Producers vs Predators--the good guys win one

Those of us who subscribe to the Veblenian notion that the world is best understood by concentrating on the conflicts between the Leisure and Industrial Classes were handed a perfect example in Germany this week when a court ruled that a bank had defrauded an industrial company by selling a designed-to-fail product called a spread-ladder swap.

It is almost certain that the banksters will try to get this ruling overturned for one simple reason--the profits booked by the moneychangers these days are simply not possible if they cannot resort to fraud.  In fact, my personal estimate is that if restricted to useful activities--you know, the ones they would rather talk about when confronted with their sleazy practices, the banking sector would be about 1/10th of its current size.

The World from Berlin   03/23/2011 

'A Costly Defeat for Deutsche Bank'

Germany's highest civil court has ruled that Deutsche Bank should have warned its customers of the risks of an exotic investment product it sold in the run-up to the financial crisis. The landmark ruling has huge implications for the banking industry and could unleash a wave of similar cases, with compensation possibly running into the hundreds of millions.

The amount of money at stake is peanuts for a bank that made over €2.3 billion ($3.3 billion) in profit last year. But the repercussions of the €541,074, plus interest, that Deutsche Bank will now have to pay in compensation to Ille Paper Service could be large enough to keep financial executives awake at night. The bank's lawyer even went so far as to warn of a "second financial crisis."

On Tuesday, Germany's Federal Court of Justice, the country's highest court for civil cases, ruled that Deutsche Bank had to compensate Ille, a medium-sized German paper company, for losses it suffered on a complex investment product that the bank sold it in 2005. Ille had sued the bank, claiming it had not been adequately informed about the risks that the financial product entailed.

The presiding judge, Ulrich Wiechers, ruled that Deutsche Bank had abused its obligation to give its customers proper advice. The product, called a "spread ladder swap," was essentially a bet on how interest rates would develop in the future. The judge said that bank did not explain the risk of the product properly, particularly given the fact that the risk to the customer was unlimited if they lost the "bet."

There was also a conflict of interest, the court ruled, as the bank was effectively betting against its own customer and giving them advice at the same time. Wiechers also said that the bank had deliberately structured the product to the customer's disadvantage, in order to make a profit from the deal.

In the future, banks will be obliged to ensure that their customers have essentially the same "level of knowledge" as the bank itself when selling such products, the court said. Only then could customers decide if they wanted to take on such a bet.

Wave of Cases Expected

The landmark decision is the first of its kind and could unleash a wave of other claims. There are dozens of other ongoing disputes between Deutsche Bank and local authorities and companies in Germany that claim they were not properly warned about the risks of investments. Customers of other German banks are also seeking damages.

In the years before the financial crisis, banks such as Commerzbank, the Landesbank Baden-Württemberg (LBBW) regional bank and HypoVereinsbank, among others, sold such swaps to hundreds of local authorities, small- and medium-sized companies and wealthy individuals. These and similar deals became symbolic of the excesses in the financial industry in the run-up to the crisis, and are thought to have caused losses of hundreds of millions of euros for local authorities alone.

"Many towns and cities that lost millions because the bank did not clearly explain the risks of such deals can now hope to get their losses fully compensated," said Jochen Weck, who served as Ille's lawyer in the case. He spoke of 700 potential suits with average damages of around €1 million per case. Eight similar cases are already waiting to be heard by the Federal Court of Justice.

Weck's client was similarly jubilant after the court's decision, issuing a press release titled: "Ille Paper Service Brings Deutsche Bank to Its Knees."

For its part, Deutsche Bank reacted calmly to the ruling. Lawyer Christian Duve said that the number of similar cases was "limited" and that the bank had made "appropriate risk management provisions."

On Wednesday, Germany's main newspapers take a look at the ramifications of the case.

The Financial Times Deutschland writes:

"The ruling will give the entire financial sector food for thought: Banks should no longer try to outwit their customers. Naturally every investor is primarily responsible when he risks his money. To a certain degree, it's (the customer's) own fault if they take a gamble and lose their stake, or even worse, taxpayers' money, in the case of local authorities."

"It's true that the Federal Court of Justice is going very far when it demands that customers should have the same level of knowledge as the bankers. But that is only logical. Only if the client has that information, can they decide if they want to place a bet against the bank or not."

