When the markets question the viability of a financial institution, then that firm is toast.
The capital markets were the ultimate forum for picking winners and losers, that was until 2008, when the term “Too Big To Fail” came into vogue.
Once a firm is tagged with the TBTF label, markets no long can become efficient and take the financial institution out through bankruptcy or merger.
This is where you see Deutsche Bank today. In the past before TBTF, Deutsche would be in a liquidity squeeze as markets question the viability of the firm ( see Lehman).
However, there has to be an explicit backing by the German government in order for Deutsche to still have its doors open.
Yes we get headlines that Deutsche’s borrowing costs are going up, that other firms are poaching Deutsche’s bankers and that its derivative book has been reduced to 43 trillion euros from 75 trillion euros.
But let’s work the notional value of a 50 trillion euro book, which conservatively could be 5 trillion euro in exposure. Deutsche’s current book value would have trouble covering the $14 billion Justice Department fine for mortgage security fraud charges. So how can the bank cover a 1% move on 5 trillion euro?
If the market could clean out a troubled firm (see Citigroup), then we would not have had to go through the last eight years of economic malaise. But that’s not to be, as governments and central banks — not the markets — pick winners and losers.
So if the Merkel government has given the markets a thumbs up in backing up Deutsche, which is the only explanation, then we can welcome back the zombie banks in Europe.