Deutsche Bank CEO: Bond Insurer Downgrade Will Create Debt " Tsunami"

Deutsche Bank’s CEO Josef Ackermann issued a stark warning today: bond insurer downgrades would have catastrophic consequences, on par with the subprime crisis.

Note tha this view is in contrast with teh comparatively sanguine readings that have been coming from some US analysts and the US media, which now appears to regard teh increasing possibility of bond insurer downgrades are No Big Deal. The stock market is staging a wee rally despite a downbeat reading on the odds of success for the bailout talks led by New York insurance superintendent Eric Dinallo.

Ackermann’s warning is consistent with a rumor we heard earlier this week from a well-placed source, who said that Trichet, the ECB’s chief, had made a strong plea for the Treasury to bail out the bond guarantors. And by that we don’t mean mean merely “get involved in Dinallo’s talks”; we mean stump up cash. (Note this same source predicted Trichet’s about face on interest rate cuts, and said they would be triggered by worries about the banking system, so his quote at the end of the Bloomberg story may be obligatory posturing).

The reason is that European banks were big buyers of later vintage CDOs (2006-2007) and RMBS, which will not only take a hit when any credit enhancement provided by the bond guarantors is removed but independent of any price impact, downgrades will also reduce their statutory capital. Why? Banks (which bought primarily AAA tranches) can treat AAA paper as a risk free asset; the reserve requirements are minimal. A downgrade to AA increases the reserve requirements markedly, and CDOs are generally downgraded more than a mere grade or two when they fall (I wish I could be more crisp here, but Basel II makes matters more complicated). Thus a loss of the bond guarantor AAA has a quick and nasty impact on bank capital adequacy.

From Bloomberg:

Deutsche Bank AG Chief Executive Officer Josef Ackermann said rating downgrades for bond insurers pose risks that could match the U.S. subprime market collapse.

“It could be a tsunami-like event comparable to subprime,” Ackermann said in a Bloomberg Television interview in Frankfurt today. Deutsche Bank, Germany’s biggest bank, is “well positioned” on its risk from bond insurers, he said…..

Banks and securities firms have already reported credit losses and writedowns of $146 billion. Downgrades of the bond insurers may force financial firms to write down a further $70 billion, Oppenheimer & Co. analyst Meredith Whitney said last month….

“It is bad practice to rely on the judgment of those whose misjudgments have caused the current crisis,” Ackman wrote in the letter dated Feb. 5.

European Central Bank President Jean-Claude Trichet rejected Ackermann’s characterization of the potential fallout from bond insurer downgrades.

“I certainly would not mention anything like waves of tsunami or any other mention of that sort,” Trichet said at a press conference in Frankfurt. “The fact that this correction continues along various markets is not something which should surprise us, its an ongoing process.”

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  1. Doc No

    Hey Yives,

    Ot, but what do you know about TIPS and treasuries?

    I went here and this is a little new to me:

    My interest today is related to how The Fed target rate for lending is adjusted in relation to Treasuries.

    This caught my attention today: Adjusted for inflation, the Fed’s benchmark rate “is now approaching zero,” making it “clearly an accommodative level,” Plosser said. Traders expect the Fed to lower the target rate for overnight loans between banks to 2 percent by June, futures show.

    Thus my question related to both parts above, is, is The 10 year treasury adjusted for inflation; I think not, but perhaps you can take a few seconde to explain that if possible.

    The reason that interest me is because I sometimes look at stock index valuations based on earnings yield, e.g, The inversion of the S&P 500 index P/E is the earnings yield and can be thus correlated to a 10 year bond yield; this gives a simple range of overvaluation of undervaluation, but now, I am very curious as to the great possibility, that the 10 year treasury yield is not adjusted for inflation, thus this benchmark I use could be off by 3 or 4%.

    Several weeks ago, I wondered if the S&P was overvalued by 5%, but now Im thinking maybe 8%.

    Any thoughts?

  2. Anonymous

    Re: ““It is bad practice to rely on the judgment of those whose misjudgments have caused the current crisis,” Ackman wrote in the letter dated Feb. 5.”

    >> Is he talking about himself there or who? I assume he is speaking in terms of some other underwriter, banker, investor or rating agency and trying to do some PR to make himself look less guilty?

  3. Yves Smith

    Anon of 4:35 PM,

    Ackman did not make the bad business decisions that led to the bond insurers’ woes, so I find it a bit odd that he is the target of your ire. Saying that the emperor has no clothes doesn’t make one responsible for his nakedness. I suggest you read his 145 page slide show on MBIA and Ambac, or his more recent 30 page letter to the regulators before casting aspersions.

    Moreover, if this was merely a slander campaign by a determined short, the markets would shrug it off. But the credit default swaps for all the insurers are trading at distressed levels, and for some time.

    Ackman has been saying since 2002 that the monolines’ business model didn’t work. If the regulators had listened to him then, the insurers never would have gotten in the position to endanger the financial system.

  4. Anonymous

    Hi Doc no,

    Real interest rates = Nominal interest rates minus Inflation

    TIPS – Treasury Inflation Protected Securities. A bond that receives a fixed stated rate of return, but also increases its principal by the changes in the Consumer Price Index.

    A straight treasury bond only has a fixed nominal rate of return when purchased.

    TIP usually pay 1- 3 % real return.

    Treasuries pay a nominal return, but can even yield a negative real return. Say inflation is 7 % and a treasury pays 4%, so the treasury would yield a negative 3% real return

  5. Anonymous

    Debt tsumami story (OT):

    Northern Rock was officially reclassified as a public enterprise yesterday in a move that means one of the Treasury’s cherished rules for the public finances has been breached.

    The Office for National Statistics said it had taken the decision to designate it a state entity because the size of the government’s support for the stricken bank meant it had effective control. The move has the effect of bringing up to £100bn of Northern Rock’s liabilities onto the national debt.

    Although the Treasury said the move was only temporary, it means that one of Gordon Brown’s two fiscal rules – that public debt should not exceed 40% of gross domestic product – will be broken. The national debt stands at £537bn, equivalent to 37.7% of GDP. The ONS said the reclassification would add 6.7 percentage points to that figure, taking it to 44.4%.

  6. Yves Smith


    Whoops. Thanks. Readers know proofreading is not my strong suit, and the spell check in Blogger hasn’t been working this week.

  7. invictus

    You bring up a stellar point about the new Basel II which banks have to adhere to. Perhaps you could elaborate in a later post on the ramifications of CDO downgrades and on the different tier capital levels. Just something to keep in mind since you could articulate the nuances of Basel II as good as anyone IMO.

  8. tom a taxpayer

    Real justice would be for the the bond insurers to tell Deutsche Bank, Citigroup, Goldman Sachs, and all the other Mismanagers of the Universe to go pound sand.
    Why? Because like any insurer, the insurer does not have pay claims when the claimant has acted recklessly or fraudulently.

  9. eh

    …who said that Trichet, the ECB’s chief, had made a strong plea for the Treasury to bail out the bond guarantors.

    I been positing elsewhere over the last couple of weeks that this would ultimately happen, and be justified as the lesser of two evils.

    Still, I personally would like to tell Trichet to phuck off, even if US officialdom won’t.

  10. Anonymous

    Just a thought.

    Seems like Deutsche Bank and Goldman are the ones who pretty much hedged the subprime crisis — using CDS. I suspect that the current situation leaves them both scared silly — not that Goldman will ever show it.

Comments are closed.