With astonishing speed, Deutsche Bank went from being the toast of the industry to arguably its leading problem child. What had once made it a darling of investors—its securities-selling and investment-banking juggernaut—now made the company a pariah among crisis-scarred shareholders. Regulators and investors worried that the bank—which had not strengthened itself with new capital from the government or private investors—didn’t have enough of a financial cushion to absorb potential losses in the future. International groups like the Organisation for Economic Co-operation and Development were warning that Deutsche’s ratio of assets to equity—its leverage ratio—was still nearly fifty-to-one. No responsible business would operate like that—if the borrowed funds dried up, the company would be dead.
Because the bank had enjoyed a “good” crisis, it hadn’t felt much pressure to shrink. Executives didn’t realize that they had delayed, not avoided, their reckoning. Investors did, however, and the bank’s share price reflected that lack of confidence. As the world emerged from the financial crisis and the resulting Great Recession, the shares of Deutsche’s closest rivals—companies like JPMorgan and Citigroup—rallied back to their pre-crisis levels and then scooted higher still. Not Deutsche. Its shares had peaked back in May 2007 above ninety-one euros apiece and then bottomed out in January 2009, just as Barack Obama was sworn in as president, at about thirteen euros. By the following May, they had rallied to nearly forty-seven euros. At this point, the shares were worth just over half of what they’d fetched three years earlier. It was the highest they would ever get.
It wasn’t just the bank’s shortage of capital that was unnerving investors. Deutsche’s stockpile of derivatives had been growing ever since the arrival of Mitchell, Broeksmit, and Jain more than a decade earlier, swelling even more with the Bankers Trust acquisition. Investors—newly attuned to the potential perils of derivatives, given their pivotal role in the just-ended financial crisis—started running the numbers, and they realized Deutsche was sitting on trillions of dollars of these instruments. Deutsche expected the derivatives to make money over time, and it had booked the anticipated profits up front, even though many of the contracts extended for years, even decades, into the future. A dramatic change in the economy or regulations or laws or their trading partners had the potential to slam Deutsche with enormous losses. And since the bank had already reaped the profits, there was nothing but downside ahead. If Deutsche had to sell the derivatives, it would essentially have to give back those profits. Did the bank really have a handle on its exposure? What if its math were wrong?
Ackermann had an opportunity at this moment to take advantage of the bank’s relative strength. He could have thickened the bank’s capital buffers by selling new shares—a course supported by some of the bank’s top executives. He could have moved expeditiously to scrub the bank of unwanted assets, which would have entailed some short-term financial pain but eased investors’ anxiety about the company’s long-term health. He could have invested in a massive overhaul of Deutsche’s rat’s nest of IT systems.
He did none of those things. Instead, Ackermann’s biggest strategic move was to buy Germany’s downtrodden post office bank. Ostensibly, the acquisition of Postbank was crafted to bolster Deutsche’s presence in its home market. But the rationale never made much sense. Postbank was a colossal mess, its technology even more antiquated than Deutsche’s. And serving Germany’s notoriously frugal savers was far from a lucrative business. To finance the deal, shareholders had been asked to pony up $13 billion, and those who refused saw the values of their current investments diluted as Deutsche issued more than 300 million new shares—what it could have done to replenish its capital—to get the Postbank money anyway. Several senior executives had cautioned Ackermann against the deal, arguing that it was crazy to squander money at the precise moment that American banks were bolstering themselves with billions of dollars of fresh capital. Ackermann swatted away the concerns and noted that the purchase was the right thing, the patriotic thing, to do for Germany in the midst of the continent’s economic crisis. (Quite a few executives believed Ackermann was more interested in burnishing his public image than in doing what was right for the bank.) But Deutsche’s board sided with the CEO, and the deal got done.
