- - Sunday, October 23, 2016

BERLIN — Preparing to face the voters again in 2017, Chancellor Angela Merkel has had to deal with an onslaught of challenges over the past year, from the Greek debt crisis to an upsurge in far-right populism to a rebellion in her own Christian Democratic Party over her open-door policy for Syrian refugees.

But it’s unlikely that Ms. Merkel was expecting a problem on another front, a problem that could damage not only her electoral prospects but Germany’s global image as a model of economic quality, financial conservatism and market efficiency: the soundness and future of the country’s flagship financial institution, Deutsche Bank.

“When you think of Germany, you don’t tend to think of failing banks,” said Todd Williamson III, a senior fellow with the Atlantic Institute, a nonpartisan Berlin think tank. “It doesn’t help the case for Germany, which has been stable and is the financial and economic leader in Europe.”

Last month, Deutsche Bank, Germany’s largest, was thrown into turmoil after an extended clash with the U.S. Department of Justice. As part of its campaign against some of the world’s biggest banks, the Justice Department has demanded $14 billion in penalties to settle a case involving sales of residential mortgage-backed securities by Deutsche Bank in the run-up to the 2008 global financial collapse. Speculation that the bank might not have the capital cushion to pay the fine immediately raised questions about whether the 146-year-old financial institution might become the world’s next Lehman Brothers and trigger another meltdown.

The development was just the latest body blow to the Frankfurt-based investment bank.

Deutsche Bank’s stock has plummeted by more than half in the past year as its investment bank business has shrunk due to negative interest rates, anemic growth in Europe and new regulations adopted after the 2008 crisis to curb risky speculation. It has recovered some of those losses in the past month, but the volatility of the stock continues.

This summer its U.S. unit failed a Federal Reserve “stress test,” and the International Monetary Fund named the bank as “the most important net contributor to systemic risks.” The bank recently announced drastic staff cuts and is reportedly considering scrapping bonuses and trimming down its American operations significantly to improve its balance sheet.

For Ms. Merkel, the pressing question today is whether or not the German government should support Deutsche Bank in the event of a cash crunch that could have catastrophic repercussions from Wall Street to Hong Kong. Ms. Merkel has not ruled out a government bailout of the bank, but she hasn’t signaled her support for one either.

Complicating Ms. Merkel’s task is the hard line she has taken on bailouts for other countries in the European Union’s eurozone, demanding “austerity” and deep social spending cuts from other countries that failed to manage their finances. She and her aides have been particularly critical of other EU governments bailing out failing national banks.

And the case is also putting a new strain on German-American relations, with many here arguing the huge Justice Department fine is in fact retaliation by the Obama administration for the EU’s ruling in August that U.S. computer giant Apple must pay some $13 billion in back taxes over its operations in Ireland. Peter Ramseur, who chairs the German parliamentary committee overseeing the economy, told the Welt am Sonntag newspaper this month that the massive Deutsche Bank fine “has the characteristics of an economic war.”

Deutsche Bank’s executives have insisted they won’t need to raise capital to remain in the black. Analysts agreed, saying the bank was unlikely to collapse. German financial newspapers reported recently the company was hoping to whittle the U.S. fine down to between $4 billion and $5 billion.

“I certainly believe that Deutsche Bank will not have to pay the 14 billion euros. I’m pretty sure about that. I do not see the scenario getting out of control,” said Dorothea Schafer, a financial markets research director with the German Institute for Economic Research (DIW) in Berlin. “The federal government wants to avoid any bailouts. That’s something that nobody wants.”

Reports of a rescue plan

But German press outlets have reported that Ms. Merkel’s government has drawn up a draft rescue plan for the bank. Senior members of her conservative governing coalition have openly ruled out such claims, however, saying federal aid similar to the lifelines Germany, the U.S. and other Western governments threw to failing banks after the 2008 financial crisis were out of the question.

“The German government isn’t interfering here,” said Ms. Schafer. “This is the issue of a large private bank dealing with U.S. courts. The first step in resolving this issue is that the bank is active, and not the government.”

A representative of the German Ministry of Finance echoed this sentiment but refused to comment in detail on the matter, instead saying that “it’s a matter of negotiation between U.S. administrative bodies and Deutsche Bank.”

A taxpayer rescue could seriously tarnish Germany’s relationship with other countries in Europe, like Greece, whom Germany has lectured on financial responsibility.

“I think that Angela Merkel and [Finance Minister] Wolfgang Schauble have been playing a very shrewd and clever political game in which they’ve shifted the focus away from their bank onto other Southern European countries,” said Aiden Reagan, an assistant professor in comparative and international political economy at the University College Dublin. “But there’s only so long they can do that before the reality of the debt that those core banks hold will be exposed.”

The German public doesn’t support a bailout either. The German magazine Focus clocked support for a Deutsche bailout at a mere 24 percent in a recent poll.

“The public is naturally not too inclined to go for a bailout given the past financial crisis,” said Ms. Schafer.

Members of Ms. Merkel’s coalition government have openly lashed out at the bank, blaming its spotty financial dealings over the decades as the main factor for its current trials.

“I did not know if I should laugh or cry that the bank that made speculation a business model is now saying it is a victim of speculators,” Vice Chancellor Sigmar Gabriel, who also serves as the energy and economy minister, told reporters early this month, referring to bank leaders’ claims that the media coverage of the bank’s troubles has been fueling speculation.

While balancing the needs of Deutsche Bank and the German economy, Ms. Merkel needs to keep a close eye on public opinion.

The long-dominant Christian Democrats have lost a series of local elections recently to the anti-immigrant, far-right Alternative for Germany political party, in part due to dissatisfaction over her acceptance of more than 1 million refugees from the Middle East, North Africa and elsewhere last year.

Fresh off beating a Christian Democrat in Ms. Merkel’s home state in local elections last month, Alternative for Germany leaders are already seizing on Deutsche Bank’s troubles as another issue to attack the government.

“That the federal government knew about the dealings of Deutsche Bank is more than a probability — it’s very likely,” said Markus Frohnmaier, an Alternative for Germany candidate in Baden-Wurttemburg. “It’s alarming that there’s a lack of transparency and that we don’t know exactly what concrete effects such good-old-boy networks will have.”

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