On many, if not most subjects, the Frankfurter Allgemeine Zeitung is an utterly sensible paper.  This ruling has reduced them to crude screeching about how unfair it is to characterize Germany's largest financial institution as a "semi-criminal gang of rascals."  Why do you suppose this is so?  I would speculate it is because Frankfurt is the financial center of Germany and most of their important readers belong to one (or more) of the gangs of rascals.  To be brought down in court by a company that makes toilet paper is too much to bear for these arrogant rulers of finance.  In fact, Frankfurter Allgemeine Zeitung has probably cleaned up the real reaction in their city by quite a bit to make it suitable for publication.

The center-right Frankfurter Allgemeine Zeitung writes:

"Germany's highest civil court has given Germany's largest financial institution a dressing down, as if it were a semi-criminal gang of rascals. This 'bank bashing' fits neatly into the general political climate. Representatives of all parties -- not to mention the European Union -- are outdoing each other to see who can give investors the best protection. This is slowly but surely turning our economic system on its head."

"The flaw in the current ruling is that it interprets banking transactions as if they included an unwritten financial advice contract. It's like forcing a butcher to conduct a cholesterol test on his customers before he sells them red meat. The fact that the federal judges are now absolving Ille, a company which has millions in annual sales, of responsibility for its miscalculation is outrageous."

The leftist Die Tageszeitung writes:

"Deutsche Bank has suffered a costly defeat before the Federal Court of Justice. The verdict is also a groundbreaking setback for other institutions."

"Deutsche Bank was the institution that tried hardest to tempt its customers (into buying overly complex products). But other German financial institutions such as WestLB, Commerzbank and HypoVereinsbank also offered these dubious deals to customers all over Germany in the run-up to the banking and financial crisis."

"Germany's highest court (for civil cases) has now ruled that such opaque products are not only illegitimate but also illegal. That ruling could now prove expensive for many banks who could also face compensation claims. No wonder that Deutsche Bank's lawyer had warned during the hearing of 'a second financial crisis.' But the attempt at blackmail failed. This time around, the bank has lost the bet."

The conservative Die Welt writes:

"The court could hardly have expressed itself any clearer … It left no doubt about where the responsibility lies when selling complex financial products in Germany, namely with the bank, not the customer. This ruling has far-reaching consequences. After all, it does not only apply to Deutsche Bank. Other institutions also sold interest-rate swaps and other derivatives that only financial wizards could understand."

"This verdict contributes more to investor protection in this country than many of the well-intentioned laws that have been introduced by the German government since the financial crisis. In the future, banks will now think carefully about what they are offering their customers. Their products should not be too complicated. After all, the new requirement, laid down by the court in its ruling, that customers have to have the same level of knowledge as the bank, will cost the institutions a lot of time in advice and hence money. Additionally, some customers might even leave their banks if they knew everything (about the products in question). Many of the products on offer will simply not make economic sense any more -- including for the banks."

The business daily Handelsblatt writes:

"It is clear that conflicts of interest and overly complex products have become a structural problem in a sector that is very important for the German economy. The lesson for the banks should be clear: Selling excessively complex products to customers who are not able to understand them backfires on the bank so often that they are not worth it in the long term."

"The court's verdict is a timely warning. It is not only directed at banks, who should not ask too much of their customers, or even exploit them. Investors, too -- both private and institutional -- should learn the lesson that they should avoid products they do not understand."

"Today, at a time of low interest rates coupled with rising inflation, the temptation is once again great to go in search of higher returns. Some investors might be tempted to pester bank staff to offer them products that bring a few more percentage points in yields, thinking that they do not need to understand them in detail. In some respects, the situation is reminiscent of the days when financial innovation and exotic derivatives were in fashion. But investors' greed is also an important reason why excesses repeatedly arise in the financial system, and why the recent financial crisis happened."

-- David Gordon Smith more

This ruling was only possible because Germany still has a large and important fraction of its economy tied to the principles of Industrial Capitalism.  I am NOT going to hold my breath waiting for such a ruling in the English-speaking world where defrauding industry is considered standard operating procedure and the practitioners of Finance Capitalism own the banks, schools, government, and media.