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Deutsche Bank Derivatives Bomb and the ECB Cover-Up

March 21, 2017 (EIRNS)—The derivatives bomb of Deutsche Bank (DeBa) has not vanished: it is still there and has been covered up by the European Central Bank, according to an investigation by the Italian financial daily Il Sole 24 Ore. Il Sole’s story, published March 17, has provoked a bitter public reaction by Sabine Nouy, head of the Single Supervisory Mechanism (SSM).

According to Il Sole, the SSM has neglected twice, in 2014 and 2016, to assess the Level 3 derivative assets of Deutsche Bank because 1) it would take too long and 2) the SSM does not even have the competency to do that.

("Level 3" assets have no market price because they have no market. They are so toxic that a transaction can occur only bilaterally on a "fideistic" base, as a banking expert told EIR. As a matter of fact, their value is zero, but banks are allowed to price them according to their own model. So, at the end of 2015, Deutsche Bank had priced its Level 3 toxic waste at €31 billion!)

Il Sole reports that in 2014,

"both the SSM and its advisors, Oliver Wyman, had openly decided not to assess Level 3 assets. Il Sole learned that the Oliver Wyman team head, Ian Shipley, explained that it would not be possible to certify highly structured products because both central banks and consultants such as Oliver Wyman lack the competence."

Shipley, Il Sole writes,

"insisted that with derivatives, the only ones able to apply models that allow one to proof balance sheet values, are American investment banks, from Goldman Sachs to Morgan Stanley, which had invented the products [sic] themselves and sold them to European banks. To involve them, would mean a potential conflict of interest."

Indeed, as EIR at that time reported, SSM head Daniele Nouy admitted in a European Parliament hearing Nov. 3, 2014, that the SSM did not assess Level 3 assets for ... lack of time!

Now, the SSM insists that they do have such competence, but experts interviewed by Il Sole deny that. Emilio Barucci, expert of quantitative finance at the Milan Politecnico University, says that

"The SSM has apparently not made those estimates even in the second round of stress tests, which leads me to conclude that they have not yet developed internal competence to put them in the condition to face the situation."

Nicolas Veron, a Breugel economist who is considered to be close to the ECB, also thinks that the SSM has not yet achieved that capability.

That is why the "inspection letter" with the mandate from the ECB to the inspection team for Deutsche Bank did not include the job of pricing derivatives, Il Sole explains.

Despite public denials, the SSM and the ECB are, themselves, aware of the problem: In fact, even the final findings report on Deutsche Bank, not yet published, says that the risk management office is weak. Well, is this because the chief risk officer of Deutsche Bank is Stuart Lewis, who has been there since 1996, including when the risk management structure was accused of covering failures that caused the SEC to impose a $55 million fine?

"Il Sole 24 Ore has also found out that also Bill Broeksmit, the DeBa official who was expert in risk management and unanimously considered a person of high moral standard, had expressed doubts about Lewis. On January 26, 2014, in the midst of a period when the bank was under several investigations, Broeksmit took his life. In an email to a friend before dying, Broeksmit wrote: ’Stuart’s background is credit risk. He is not particularly fluent in model risk.’ And yet, since 2012 DeBa has given him the task of monitoring the biggest risk it has, the model risk."

(Credit risk is the risk associated with commercial loans and it is relatively easy to assess. Model risk is the risk associated with so-called financial products, whose pricing is assessed by models. )

Behind the curtain, the SSM is aware of the mess inside DeBa, and has activated a task force with the mandate of performing a "thematic review," involving Patrick Amis, one of the two deputy general directors of micro-prudential supervision. The ECB has a "no comment" on that.

Of course, Il Sole contrasts the soft approach used by SSM with Deutsche Bank, with the super-hard approach used with Monte dei Paschi.

Daniele Nouy has written a long letter to Il Sole, but without denying one single fact, according to author Claudio Gatti.