The sudden concern over Dexia, which is heavily invested in European government bonds whose value is now in doubt, highlighted the threat that euro-zone bank failures could trip up the world economy.
The governments of France and Belgium, co-owners of Dexia since an earlier 2008 bailout, pledged support for the lender and reassured depositors that they would not lose their money. The bank may be heading for a restructuring that would segregate its government bonds and other suspect investments in a new “bad bank.”
With Dexia’s stock price plummeting, European finance ministers in Luxembourg indicated that they may finally embark on a course urged for months by the United States and officials at the International Monetary Fund. This could involve a broad effort to bolster capital levels among Europe’s major banks.
Problems in the banking system — particularly doubts about the value of government bonds — have prompted banks to stop lending to each other and, according to analysts at the IMF and elsewhere, begun to undermine the region’s already tepid economic growth.
U.S. officials in recent weeks have intensified their focus on Europe’s problems and the potential threat to the U.S. recovery. Treasury Secretary Timothy F. Geithner warned of “cascading default, bank runs and catastrophic risk” posed by the region. Federal Reserve Chairman Ben S. Bernanke told Congress on Tuesday that at a minimum Europe’s problems “have hurt household and business confidence, and . . . pose ongoing risks to growth.”
According to wire service and other reports from Luxembourg, finance ministers have been discussing a regionwide move to boost bank capital.
“There is an increasingly shared view that we need a concerted, coordinated approach,” European economic and financial commissioner Olli Rehn told the Financial Times after the meeting. “There is a sense of urgency among ministers and we need to move on.”
The problems at Dexia set off fresh alarms about whether banks may face losses stemming from Europe’s government debt crisis. Bank failures in Europe could trigger the kind of worldwide financial seizure seen after Wall Street investment bank Lehman Brothers collapsed in late 2008.
Dexia’s problems go back at least that far, when it received billions of dollars from European governments and the U.S. Federal Reserve to stay afloat.
The bank’s troubles have returned, with the danger now resulting from troubled bonds issued by ailing countries such as Greece rather than from subprime mortgages in the United States.
On Tuesday, Dexia’s plight was further aggravated by broader concerns among investors in European government bonds. This anxiety spiked after European officials meeting in Luxembourg suggested that they may force private bondholders to take far steeper losses as part of a deal to bail out near-bankrupt Greece. Such losses would deal a particularly strong blow to Dexia, which specializes in lending to governments and holds billions of dollars in bonds issued by Greece and other nations swept up in the debt crisis, including Italy, Spain, Portugal and Ireland.
Dexia, like some other financial firms, has struggled to raise money to make loans as credit markets have tightened in recent weeks amid growing fears among investors. On Monday, Moody’s warned it could downgrade the bank’s credit rating because of concerns over its ability to maintain an adequate cash flow.
The ratings agency also cut the credit standing of Italy on Tuesday, the latest in a series of downgrades of the highly indebted country.
In a joint statement, the French and Belgian finance ministers said their governments would “take all necessary measures to protect savers and creditors” at the bank, offering an implicit guarantee to depositors and raising the possibility of pumping more cash into the bank if needed.
Borrowing costs for both nations rose Tuesday amid concerns that any backstop would increase the already-high debt loads of Belgium and France. The need for more bank rescues in the months ahead could weigh even more on the stressed nations of Europe.
Dexia’s troubles are evidence that Europeans authorities have failed to spot weaknesses in their banking sector. Dexia, for instance, easily passed a “stress test” conducted by European regulators only weeks ago that was aimed at identifying weak banks. The question now, analysts say, is how many more weak links are out there.
“You can’t have credit markets this paralyzed without doing significant damage to the banking system,” said Louise Cooper, markets analyst at BGC Partners in London. “Why are credit markets bad? Because they are worried about solvency. And why is that? Because of worry about the euro-zone crisis and politicians’ ability to sort it out.”
A report by Goldman Sachs has suggested Europe’s largest banks may require between $40 billion and $125 billion in the event of broad losses from their holdings in Greek, Irish, Portuguese, Italian and Spanish debt.
Economists are increasingly concerned that Europe is dragging its feet on dealing with its troubled banks and lacks a plan to recapitalize them. The euro-zone nations have agreed to expand the powers of their existing rescue fund, set up to help foundering governments, so it can help save banks.
But the measure has not yet come into effect. That is because all 17 nations that use the euro must first ratify it, and as of Tuesday, the Netherlands and Slovakia had yet to vote on its approval.
Schneider reported from Washington. Special correspondent Karla Adam in London contributed to this report.