It was one more abdication of leadership that the bank would come to rue, especially because Deutsche was about to face a new source of financial pressure. After years of laissez-faire regulation and law enforcement, the pendulum was swinging back toward intensive government oversight of an industry that, not for the first time, had demonstrated its propensity to shove the world into a deep economic pit. The conventional wisdom over the previous decade had been that banks could be trusted to basically police themselves—after all, they had a powerful interest in self-preservation. But their capacity to exercise restraint had proven woeful, and so a new period of government scrutiny got under way, with regulators devoting more resources to monitoring the inner workings of giant financial institutions and prosecutors on the prowl for serious misconduct.
Deutsche, propelled by a culture that rewarded aggression and having profited from its envelope-pushing and sometimes illegal behavior, had been a big winner in the hands-off period. It would be an even bigger loser in this new era, and the trouble would affect not only the bank but also its top executives—men like Bill Broeksmit.
Rod Stone’s first real job was watching porn. It was the early 1980s, and Stone, who grew up in the hardscrabble London neighborhood of Brixton, worked for Her Majesty’s Customs and Excise, a government agency whose main mission was combating the smuggling of goods into Britain. A brisk business had sprung up around secreting sex videos into the country, and when a truckload of videocassettes was intercepted, it was Stone’s job to sit in a room and watch each one, logging the nature of the obscene acts. For a few years, he spent fifty hours a week watching and describing porn. In 1984, still working for the customs department, he graduated to more serious law enforcement. He helped chase down Gaddafi’s London-based weapons trafficker. He busted tobacco- and alcohol-smuggling rings. He got a thrill out of navigating through labyrinths of tax and real estate records and going head-to-head with criminal masterminds. “It was the pitting of wits,” he would explain.
The customs agency eventually gained responsibility for collecting taxes, and Stone, now in his forties, shifted gears, developing an expertise in a type of sales tax that was rife with fraud. In theory, every time a company shipped products from, say, France to England, it had to pay an import tax when their goods crossed the border. But because the European Union was a free-trade zone, the importer could then apply for a government refund of whatever taxes had been paid. Criminal gangs around the EU had cooked up elaborate schemes in which they didn’t pay the initial tax but still claimed the refund. The British government was losing billions of pounds to these fraudulent refunds, and Stone picked apart the international chains of shell companies that were shipping products, evading taxes, and claiming fake refunds.
In 2008, Stone noticed that some of those same fraudsters were getting into something called carbon-emissions permits, part of an EU program to reduce greenhouse gases. Sales taxes were due each time a permit changed hands, but as with any product sold within the EU, those taxes were eligible for refunds. In 2009, groups of fraudsters started claiming fake refunds from the British government. Stone was surprised to see that a few large banks were working with these gangs—and Deutsche, which had a team of London traders devoted to trading emissions permits, was leading the pack. Up until 2009, Deutsche had always been a net payer of sales taxes, known as VAT. Then that June, it claimed a refund of more than £15 million. That refund was processed and paid. Three months later, Deutsche submitted another refund request, this one for £48 million. Stone launched an investigation.
Early on, he warned Deutsche in writing that its traders appeared to be partaking in tax fraud. But the Deutsche traders—one of the alleged participants was surnamed Lawless—kept doing it. In November 2009, Stone marched into the bank’s London offices and told its lawyers that Deutsche had already been put on written notice that it was likely engaged in fraud and that the consequences for the continued misbehavior could be severe. Stone paid another visit the following month and read the lawyers the riot act.
The British government eventually altered its tax rules to prevent the fraud, and Deutsche’s London trading desk adapted—moving to claim refunds in Germany rather than Britain.
When a Deutsche employee asked a colleague why the bank was willing to take such a large legal risk, the response came back: “Because we’re that greedy.” Stone helped his German counterparts figure out what was happening. In April 2010, police raided Deutsche’s Frankfurt headquarters. Finally executives pulled the plug on the emissions-trading strategy, which by then had generated nearly $250 million in illegal refunds. A German judge would later find that the fraud was enabled by the “risk-affirming climate” that dominated Deutsche. Internal safeguards, such as a tough compliance squad or rigorous know-your-customer rules, were strangely absent.
