BY Ernest Cheong
We are living in very perilous times. Since the beginning of 2015, the economic situation in Malaysia has worsened in tandem with the worsening global economy particularly in Europe and the United States.
Reuters reported in 2015 that falling oil prices have driven Malaysia’s current account into a deficit and forced the government to review its Budget 2015 tabled in 2014, and there were four “red lights blinking on Malaysia” including government debts, household debts, capital account debts and current account debts.
Deutsche Bank in its special report on Asia’s 2015 macro outlook predicted that the ringgit will fall to the 2008 crisis level of RM3.73 against the US dollar, as it believed that Malaysia’s “worrying profile of indebtedness” will act as the currency’s Achilles heel in 2015.
Deutsche Bank further stated that “Malaysia stands out as the weakest link in the region, boxed in on four metrics of indebtedness: the external debt metrics are worrying, the fiscal debt is likely to overshoot, household debt is of concern and the current account is at risk of dipping into deficit”.
In a 2015 report, CNN warned that investors are taking an increasingly critical view of the Malaysian economy amid fears that the major oil-exporting country might start running current account and fiscal deficits at the same time due to the recent plunge in oil prices. It also said the country is running a deficit, and the outstanding balance of government debt is equivalent to around 55 per cent of GDP, the highest among Southeast Asian nations.
With these four “red lights blinking on Malaysia” reported in 2015 in various forms, how would the country fare in the looming global economic and banking crisis that is beginning to happen in many parts of the world in 2016, and into 2017 and beyond?
Economic news from Europe and the US during the past 12 months pointed to the deteriorating global economy.
Here are some of the more alarming news:
i) US banks’ US$278 trillion exposure to derivatives
It is reported that the six largest US banks collectively have US$278 trillion exposure to derivatives. The US government’s Office of the Comptroller of the Currency (OCC) in its most recent quarterly report released details of their individual exposure as follows:
a) JP Morgan Chase
Total assets: US$2,573,126,000,000 (about US$2.6 trillion)
Total exposure to derivatives: US$63,600,246,000,000 (about US$63 trillion)
Ratio of derivatives to assets: US$63 trillion/US$2.6 trillion
JP Morgan Chase’s exposure to derivatives is 24.23 times their total assets.
Total assets: US$1,842,530,000,000 (about US$1.8 trillion)
Total exposure to derivatives: US$59,951,603,000,000 (about US$D59 trillion)
Ratio of derivatives to assets: US$59 trillion/US$1.8 trillion
Citibank’s exposure to derivatives is 32.77 times their total assets.
c) Goldman Sachs
Total assets: US$856,301,000,000 (about US$0.85 trillion)
Total exposure to derivatives: US$57,312,558,000,000 (about US$57 trillion)
Ratio of derivatives to assets: US$57 trillion/US$0.85 trillion
Goldman Sachs’ exposure to derivatives is 67.05 times their total assets.
d) Bank of America
Total assets: US$2,106,796,000,000 (about US$2.1 trillion)
Total exposure to derivatives: US$54,224,084,000,000 (about US$54 trillion)
Ratio of derivatives to assets: US$54 Trillion/US$2.1 trillion
Bank of America’s exposure to derivatives is 25.71 times their total assets.
e) Morgan Stanley
Total assets: US$801,382,000,000 (about US$0.8 trillion)
Total exposure to derivatives: US$38,546,879,000,000 (about US$38 trillion)
Ratio of derivatives to assets: US$38 trillion/US$0.8 trillion
Morgan Stanley’s exposure to derivatives is 47.50 times their total assets.
f) Wells Fargo
Total assets: US$1,687,155,000,000 (about US$1.7 trillion)
Total exposure to derivatives: US$5,302,422,000,000 (about US$5 trillion)
Ratio of derivatives to assets: US$5 trillion/US$1.7 trillion
Wells Fargo’s exposure to derivatives is 2.94 times their total assets.
Summary of 6 largest US banks’ exposures to derivatives
1) Goldman Sachs: 67.05 times total assets 2) Morgan Stanley: 47.50 times total asserts
3) Citibank: 32.77 times total assets
4) Bank of America: 25.71 times total assets
5) JP Morgan Chase: 24.23 times total assets
6) Wells Fargo: 2.94 times total assets
Overall 6 largest US banks’ exposures to derivatives
Total exposure to derivatives: US$278,937,792,000,000 (about US$278 trillion)
Total assets: US$9,867,290,000,000 (about US$9.8 trillion)
Ratio of derivatives to assets: US$278 trillion/US$9.8 trillion
6 largest US banks’ exposure to derivatives is 28.36 times their total assets.
ii) Germany’s Deutsche Bank AG’s US$75 trillion exposure to derivatives
How exposed is Deutsche Bank? The trouble is that its conventional retail banking operations are not generating significant profits. To maintain margins, it ventured into riskier business activities than its peers.
It is reported that Deutsche Bank AG in Germany has US75 trillion exposure to derivatives. Germany’s Gross Development Product (GDP) is only US$3.75 trillion. Effectively, Deutsche Bank AG’s US$75 trillion exposure to derivatives is 20 times the German GDP.
Deutsche Bank AG’s total assets is US$2 trillion and the ratio of derivatives to assets may be computed as follows:
Total assets: US$2,006,000,000,000 (about US$2 trillion)
Total exposure to derivatives: US$75,000,000,000,000 (about US$75 trillion)
Ratio of derivatives to assets: US$75 trillion/US$2 trillion
Deutsche Bank AG’s exposure to derivatives is 37.5 times their total assets.
iii) What are derivatives?
