Oct 06 2011

Print this Post

Dexia and Lehman Brothers

Share to Google Plus

Now What?

What if Lehman Brothers had been saved? That’s the haunting question from 2008.

Had Treasury Secretary Hank Paulson and Treasury intervened decisively and provided a backstop for Lehman, could the financial meltdown of 2008 have been avoided?

Indeed, given that the $700 billion TARP bailout of the entire financial sector was made law only 18 days after Lehman declared bankruptcy, could action two weeks earlier have made the difference?

We are about to see by way of a European example.

High risk sovereign debt from the PIIGS (Portugal, Ireland, Italy, Greece and Spain) of the EU is looking very much like the toxic, sub-prime mortgage debt that unraveled the US banking system in 2008.

Despite official EU assurances that its financial sector is adequately capitalized against sovereign exposure, the market has indicated otherwise, with inter-bank lending in the EU having ground to a near halt.

Europe’s Lehman moment may have come Tuesday.

Dexia S.A., a Belgian bank that counts the governments of France and Belgium as owners, has been unraveling in 2011. It reported huge losses in the second quarter. On Monday, rumors of a Moody’s downgrade, based on Dexia’s inability to access credit markets, created a run on the stock, forcing it down by 20%.

And this isn’t just market madness. Dexia’s problems are real.

The bank is heavily over-extended in EU sovereign debt, including 17 billion Euros in Greek debt. Overall, as of June 30th, Dexia’s assets (518 billion Euros) were an eye-popping 75x its shareholder’s equity (6.9 billion Euros).

But, unlike Lehman, the Europeans judged Dexia to be too big to fail.

On Tuesday, the French and Belgian governments issued a joint statement backing the bank with “all necessary means.”  Discussions are under way now to break up the bank into its component parts and to somehow “wall off” the toxic sovereign debt while protecting depositors and shareholders.

Wall Street loved the news. The Dow rocketed 15o points on the bailout announcement, taking the action as a sign that the EU was finally serious about addressing the twin issues of financial instability and toxic sovereign debt.

That sense was enhanced Wednesday when German Chancellor Angela Merkel pressed euro-zone governments to quickly agree on a system of backstops that relies principally on national support measures, but could potentially draw on euro-zone’s bailout fund, the European Financial Stability Facility (EFSF).

Merkel clearly hopes that establishing national “back-stops” in advance will prevent Dexia-style funding problems that would further erode confidence in European banks, which are already suffering from a near freeze on inter-bank lending.

Specifically, the Chancellor stated that euro-zone governments should define “common criteria” for when banks need more capital and that for their part, financial institutions should first seek capital from the private market, before seeking additional injections from national authorities, or failing that, the EFSF.

But this is fanciful at best and denial at worst.

To explain, back to Dexia for a moment. France and Belgium have pledged to fully support the bank.

To get a sense of the task at hand, consider Anne Jolis’ analysis in today’s Wall Street Journal. Dexia’s total outstanding assets are equal to 33% of French GDP, or 140% of Belgium’s GDP; a simply staggering burden.

And it is not as if the break-up of Dexia will make certain assets any more attractive. Greek debt will still be Greek debt.

Thus, when the French finance minister states that the additional commitment to Dexia will not impact France’s sovereign credit rating – when French debt to GDP is 82% and climbing – he is clearly whistling past the graveyard.

Dexia is not, for instance, France’s Societe Generale (SG), which has over one trillion euros in liability and 52 billion in equity.

What happens then? Neither France nor the expanded EFSF could handle such a staggering burden. The impacts cascade across the continent from there.

Simply put, there is not enough money in Europe to pay off the bad debts of Europe, even if the sovereigns in the EU would agree to such a thing.  Because of that, the problem only gets worse with continued policy dithering that saps confidence and the prospects for growth, and increases uncertainty.

So back to Lehman.

Would a bailout have prevented the financial crisis?


It might have spared the market temporarily, but a bailout would not have changed the reality of Lehman’s balance sheet and the toxic debt it held, or for that matter, the toxic debt held by others.

It was only a matter of time.

Thus, Lehman was a pivot point.

Bankruptcy or bailout, Lehman was destined to be the start of direct and massive US government intervention in the financial sector.

The lesson of Lehman for the Europeans is not that the US failed to act initially sparking a crisis.  It is that when the crisis was manifest, the US acted decisively with TARP, restoring confidence and stability by pumping liquidity directly into the banks.

Having bailed out Dexia, what is Europe’s plan for everyone else?

A smart bet is that it’s not going to be pretty.




Leave a Reply

Your email address will not be published. Required fields are marked *

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <s> <strike> <strong>