Just as Mark Ferron had suspected, Christian Bittar, the star trader and one of Anshu’s anointed, had been cheating. The success or failure of many of his trades hinged on tiny movements in something known as Libor (an acronym for the London interbank offered rate). Each day the world’s biggest banks estimated how much it would cost them to borrow money from other banks. Their estimates were averaged together, and the result was Libor. Libor served as the basis for trillions of dollars of interest-rate derivatives, which were the primary instruments that Bittar was using to make his market bets. Bittar had realized it was surprisingly easy to manipulate Libor. Since the benchmark was an average of banks’ estimated borrowing costs, all you had to do was to get a few banks to move their estimates up or down. That’s what Bittar did—and he soon became one of the entire company’s most prolific profit engines. (Much of his success stemmed from a bet—apparently unrelated to his Libor manipulation—on where broader financial markets were heading.)
In 2009, Bittar was in line for a bonus of more than $100 million, thanks to an arrangement Jain had approved that awarded him a percentage of whatever revenue he generated for the bank. There was no way to avoid scrutiny of such a monster payout, and Ackermann was appalled when he heard about it. Anshu phoned the CEO to defend the bonus and described Bittar and his colleagues as “the best people on the Street.” These traders were making “mountains of money.” But before cutting Bittar his nine-figure check, the bank initiated a review of his desk’s windfall. Did Bittar have a golden touch or was something else at play? The examination was conducted by the bank’s “Business Integrity Review Group,” and it was a farce: A single Deutsche employee was responsible for sifting through tens of thousands of internal documents and transcripts to see if Bittar was cheating. Many of the materials were in French, which that employee didn’t speak. The review didn’t find anything problematic. Bittar collected his money.
Word of the gigantic payout rippled through London’s banking circles. As U.S. and British authorities started investigating Libor manipulation, Bittar’s bonanza would serve as an extreme example of how traders were incentivized to engage in fraud.
Since the late 1990s, Deutsche had been peddling products to hedge funds, including the enormous Renaissance Technologies, that helped them avoid taxes. Founded by a former government code-breaker, Renaissance specialized in using computer programs to scout out tiny market inefficiencies that could be exploited. The firm recruited engineers and mathematicians, including an IBM programmer named Robert Mercer, a right-wing zealot who once noted that he enjoyed spending time with cats more than with people. Mercer eventually rose to the top of Renaissance, helping it become one of the world’s most successful hedge funds.
Renaissance was always looking for a new, sharper edge, and that’s where Deutsche came in. The bank hatched a plan in which Renaissance parked billions of dollars of securities and other assets with Deutsche. The bank legally owned the assets, but Renaissance handled the trading of them. Once a year, Renaissance could withdraw profits from the Deutsche account and get taxed at a long-term capital gains rate of 20 percent—about half what it would have faced without the Deutsche structure. The strategy generated billions of dollars in tax savings for Renaissance. Deutsche collected fees totaling $570 million from Renaissance and other hedge funds for setting up the structures.
Unfortunately for Deutsche and Renaissance, the transactions caught the attention of Bob Roach.
Roach had grown up in Beacon, a factory town in New York’s Hudson Valley whose main claim to fame was being home to Pete Seeger. Roach was a star wrestler, and after graduating from college, he continued wrestling—with big companies. He worked on environmental investigations for the Massachusetts government and then, in Washington, for Michigan representative John Dingell, holding dirty industries accountable for the messes they’d made. Roach was self-effacing, with an aw-shucks demeanor and a wide-mouthed, infectious laugh, and that served to disguise his doggedness; his motto was “be a grinder.” He developed a knack for surfacing documents that proved corporate culpability. In 1998, he became a staffer on the Senate Permanent Subcommittee on Investigations. The committee’s members, led by Senator Carl Levin, prided themselves on picking investigative targets based on merit, not politics. When the interests of Republican and Democratic panelists diverged, Republicans made a point of signing off on Democratic subpoenas, and vice versa.
More or less from the moment he joined the committee, Roach had been chasing Deutsche. The first time he came across the bank was in 1999, right after its acquisition of Bankers Trust. Roach was investigating how banks catered to dictators and their families, helping them keep their embezzled money secret. It turned out that Bankers Trust—through its private-banking division that served many of the world’s richest people—was among the banks that moved money for Raúl Salinas, the corrupt brother of Mexico’s former president.
