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How US regulators may be creating panic around Deutsche Bank

Attorney General Loretta Lynch
Allison Shelley | Getty Images
Attorney General Loretta Lynch

Deutsche Bank finds itself in the center of a panic, and some analysts are pointing fingers at U.S. regulators.

Germany's biggest bank fell under fresh scrutiny beginning on Sept. 16 when it surfaced that the U.S. Department of Justice was demanding it pay a $14 billion fine for its mortgage lending activities during the housing bubble. Shares of Germany's biggest bank plunged on Thursday on reports that a handful of its big hedge fund clients were limiting their exposure to Deutsche Bank, though the bank has characterized those media reports as "unjustified concerns."

Certainly, the Justice Department is not the only organization scrutinizing Deutsche Bank: The IMF released a report this summer stating that that Deutsche Bank poses a greater risk to the global financial system than any other bank in the world.

But the size of that Justice Department fine has many analysts talking.

"We see little practical or political upside for the Justice Department to press Deutsche Bank for a penalty that is so large that it could destabilize the bank and provoke a new financial crisis," Jaret Seiberg, managing director at Cowen, said in a Thursday note. Like many analysts, he said he expects the final settlement to be negotiated to a lower price.

The Department of Justice declined to comment to CNBC, as did Deutsche Bank.

Some market participants worry that Deutsche Bank can't pay the billions in fines without some help from the German government or the European Central Bank. As of June 30, the bank had 5.5 billion euros ($6.17 billion) in litigation reserves.

"Certainly this appears to be severe. The size of the fine is severe. It may be intended to be severe. It may in fact prove to be devastating, and I wonder if the regulators thought that through," said Michael Farr, CEO and founder of financial consulting firm Farr, Miller & Washington.

He said he does not think a failure of Deutsche Bank would cause a banking crisis. "I think it really depends on how nervous investors get," he said, adding that a possible outcome for the bank could be a merger with another bank.

A plunge in Deutsche Bank's shares to record lows in New York trade Thursday temporarily left the financial institution with a market value of less than $17 billion, though the stock rebounded sharply on Friday.

Size of US bank settlements compared with issuance of mortgage-backed securities

Indications of diminishing confidence in the firm picked up this week. Selling began Monday following a weekend report that German Chancellor Angela Merkel ruled out state aid for her country's largest lender and any interference in the Justice Department investigation, according to a Reuters translation.

One of the messages the German chancellor may have wanted to send was to tell the United States, "if you take down Deutsche Bank, it's going to affect you as much as it did us," said George Friedman, chairman of Geopolitical Futures, an online publication that forecasts global events.

The last few days have seen various statements in which German authorities and Deutsche Bank representatives, including CEO John Cryan, have repeatedly said there is no need for government support.

The Department of Justice has been relatively quiet in contrast. Principal Deputy Associate Attorney General Bill Baer said at a conference Tuesday how banks generally could receive credit for their cooperation with investigations into residential mortgage-backed securities. And rather than make an official government announcement, The Wall Street Journal was the first to report two weeks ago that the Justice Department had proposed the $14 billion settlement. Deutsche Bank then confirmed the news in a press release.

"My guess is the U.S. regulators would (have) called it off if you thought it would really damage Deutsche Bank," said Maris Ogg, president at Tower Bridge Advisors. "You've got to worry about, certainly the U.S. regulators are not going to bring a bank down that's going to jeopardize the system."

Foreign bank, bigger fine?

Even if the fine is eventually negotiated lower, some speculate one of the reasons for the huge starting figure from the Department of Justice is the fact that Deutsche Bank is a European bank rather than an American one.

The DOJ "ran into a political green light because there was action to punish," David Bahnsen, chief investment officer of HighTower's The Bahnsen Group, said in an email. And since Deutsche Bank is a "non-U.S. bank they could take a shot at it."

Deutsche Bank would be the first European bank to settle on residential mortgage-backed securities with the DOJ. Others on the radar include Barclays, Credit Suisse, Royal Bank of Scotland and UBS.

On Friday, the Financial Times reported, citing sources, that the U.S. Department of Justice hopes to combine cases against Barclays, Credit Suisse and Deutsche Bank into a multibillion dollar settlement. All four parties declined to comment to the newspaper.

Looking at the relative volume of mortgage-backed securities issued by U.S. banks during 2005 and the actual fines they paid, Goldman Sachs analysts in a Wednesday note estimated Deutsche Bank will likely face a settlement in the range of $2.8 billion to $8.1 billion.

'Individuals commit crimes'

Certainly, prominent critics both within and outside government, as well as the U.S. public at large, have repeatedly said that big banks in general have not paid a dear enough price for the role they played in triggering the Great Recession.

Bartlett Naylor, a shareholder activist and a member of financial watchdog group Public Citizen, said the U.S. regulators should go after the individuals who misrepresented mortgage-backed securities rather than the entire bank.

"We're looking for individuals, because individuals commit crimes, not shareholders," he said. He's owned shares of Deutsche Bank for at least five years.

Reporting on those individuals is one of a bank's steps towards receiving cooperation credit, the Justice Department's Baer said in his speech.