Last week began the annual Ryder Cup battle between the best of American and European golfers held this year across the pond.
The first Ryder Cup tournament was in 1927, based on player selection only from America and Britain. Even though Britain is the historic home of golf, during the subsequent 22 years of play, British teams lost 18 times. Then in 1979 as the European Union was getting established, the terms of British team selection were expanded to include players from all of Europe. The tide began to change with the European team winning 10 of the next 18 tournaments, and more recently, winning the last eight of 10 contests.
However, the friendly battles on the links are nothing compared to the battles between our respective governments. In August, the European Union sent Apple (AAPL) a 13 billion Euro ($14.6 billion) tax bill which CEO Tim Cook described as “total political crap.” Not to be outdone, in mid-September, Jack Lew and the US Department of Justice were reported to be seeking a $14 billion penalty against Deutsche Bank for its alleged transgressions in the mortgage bubble and bust.
Both governments are desperately trying to fund the massive debts incurred from their unprecedented monetary stimulus policies of the past eight years. Since the great recession, we have witnessed party lines drawn in obtuse stature. From Washington, the message seems to be echoing from polar opposite viewpoints. Power moves are displayed on a daily basis to elevate one parties’ agenda over the next, and astute high net worth investors know exactly how to profit from these engagements.
Barron’s reported on Friday that some hedge funds had
“Handsomely profited by shorting Deutsche stock – including some of the very ones that were said to have yanked their collateral – news of which helped propel the stock lower.”
The Deutsche Bank American Depository Receipts (DB) plunged by 20% on the announcements. Unlike Apple, Deutsche Bank total market capitalization is only $17.70 billion even after its 14% recovery bounce on Friday. By the end of last week, Deutsche Bank stock traded at 25% of its book value with the threat of a US penalty representing 78% of the entire company’s valuation.
As appealing it is to have “others” support failed government programs and resulting debt, it’s the average Americans that are most impacted. As hedge funds and astute investors are profiting from short positions (betting on Deutsche Bank’s decline) while closing their Deutsche Bank accounts, it is an erring similarity to September 2008 when similar hedge fund transactions and withdrawals resulted in bankrupting Lehman Brothers, a 100+ year financial institution. The bankruptcy ruined the careers and savings of 10,000+ employees. Many still remember the sad footage of 1,000’s of Lehman employees marched out of Lehman headquarters under police supervision carrying boxes of their office possessions. Not recorded were the years these average Americans struggled in paying their bills, providing for their families, and finding new jobs.
Don’t get me wrong; I am not saying any of the big banks that failed to properly vet mortgage-backed securities before selling them to investors as high-quality debt is an acceptable business practice. However, we should be equally outraged by the flimsy government legislation and regulation that has enabled this environment.
Since the establishment of the Community Reinvestment Act (CRA) in 1977, banks were required to issue mortgages to buyers of homes in “redlined” districts, areas with high percentages of lower income households. The CRA was advertised to the American people as a way to stop the supposed discrimination of lower income earners right to buy a home. Under CRA, banks were required to issue a percentage of their loans to potential homebuyers whose finances were outside bank lending standards. Each election, the rallying cry of politicians that everyone has a right to own a home, which resulted in the deregulation of banks issuing higher percentages of mortgages to unqualified borrowers. Remember George Bush in his 2002 homeownership speech?
“We certainly don’t want there to be a fine print preventing people from owning their home… We can change the print, and we’ve got to.”
It was only a matter of time that the multi-trillion-dollar mortgage industry would collapse.
Astute investors profited from these failed policies. However, it was again average Americans who paid the price with foreclosures, bankruptcies, eight subsequent years of stagnant economic growth, and owners of over $19 trillion in government debt (now more than all of the world’s physical cash, gold, silver, and bitcoin combined).
The same cycle is happening with Deutsche Bank. As a result of our governments tossing multi-billion dollar bills across the pond, American homeowners see a spike in newly issued mortgage interest rates, a cost they will be paying for the next 30 years. As Barron’s reported on Saturday:
“The negative headlines last week [about Deutsche Bank] sharply pushed up European banks’ funding costs, resulting in the highest spike in dollar borrowings from the European Central Bank since the European crisis of 2012-2013…
Libor [London Interbank Offered Rate] is the base rate for many U.S. loans, including some home mortgages. Three-month Libor has risen by more than 50 basis points (one-half of a percentage point) over the past year, to 0.825%, while the Fed has boosted its federal-funds target range just 25 basis points, to 0.25% -0.5%.”
WHAT DOES THIS MEAN TO ME?
Does any of this get your juices going? Whether or not Jack Lew and company drive Deutsche Bank into bankruptcy, their actions of pursuing an outlandish penalty is already impacting financial markets worldwide. DB stock rebounded sharply on Friday as rumors that the DOJ is willing to reduce the penalty to a mere $4.5 billion. Astute investors wait for anomalies in the marketplace to place large bets against the herd mentality. In many cases, it appears they are correct. Warren Buffet lent $5 billion to Citi Bank in 2008 on extraordinary costly terms to the bank and has benefited significantly. Those that bought US index funds during the darkest hours of the 2008 financial crisis have significant profits. However, not all trades are profitable. Shareholders of Lehman Brothers, Fannie Mae, and Freddie Mac have total losses. Many tech stocks from the 2000 tech bust don’t exist today. Currently, industries that appear under the most stress include financials, energy, medical, biotech, and pharmaceuticals. Certainly, contrarian style investing is a risky strategy but the rewards have been significant to those that were correct.
What industries do you think are being impacted and what is your investment strategy? How do you anticipate events like presidential election, OPEC policy changes, global warming legislation, and Federal Reserve on-off support of monetary stimulus will influence markets? Or what about the massive cash-out refinancing that has taken place due to artificially low-interest rates? We would like to hear your thoughts in the comment section!