By Edward Taylor
FRANKFURT (Reuters) - Deutsche Bank's pursuit of success on Wall Street has come at a high price, a $7 billion plus penalty illustrating the extent of its decline since 2008 when its then chief executive claimed it was one of the "strongest banks in the world".
Expanding from its roots in Germany dating back to 1870, Deutsche (DBKGn.DE) transformed itself into a major player on Wall Street over the past two decades, often taking extravagant bets to do so.
But it is now set to cut back its activities in the world's biggest economy after a penalty for the sale of toxic mortgage securities that contributed to the biggest economic crash in a generation.
"The strategic options open to Deutsche Bank in the U.S.A. are clearly restricted because the profitability of the business will be weakened," said Ingo Speich, a fund manager at Union Investment, a shareholder in Deutsche.
German regulators also want Deutsche, the country's largest bank which employs around 100,000 people around the world, to rein itself in.
"Size in itself is no sign of success," said one senior official in Germany, where the mood among regulators has hardened towards the bank. "They now want to curtail their ambitions."
Last year, the bank's U.S. arm, where roughly one in ten of its staff are based, racked up a loss of 2.8 billion euros ($2.9 billion) - almost half the total loss made by the group.
That was a swing from a profit of more than 1 billion euros in the previous year. Much of the damage was done by a writedown on the value of Bankers Trust, while tighter regulation has made it more expensive to trade.
The $7.2 billion penalty for the sale of toxic mortgage securities closes a sobering chapter in the bank's international drive, launched in 1989 by the then chief executive, Hilmar Kopper, when he bought lender Morgan Grenfell in London.
Kopper is remembered for his public description of a multi-million Deutsche mark sum as "peanuts" - opening a divide between an increasingly Anglo-Saxon bank and the prevailing frugal culture among ordinary Germans.
A decade later, Deutsche bought Bankers Trust, paying $10 billion for the American bank and an estimated severance of $100 million to its chief executive. Management even discussed a takeover of Lehman Brothers, which later collapsed at the lowest point in the global financial crisis in 2008.
This strategy of buying to expand in shares and bonds was expanded to add outsized bets on toxic derivatives - and the lender's total assets swelled to more than 2 trillion euros in 2007.
One former senior Deutsche executive, who asked not to be named and who was instrumental in building the bank's U.S. business, said he had preferred using leverage to sell more structured debt and derivatives to buying a Wall Street rival.
"Buying a U.S. firm is like climbing Everest without oxygen. It is risky, and the achievement is substantial, but is it really worth it?" the former executive said, asking not to be named. "You may find that the view from the summit is quite cloudy."
Yet this alternative route proved perilous.
As the bank placed large trades at the end of 2011, its leverage ratio, which divides the value of assets by equity, reached around 21 - measured by U.S. accounting standards.
As a rule of thumb, the higher this leverage, the steeper the risks. JPMorgan (JPM.N), a much larger bank, had a lower ratio of around 17.
There was another important difference between Deutsche and its U.S. rivals. They had been able to improve their capital with a compulsory $700 billion "Troubled Assets Relief Programme" (Tarp). Rivals JP Morgan Chase, Morgan Stanley (MS.N), Goldman Sachs (GS.N) and Bank of America (BAC.N) all took the money.
At that time, in October 2008, Deutsche Bank's then Chief Executive Josef Ackermann described the bank as one of the "strongest and best capitalized banks in the world," privately saying he would have been "ashamed" if it needed state help.
However, analysts and regulators have since bemoaned Deutsche's thin capital cushion.
Encouraged by its apparent success in the early years of the crisis, the bank's management focused on structured finance and securitization, credit and equity derivatives, distressed debt and leveraged lending.
But the mood in the United States had changed towards banks that juiced profits with large punts.
In September 2016, Federal Reserve Governor Daniel Tarullo demanded a new capital buffer from investment banks, and, crucially for Deutsche, that it be held locally - in the United States.
"Financial regulation should be progressively more stringent for firms of greater importance," Tarullo said at the time.
Other problems were also brewing. Deutsche had been singled out in a 2011 U.S. Senate committee report that said one of its traders had called reparcelled mortgage debt "crap" or "pigs".
That trader, Greg Lippmann, who the committee said in its investigation had also described such securities as a "Ponzi scheme", took a $5 billion short position on behalf of the bank, betting that mortgage related securities would fall in value.
That inspired 'The Big Short' film, where actor Ryan Gosling played a character inspired by Lippmann.
Lippmann has declined to answer questions from Reuters on the subject.
The U.S. market no longer has pride of place for the bank, which has begun to lay more emphasis again on its German roots.
People with knowledge of the bank's strategy have recently said it is looking to cut its loan securitization business, starting with repackaged U.S. mortgages.
A final decision about this core business is set to come early next year, the people said, with a rolling back of the repackaging and resale of U.S. mortgages also expected as Chief Executive John Cryan seeks to move the business ahead.
(Additional reporting by Arno Schuetze; Writing By John O'Donnell; Editing by Keith Weir)