Last Friday, what was already a bad global banking crisis following the implosion of the US regional banking sector and the collapse of Credit Suisse last weekend, turned much worse when as we showed at the time, the CDS of Deutsche Bank blew out to levels wider than those hit during the covid crash…
… and sparking another global market rout amid growing fears that the largest European bank could fail next.
The CDS – and stock – rout prompted a barrage of verbal defense by everyone from Wall Street analysts (working for other banks and thus who are thus quite incentivized, and conflicted, in preventing a bank crash that would dwarf Lehman) and European politicians (who would be on the hook for the multi-billion bailout and/or depression should DB fail), and for now this has succeeded with both DB stock and CDS stabilizing in the past few days. Meanwhile, realizing they must quickly bolt down all the “weakest links” moments ago Bloomberg reported that regulators are taking a page out of the post-Lehman playbook and as part of the scapegoating campaign which looks at everyone but those responsible, are “singling out a trade on Deutsche Bank AG’s credit default swaps that they suspect fueled a global selloff on Friday.”
The trade in question, according to Bloomberg sources, represents a laughable €5 million ($5.4 million) bet on swaps tied to the German bank’s junior debt, which also happens to be the smallest tradable denomination and blaming the near collapse on DB on one single CDS trade is equivalent to blaming the May 2010 flash crash on two-bit stay-at-home daytrader Navinder Sarao (which, come to think of it, is precisely what happened so we aren’t that shocked). And to frontrun the perpetual mockery from those who actually know how the CDS market works, BBG was quick to note that CDS contracts can be illiquid, “so a single bet can trigger big moves.” Yes it can… and a big move will trigger even bigger counter moves, assuming there is anyone in the market with any conviction. It is the fact that nobody was willing to take the other side on the smallest possible short risk bet targeting DB’s junior debt, that speaks volumes about this idiotic “explanation” for why DB almost went down last Friday.
Of course, if one is dumb enough to believe that one single, solitary trade can spark a marketwide avalanche, then what happens next is obvious:
The suspected knock-on effect was a rout that sent banking stocks tumbling, government bonds higher and CDS prices for lenders soaring, trimming about €1.6 billion off Deutsche Bank’s market cap and more than €30 billion off an index that tracks European banking stocks.
So yeah, tens of billions in value wiped out because of literally the smallest possible CDS increment one can trade. Good narrative-shaping there, guys.
There is a reason why regulators are scrambling to pin the blame on some tiny family office that was hoping to hedge against a DB collapse: European banks and their regulators have sought to underline that they have a close watch on risks — including rising rates — and that the industry is on a sound footing. Events last Friday showed just how clueless Europe’s regulators are. One could say they are almost as clueless as their US peers who allowed the regional bank crisis to reach a level where nobody knows what is safe anymore.
Amid the unwanted attention, German lender published a presentation on Monday that cited its “well diversified portfolio” of deposits, a key focus for investors following the collapse of Silicon Valley Bank. Deutsche Bank and the broader index rebounded on Monday, erasing some of Friday’s losses.
So who gets to be the Nav Sarao of this bank crisis? We don’t know yet, because according to BBG, “it’s unclear who placed the relevant trades or why they did it.” Hilariously, even BBG admits that this wasn’t some premeditated attempt by some rookie to crash the banking system, but rather concedes that “some data point to the trades being for hedging purposes, said one of the people.”
And just in case the laughter isn’t loud enough yet, the report goes on to note that “there’s also a trade on Deutsche Bank’s five-year, senior CDS contracts executed on Thursday that attracted scrutiny, one of the people said.”
Oh, so it wasn’t one CDS trade… it was two. Well, congrats to DB for surviving not one but two short trades!
The search for triggers underscores a general lack of transparency in the asset class, which Andrea Enria, the European Central Bank’s top oversight official, flagged on Tuesday. He also called for global financial regulators to take a closer look at the CDS market.
“There are markets like the single name CDS market which are very opaque, very shallow, very illiquid,” Enria said at a conference hosted by German newspaper Handelsblatt. “With a few millions, you can move the CDS spreads” of a major bank “and contaminate also stock prices and possibly also deposit outflows,” he said, without naming any banks.
And just like in 2008, the demonization of CDS traders has begun. Unfortunately, it also means that the crisis is only just starting, and before it is done, plain vanilla stock shorts will also be thrown under the bus and shorting itself will be prohibited.