A few years later, Deutsche popped up again. This time it was part of a Senate investigation into tax shelters arranged by accounting firms like KPMG. Deutsche had extended a huge credit line to KPMG to finance what appeared to be fraudulent financial structures. Roach and his team uncovered evidence that Deutsche executives in Frankfurt knew about the illicit practices. Next up, Roach dug into Deutsche’s peddling of sure-to-lose CDOs to unsuspecting clients. Now Roach got wind of the bank’s tax work with Renaissance, and it smelled foul. He convinced his boss, Senator Levin, that it was a worthy target of a major investigation.
The world’s oldest bank was headquartered in the picturesque Tuscan hill town of Siena, best known for a raucous horse race, the Palio, around its central piazza. Banca Monte dei Paschi di Siena had been founded in 1472, two decades before Columbus sailed to America. The bank occupied an ancient stone palace, its walls bedecked with medieval and Renaissance masterpieces. For 530 years, it existed peacefully, becoming a pillar of the Tuscan community. Its charitable foundation doled out hundreds of millions of dollars a year to the local university, sports teams, museums, and the like—an amount larger than the city’s annual budget.
Then, in 2002, Paschi went to Deutsche to buy some derivatives. The goal was to free up cash so that it could participate in a wave of mergers remaking the Italian banking industry. Paschi had previously invested in another Italian bank, now known as Intesa Sanpaolo, and it wanted to liquidate that investment without forfeiting the right to future profits if the Intesa shares gained value in the future. For a steep fee, Deutsche set up a series of derivatives whose value would rise or fall along with Intesa’s stock price.
For a few years, the transaction worked as planned. But when markets went haywire at the onset of the financial crisis, the derivatives racked up enormous losses. Paschi returned to Deutsche for help in 2008, and the German bank dished out . . . more derivatives.
It was a complex two-part deal. Boiled down to its essence, the first part of the transaction was guaranteed to make enough money for Paschi that it would paper over the hundreds of millions of dollars of losses it was facing on the 2002 transaction. The Italian bank could avoid disclosing crippling losses. The second part of the trade was a guaranteed moneymaker for Deutsche—and a money loser for the Italians—but the profits would accumulate over a period of several years. In theory, if Paschi earned enough money in the future, it could pay what it owed Deutsche without outsiders realizing what was happening. In short, Deutsche could notch big profits without taking much financial risk and the client could hide losses, at least until it had to pay back Deutsche.
The executive ultimately in charge of the group that devised this plan was Michele Faissola. A slim, well-dressed man with dark eyes and hair, Faissola had grown up in Italy; his uncle was one of the country’s leading bankers. At Deutsche, Faissola had aligned himself with Anshu and had risen to be a leader of the derivatives team. By 2008, he was a top Deutsche executive. Colleagues reckoned that Deutsche had paid him tens of millions of dollars over the years; his Chelsea townhouse featured an indoor swimming pool. (Faissola and his wife, Maria, had become close friends with Bill and Alla Broeksmit.)
Late in 2008, Deutsche’s committee of risk managers met to discuss the proposed Paschi arrangement. Faissola was one of the highest-ranking members of the committee, and his underlings happily pointed out that the proposed structure could be replicated for other clients, presumably those that also were looking to mask their financial problems. Deutsche could make money over and over again. “This is fantastic!” a senior executive exclaimed. The deal got approved, and the anticipated tens of millions of dollars in profits—including the fees that Paschi paid for the privilege of working with Deutsche—would be credited to Faissola’s group for the purposes of tallying their year-end bonuses.
Behind the scenes, out of most of his colleagues’ view, Bill Broeksmit had played a role in many of these soon-to-be scandals. He didn’t cause them—in some cases, he tried to prevent them—but that was the sort of distinction that could easily get lost on government authorities looking for people to hold accountable for the banking industry’s many sins. The consequences would be tragic.