Dexia and European banking Contagion

On October 9, 2011, France and Belgium agreed to nationalize the French-Belgian bank Dexia. Although most Americans have likely not heard of Dexia, the implications of Dexia’s nationalization are massive. It shows that the European sovereign debt crisis is moving from the periphery states like Greece and into the supposedly strong core states like France and Belgium.

Dexia has a massive balance sheet. It has total assets of 518 billion dollars: about the size of the entire Greek banking system. Dexia has large holdings of Greek, Italian, Portuguese and Spanish debt. Those countries are considering some of the weakest in Europe. Many economists estimate that Greece will run out of money to pay its debts by this November. The point is that if Greece or others cannot pay their debts, it can throw the entire financial system into disarray. Dexia owns approximately 20 billion dollars in Greek debt. Sure enough, the rescue will weaken the fiscal situation of Belgium and France. Both countries have agreed to guarantee the risky loans held on Dexia’s balance sheet.

In addition, the Dexia nationalization shows the complete failure of efforts by Europe to repair the continent after the 2008 crisis. In 2008, France and Belgium injected 6 billion Euros into Dexia. Just three months ago, Dexia passed the EU stress test, a test to see if the bank would be able to survive a situation in which they occurred large loan losses. Of course, Dexia passed. Some experts believe that the stress tests were faulty and that they created a false sense of security.

Overall, concerns are rising that the problems embodied by Dexia will cause an overall bank run in Europe which could leak into the United States. Its a failure of trust. Economists are thinking: who is next. Peter Zeihan, a risk analyst with Stratford noted that the Dexia crisis will “[f]orce investors and shareholders to take a second look at what they thought was stable.”

One comment

  1. The recapitalization of Dexia has to be viewed as positive step in remedying the European Financial Crisis. The ECB is finally taking the necessary measures to ensure that the sovereign debt concerns of Greece and others will not lead to a spiral of defaults. I for one am (quietly) celebrating this move (I’m writing this comment from the library).

    Finance is all about confidence. The survival of the European banks with significant exposure to questionable sovereign debt is conditioned on the market’s confidence in the ECB’s ability to sustain these banks if there is a default. Only the ECB can initiate measures that will instill renewed confidence in the European Financial System. The recapitalization of Dexia is such a measure. It shows that ECB can and will take action to sustain the European Financial System when needed. It is the right move, and hopefully the beginning of trend as undoubtedly, many other banks will need to be recapitalized like Dexia in the near future.

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