A derivative is not an investment in anything. When you buy a stock (share) you are purchasing an ownership interest in a company. When you buy a bond, you are purchasing the debt of a company.
Most derivatives are simply bets (gamble) about what will or will not happen in the future.
The six big US banks and the German bank, when they “invested” in derivatives, they were actually engaged in betting (gambling) activities and they did not engage in their usual retail banking activities. They transformed the banking systems in the US and Germany into casinos.
When things run smoothly, they make lots of money. When things do not run smoothly like at the present time, many banks like Deutsche Bank AG find themselves in great financial difficulty or may even face bankruptcy!
Meanwhile, Hongkong and Shanghai Banking Corporation (HSBC), the biggest bank in the western world, has just declared “the global economy is already in a recession”. According to HSBC, global trade is down 8.4 per cent so far this year (2016), global GDP expressed in US dollars is down 3.4 per cent, and “we are already in a dollar recession”.
Goldman Sachs, in a note released recently, said “emerging markets (including Malaysia) aren’t just suffering through another market rout – it is a third wave of the global financial crisis” and “increased uncertainty about fallout from weaker emerging market economies, lower commodity prices and potentially higher US interest rates are raising fresh concerns about the sustainability of asset price rises, marking a new wave in the global financial crisis”.
To recap, Lehman Brothers in 2008 was “felled” by “subprime loans” that were beginning to perform poorly in the marketplace in late 2007.
The first public indication that it was going downhill was when Fitch Ratings Agency cut its srating to AA-minus, outlook negative, which started a chain of actions and reactions that three months later led it to announce a major loss and to file for bankruptcy.
The week in September 2008 that changed a decade:
Sept 10: Lehman Brothers announced US$3.9 billion loss
Sept 13: US Federal Reserve mooted liquidation option for Lehman Brothers
Sept 14: UK regulators vetoed rescue bid from Barclays Bank
Sept 15: Lehman Brothers filed for bankruptcy protection
Imminent collapse of Deutsche Bank AG in 2016/2017?
Could what happened to Lehman Brothers in September 2008, happen to Deutsche Bank AG in 2016/2017? The situation faced by Lehman Brothers in 2008 was somewhat similar to that now being faced by Deutsche Bank AG in 2016.
In 2008 Lehman Brothers was “felled” by “subprime loans”. Could the US$75 trillion derivatives they were exposed to bring down Deutsche Bank AG in 2016/2017?
Consider these signs:
i) In 2016 Deutsche Bank announced a loss of US$6.7 billion (6 billion euros) for the third quarter of 2015;
ii) In 2016 it warned investors of a possible dividend cut; and
iii) In July 2016 it announced that it is preparing to retrench 23,000 employees that represent 25 per cent of its staff.
Global domino effect of a Deutsche Bank AG collapse in 2016/2017
The global banking and financial system is an inter-connected and closely linked global trading system.
Deutsche Bank is linked to banks in other parts of the world including banks in Germany and Europe, the US, and Asia including Malaysia, China and Japan through their daily “counter-parties” trading activities.
To help readers understand how counter-parties trading activities between Deutsche Bank and other banks in the world works, let us consider a typical trading scenario between a German importer and a Malaysian exporter.
Company A in Germany wants to buy crude palm oil from Company B in Malaysia. Company A instructs Deutsche Bank in Germany to issue to Company B’s bank in Malaysia, say, CIMB Bank, an international letter of credit (LC).
Upon having been notified by CIMB Bank of the receipt of the international LC from Deutsche Bank in Germany, Company B would export and ship the purchased crude palm oil to Company A’s given address in Germany.
In due course after the purchased crude palm oil has arrived in Company A’s address in Germany, Deutsche Bank in Germany would release to CIMB Bank in Malaysia payment for the crude palm oil and CIMB Bank would in turn release the payment to Company B.
Deutsche Bank would also engage in other trading activities with Malaysian banks in the world including currency trading and the issuance of bank guarantees and other related legal documents to facilitate cross-border trade between customers of Deutsche Bank in Germany and customers of Malaysian banks.
Consequences of Deutsche Bank collapse to Malaysian citizens and businesses
When Deutsche Bank collapses before the crude palm oil arrives in Germany and before Deutsche Bank could pay CIMB Bank in Malaysia for the exported crude palm oil, Company B in Malaysia in the above scenario would not be paid for the crude palm oil it exported and shipped to Company A in Germany. Company B would suffer financial losses.
When Deutsche Bank collapses, its counter-parties in Malaysia for other trading activities including currency trading and the issuance of bank guarantees and other related legal documents would suffer losses due to Deutsche Bank’s inability to pay and its inability to honour its obligations to these Malaysian banks and Malaysian citizens and companies.
These losses would multiply across the global banking system and would affect banks and their customers that have counter-parties business and trading activities with Deutsche Bank and Deutsche Bank’s customers before the collapse of Deutsche Bank.
Its collapse would likely adversely affect other banks in the global financial system. Whether or not these affected banks would collapse or be badly wounded would depend on how closely they are linked to Deutsche Bank.
The above is part 1 of a two-part article.In part 2, I will discuss the current situation viz-a-viz the state of the Malaysian property market and how we can protect ourselves and survive the devastating effects of the looming collapse of Deutsche Bank AG and the consequential domino effects such a major western bank’s collapse can have on the global financial and banking system including our banking system and economy.
Dr Ernest Y Y Cheong holds a Doctor of Business Administration (DBA) and an MBA. He is also a Chartered Surveyor, Registered Valuer, Auctioneer, Arbitrator and Principal of Ernest Cheong PTL Chartered Surveyors. Contact him for [email protected] or visit www.ecptl.com and www.propertygandhi.blogspot.com