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Deutsche spat reopens mark-to-model/myth debate

Deutsche Bank is battling to move on from 2008 and the heart of the financial crisis. Former employees of the German bank allege it hid $12 billion of losses as the credit crunch hit. It reopens the debate over whether marking shaky assets to model was actually marking to myth - and whether it mattered.

The assets in question were complex synthetic collateralised debt obligations in Deutsche’s so-called “correlation book”. Instead of just using underlying assets, pointy-headed investment bankers also deployed credit default swaps to model portfolios. Like other trading assets, these were valued by looking at prevailing prices: marking to market, in other words.

When the crisis hit, liquidity in most structured credit assets collapsed. Banks then had a fallback: using their own valuation models. But that still required some kind of observable inputs. The debate between Deutsche, which denies the allegations, and its old employees is whether these models were appropriate, or fiddled with in order to hide the scale of the problem.

It’s not clear whether Deutsche went too far or not. It had an obvious incentive to avoid booking losses that could have led the German government to take a stake in the bank and shrunk the bonus pool. Yet, the US Securities and Exchange Commission, which has worked on the case since 2010, has not, as yet, come to any conclusion.

The wider question remains whether marking assets to market is an absolute good or a relative method. Had global accounting bodies not allowed investment banks to move large chunks of trading assets to their banking books in 2008 to avoid marking them to market, taxpayers might have had to stump up even more capital. Meanwhile, in the UK, the Bank of England is worried that lenders may be under-reporting their capital positions by not marking their loan assets to market. But restorative measures might involve shrinking loan books, hurting the economy.

An SEC ruling against Deutsche would clearly be a big blow. Although the bank had wound down most of the original correlation book with minimal losses, it is still seen as relatively undercapitalised under new “Basel-III” reforms. It would also leave Anshu Jain, the Deutsche co-chief executive who used to run its investment bank, facing awkward questions about ill-gotten bonuses, including his own. But if Deutsche is found guilty, other mark-to-market refusenik banks may find themselves in similar hot water.