Eric Reguly, European Bureau Chief, Rome –Abolishing interest rates sounds like the greatest idea since spray cheese. Money for nothing, mortgages for free! In Denmark, Jyske Bank AS is offering 10-year mortgages where the bank actually pays the borrower interest of 0.5 per cent a year. Imagine that. But that’s what happens when the banking world turns upside down.
Interest rates are tumbling everywhere and turning negative in some spots. The central banks in Switzerland, Denmark, Sweden and the euro zone (the European Central Bank) have all slapped minus signs ahead of their key rates. Some US$15-trillion of bond debt around the world comes with a negative yield, that is, their investors will get back less than they paid out if they hold the bonds to maturity.
In Europe, the yields on the 10-year sovereign bonds of Austria, Belgium, Denmark, Finland, France, Germany, Ireland, the Netherlands, Sweden and Switzerland are all negative. And the ones that are still positive are barely so. Today, in Europe, the default best bet is Italian bonds, which on Friday traded at a yield of 0.9 per cent. At the peak of the financial crisis, in 2012, Italian yields hit 7 per cent.
There’s a lot to like about negative interest rates, especially if you are borrower. There is a lot not to like too – especially if you are a saver. And the banking industry, especially in Europe, is worried sick about negative rates, which could soon turn even more negative if, as expected, the ECB rolls out another cut later this year (in July, the U.S. Federal Reserve cut rates by a quarter point, the first reduction in a decade).
For Deutsche Bank AG and many other banks, the negative rate world comes at an especially bad time. Deutsche Bank, a perennial restructuring story, needs all the help it can get as it fires thousands of employees and tries to find a strategy that produces sustainable profits. The German banks alone, dominated by Deutsche Bank and Commerzbank AG, estimate that negative rates cost them €2.4-billion ($3.49-billion) a year, about a third of the total cost to the euro zone banks.
At a conference this week sponsored by the Handelsblatt newspaper, Deutsche Bank’s CEO, Christian Sewing, said that “In the long run, negative rates ruin the financial system,” adding that another ECB cut “may make refinancing cheaper for states, but has grave side effects.”
The European banks tremble at the prospect of ever-deeper rate cuts because they have never fully recovered from the financial 2008-09 financial crisis, in good part because they were never propped up during the crisis like the American banks were. The U.S. financial system was treated to the mother of all bailouts. Remember former U.S. Treasury Secretary Timothy Geithner, and his “foam the runway” campaign to prevent Wall Street from collapsing through the Troubled Asset Relief Program (TARP) and the Home Affordable Modification Program (HAMP)? The two initiatives saw hundreds of billions of dollars devoted to buying bank shares and mortgage-backed securities, and propping up house owners who were on the verge of default.
The U.S. banks were saved and bank bosses like Lloyd Blankfein, of Goldman Sachs Group Inc., and Jamie Dimon, of JPMorgan Chase & Co., got obscenely rich. Their banks, and others, became stock market stars. Today, JPMorgan has a market value of more than US$350-billion. Deutsche Bank’s value is €14-billion.
To be sure, the European banks were supported, but to nowhere the same degree as their American counterparts. At the same time, the European recession lasted far longer than the American one, and just as the economy began to recover, negative rates began to appear (Denmark’s central bank was first off the mark, in 2012).
The result? The U.S. banks trade at about 1.2 times book value (assets less liabilities, in simple terms). The European banks trade at half their book value. There are two ways of looking at the European banks’ sorry book-value status. The first is that they are massively undervalued and represent great potential bargains. The second is that the ratio is deserved because the banks are in trouble and see no turnaround prospects any time soon. The latter view has been winning among investors.
No wonder the European banks are dumping employees and that the ECB is encouraging bank mergers, all the easier to prop them up, and reduce overhead costs, while bank shareholders and regulators pray for an economic revival. Trouble is, the European economy seems to be going in reverse. Germany, Italy and Britain – three of the four biggest economies in the European Union – seems to be heading for recession as their economic numbers deteriorate, trade tensions build and Brexit approaches.
As negative rates persist, some banks won’t make it. Even the future of once-mighty Deutsche Bank is an open question. A fresh European banking crisis is not out of the question.