Dexia: Zombie Bank's Demise Came Three Years Too Late

Last Updated Oct 10, 2011 3:55 PM EDT

Europe's sovereign-debt crisis has claimed its first bank, Franco-Belgian institution Dexia (DEXB). It probably won't be the last.

Three years after Dexia received a $9 billion bailout after suffering large losses during the financial crisis, officials in France, Belgium and Luxembourg moved this weekend to nationalize and break up the company. The Belgian government is buying Dexia's retail unit in the country for $5.4 billion and joining those countries in guaranteeing more than $120 billion of the bank's loans and other obligations.

Dexia is effectively being carved into "bad" and "good" banks. The bad will contain toxic debt, such as Greek, Italian or other European government bonds (and American mortgages, presumably). The good will include any assets, including healthier units in France and Luxembourg, that retain value. Those will be liquidated to raise money to offset further losses.

Blind man's bluff
The proximate cause for Dexia's collapse was its difficulty securing short-term funding. Concern had grown in recent weeks about the bank's credit risks, which at $700 billion are more than double Greece's GDP.

If that reeks of 2008, when the capital markets stopped lending to banks because of concerns over their solvency, that's because Dexia's problems run deeper than a taste for Greek government bonds. Dexia's "growth" strategy before the crash hinged on aggressive lending and on rapid expansion through mergers and acquisitions. In short, the company acted like most big banks before the crash.

Since then, Dexia had managed to stagger along thanks to the desperation of Europe's political leaders and the largess of taxpayers. But its latest failure, which comes at a much steeper price, raises another key question: Why didn't banking authorities seize the company three years ago? Belgian daily De Morgen raises concerns that the latest bailout amounts to another case of "playing poker with taxpayers money."

Zombie town
Indeed, Belgium will be on the hook for roughly 60 percent of the loan guarantees for Dexia, or a whopping 15 percent of the nation's GDP. Moody's (MCO) is already warning that the bailout cost could harm Belgium's credit rating. That would drive up the Belgian government's borrowing costs, damaging an already fragile "core" European economy. This is how contagion spreads.

The poker game also could include many other big European banks that, like Dexia, relied on government bailouts during the financial crisis to paper over huge losses. Although giants such as France's BNP Paribas (BNP) and Deutsche Bank (DP) have far more capital than Dexia, they also face far bigger losses on Greek, Italian, Spanish and other European sovereign debt. Said the editor of Belgium's De Standaard:

Dexia is only the tip of the iceberg. Since the start of the banking crisis, all we have done is to reassign financial institutions' debts to governments. To avoid a systemic crisis, we tried to spare banks and their shareholders, in the hope that a massive influx of cheap money would give banks sufficient time to reinforce their capital structure.... We have come as far as we can with this, and the next part of the story is going to be written in blood-red ink.
Put another way, one European zombie bank is dead. Now the issue is whether the financial markets will turn against the region's other financial undead. What finally felled Dexia -- and Bear Stearns and Lehman Brothers -- was a loss of faith among investors and other lenders. Capital reserves, no matter how ample, are no antidote to fear.

Thumbnail by Bob Jagendorf via Wikimedia Commons, CC 2.0

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    Alain Sherter covers business and economic affairs for