BOSTON — Dexia SA, an otherwise obscure Brussels-based financial institution is roiling markets across Europe and the U.S. this week.
Shares in the company tumbled by 37 percent in the first moments of trading on Tuesday. (They have recovered somewhat, after a French senator told Reuters that Dexia was in talks to be absorbed into French government banks.) Finance ministers from France and Belgium are talking about moving Dexia's toxic assets into a "bad bank."
It's never a good sign when a company whose business seemed routine or unnoticed outside its core market is suddenly in the news. Off Wall Street, for example, who knew in 2008 that AIG had such huge positions outstanding in the credit default swap market — and that its failure could change life as we know it?
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And now we have Dexia to worry about. Only this time, there’s no Uncle Sam ready to pick up the pieces. That’s turning out to be a real problem, on both sides of the Atlantic.
The fourth paragraph of the Wall Street Journal's lead article on today's market meltdown includes this zinger: "The fallout from Dexia's troubles could extend across the Atlantic, affecting every region of the U.S. because it is a major player in the $2.9 trillion market for municipal debt.”
Reuters suggested that Dexia’s role in financing France’s local and regional governments was behind the haste to prevent the company from failing.
So what exactly is Dexia, and why does it matter so much?
Active in four countries (France, Luxembourg, Belgium and Turkey) the company employs over 35,000 people. All is not gloomy among its three business sectors (retail/commercial, public-sector finance, and asset management). Income in its commercial business is profitable, and grew by 25 percent in the second quarter to 404 million euros. And its retail franchise in Turkey is expanding quickly, according to its most recent quarterly report.
Still, it had invested heavily in subprime mortgages, leading to a 6.4 billion euro bailout by France and Belgium in 2008. Now it is reeling under the some 20 billion euros in shaky Greek and other European government bonds.
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With a balance sheet of a half-trillion euros, Dexia isn’t particularly big as banks go. (Citi and Bank of America have nearly $2 trillion in assets).
But “if you look at Dexia relative the size of Belgium’s GDP, their balance sheet is almost twice the size of Belgium’s GDP. So it’s a huge problem for that country,” says Paul Simon, CIO at Tactical Allocation Group, a Michigan-based independent investment firm with more than $1.5 billion under management.
That size means that Dexia’s problems are Belgium’s problems. Yet Belgium may not be big enough to handle them.
Adding Belgium to the list of basketcase European governments would be bad enough. The country had a 2010 debt-to-GDP ratio of 100 percent — worse than Ireland and Portugal, both of which have needed bailouts already.
But the real problem is that Dexia isn’t alone in dramatically out-weighing its host government. In fact, it could be the first of many institutions that are essentially too big to save.
And it’s worth noting that Dexia is not among the continent’s worst, at least if European officials are to be believed: the bank actually passed last July’s EU stress test. Eight banks failed.
So who’s next? Time will tell. The main question is which bank could cause a meltdown.
“If you look at the three largest banks in France, their balance sheets are around 300 percent of the GDP of France,” says Simon. Right now, “French banks are very dependent on short-term financing. When the credit markets freeze up you get Lehman- and Bear Sterns-type situations where there’s a massive liquidity problem, and all of a sudden, the governments have to get involved.”
But given the extent to which these banks outsize their host government, “you run into limitations in terms of what they can do to help these banks. I believe that Dexia is the Bear Sterns of 2011: the opening act of severe stress in the European financial system.”
Of course, the euro zone’s troubles are far more difficult to manage given that there is no strong federal government to step in and save the day.
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