safely unwind their derivatives positions.
So, if DB runs into deep trouble, will the EU central bank come to the rescue? What about other large banks with large derivatives positions?
I don’t think the EU has enough assets to pull off a meaningful bailout….the FED doesn’t have the fire power either, nor would it attempt a rescue of a foreign bank for political reasons….the only possible savior would be the IMF and the World Bank, which is the only world bank that still has a pristine balance sheet. But how much damage might occur before the emergency response is acted upon?
AND what happens to the current two top reserve currencies, the dollar and the Euro, should the IMF have to bail out the European banking system?
Will the counter-parties to DB and CS’s derivatives also collapse?….after all, JPM, Citi and BAC, GS and MS (all US based banks)hold many of the counter-party trades to those swaps, options and futures held in Europe. Could the US dollar also collapse in such a scenario? If so, would the IMF make the SDR the new global currency?
I don’t claim to know the answer to that one (yet), but I do think owning some gold can soften the blow, should this selloff escalate faster than many experts are predicting!