Dexia: the end of a crisis or the beginning?
By Howard Schneider,
BRUSSELS — The collapse of Dexia Bank has been rationalized by European and bank officials as a last act of the 2008 financial crisis, a slow-bleeding casualty whose complicated structure and investment portfolio couldn’t be rearranged effectively enough to survive when new problems hit.
To that extent, they say, it holds few lessons for Europe’s banking system as a whole.
But as officials meet this weekend to take yet another stab at fixing the euro region’s financial crisis, the Dexia meltdown looms. While some of its problems were unique, others are common to the European banking system, potentially making Dexia the canary in the coal mine of a crisis to come.
From exposure to weakened government bonds to half-finished restructuring plans and a reliance on international funding that can quickly disappear, Dexia is not alone.
“There is a reasonable likelihood that it could start unwinding, and once that starts it could all go in a blur,” Sony Kapoor, managing director of the European think tank Re-Define, said of a banking system that has had increasing trouble raising the money it needs to operate.
European leaders meeting this week will be trying to rebuild confidence in the euro region as a whole. Measures aimed at insulating banks from losses on their holdings of Greek and other government bonds — and promoting lending to businesses and households — will be central to the debate.
They have imposed a Sunday deadline for decisions, but key disagreements remain. French President Nicolas Sarkozy made an unexpected trip to Frankfurt on Wednesday to meet with German Chancellor Angela Merkel about their differences over how to increase the financial power of a new European bailout fund.
They agree that its effective size needs to be increased from the existing $600 billion. But Germany is concerned that some of the more open-ended proposals would ultimately damage its budget as the chief financier of the fund, while also taking pressure off countries such as Greece and Italy to tighten their spending.
The rare beneficiary of a double-bailout, Dexia was given billions in public help in 2008 to restructure and reinvigorate itself. Jointly based in Belgium and France, Dexia is particularly prominent in Brussels, with logos blaring over the city’s subdued skyline.
The bank received another round of public help earlier this month under a plan that would split it into several pieces, including a “bad bank” housing troubled assets and a Belgian unit local officials hope will be smaller but profitable. Because of Dexia’s outsized role in the Belgian economy, the local company was nationalized with the intent of privatizing it in the future, the company said in a news release.
Bank officials declined to be interviewed for the record.
European officials insist that the company’s problems were unique. Dexia had a disproportionate share of money tied up in long-term loans to cities, national governments and other public entities. Those assets were hard to sell and hard to use as collateral for other loans, crimping Dexia’s ability to restructure and borrow the money needed to fund its operations.
But there have been large concerns developing around the European banking system, enough to cause U.S. Treasury Secretary Timothy F. Geithner to warn of “cascading” failures that could damage the U.S. and the global economy more broadly.
The problems that forced a second rescue of Dexia are in many ways the same that have prompted ratings agencies to steadily downgrade their credit rankings on European banks and caused investors to punish them with plummeting stock prices.
They are issues, moreover, that go beyond the now well-known risk that bank holdings of government bonds from places such as Greece and Italy may not be worth what the banks paid.
What undid Dexia was a complex web of problems, some of which are shared by other European banks, bolstering the case that it may be more of an example than an outlier.
Dexia twice passed regulatory tests of the European Banking Authority, proof those widely criticized exercises were of limited use in evaluating the health of banks.
Perhaps most troubling for analysts, the problems at Dexia showed the risks run by European banks in their reliance on “wholesale” loans that are extended by large investors in the United States, Asia and elsewhere for periods of time as short as a day.
Unlike retail deposits from households, which tend to be stable because of government insurance programs, wholesale funds can disappear fast if confidence in a bank begins to sag — and in Dexia’s case, the money fled with a vengeance.
By some estimates, U.S. sources pulled as much as $15 billion from the bank in May after Moody’s Investors Service took the very tentative step of putting Dexia on a credit watch. Even more money disappeared when the agency said in October it was reviewing Dexia for a possible downgrade.
And there are broader concerns: that a slowing European economy will lead to more losses, that the reliance on wholesale funding seems less and less tenable, that political leaders have been slow to come up with a response to the euro’s problems.
“If you lose the market’s confidence you take five steps backwards and you have to climb the wall again,” said Michael Cembalest, head of global investment strategy at J.P. Morgan Asset Management. “The person who runs a U.S. money market fund will not shift a lot of money into European banks” until the system has restored credibility.
Dexia may have further set back that process — and some argue that European leaders are accelerating their crisis response in an effort to limit the damage.
A weekend summit is expected to call on banks to raise more capital to prepare for possible losses. That step is not without controversy. Advocates at the International Monetary Fund and elsewhere say that a bolstered capital base would make banks more likely to lend. Others say that imposing new demands on banks in the current tough environment would simply cause them to curb credit.
And some argue that capital isn’t the only issue in a system that’s now facing an economic slowdown, shortages of cash and liquidity and other problems.
“Recapitalization is one step the European banks will have to take to pay the price to rebuild confidence,” said Christophe Nijdam, a bank analyst at the AlphaValue consulting firm in Paris. “But the recapitalization per se will not in itself and alone answer the problems.”