Dexia – Rise & Fall of a Banking Giant ______
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DEXIA – RISE & FALL OF A BANKING GIANT __________________________________________________ LES ETUDES DU CLUB N° 100 DECEMBRE 2013 DEXIA – RISE & FALL OF A BANKING GIANT __________________________________________________ LES ETUDES DU CLUB N° 100 DECEMBRE 2013 Etude réalisée par Monsieur Nicholas Whitbeck (HEC 2013) sous la direction de Monsieur Ulrich Hege Professeur à HEC Paris Introduction .................................................................................................................................................... 3 I. How Dexia conquered the world ............................................................................................................ 4 A. Marriage of convenience ............................................................................................................................................... 4 B. Consolidation .................................................................................................................................................................. 6 C. Expansion in all directions ........................................................................................................................................... 8 D. Kempen & Labouchère – Dexia’s first warnings ................................................................................................... 10 E. Short-term liabilities fuelled the expansion of Dexia’s balance sheet ................................................................. 11 F. Under the leadership of Axel Miller, Dexia continued to grow .......................................................................... 15 II. The Fall of a Giant ................................................................................................................................. 17 A. Financial Security Assurance (FSA): the trigger...................................................................................................... 17 B. Dexia’s first bail-out..................................................................................................................................................... 23 C. Until October 2011, Pierre Mariani strived to deleverage Dexia’s balance sheet ............................................. 29 D. The sovereign debt crisis carried a fatal blow to Dexia......................................................................................... 35 E. The end of Dexia ......................................................................................................................................................... 39 III. A Widespread Failure ............................................................................................................................ 44 A. The failure of external and internal control bodies ................................................................................................ 44 i. Why did the European Banking Authority (EBA) give Dexia a clean bill of health in July 2011? ............................. 44 ii. Did the national regulators carry out their responsibilities? ............................................................................................. 54 iii. The utter failure of Dexia’s internal control system ........................................................................................................ 55 B. Rating agencies – omnipotence and self-fulfilling prophecies ............................................................................. 58 C. Above all, an unsustainable business model and management mistakes ........................................................... 62 i. Management mistake #1: an unsustainable financing scheme ........................................................................................ 63 ii. Management mistake #2: an excessive bond portfolio .................................................................................................... 67 iii. Management mistake #3: an unfunded international expansion .................................................................................... 68 IV. How should the multiple government-sponsored bailouts of Dexia be viewed from an optimal bank resolution standpoint? .................................................................................................................................... 71 A. Sub-optimal bank resolutions: the cases of Lehman Brothers, Fortis, Anglo-Irish and Icelandic banks .... 72 i. Lehman Brothers – a disorderly bankruptcy .................................................................................................................. 72 ii. The Icelandic banking crisis – the ring-fencing of domestic assets .................................................................................... 73 iii. Fortis – a speedy break-up driven by national interests .................................................................................................. 75 iv. Anglo-Irish Bank – a public bailout that dragged Ireland into severe debt and recession ................................................ 79 B. Alternative bank resolution models .......................................................................................................................... 82 i. The 1990s Swedish banking crisis – the case of a successful bank resolution .................................................................. 82 ii. The bail-in model ........................................................................................................................................................... 84 C. Conclusion on Dexia’s multiple government-sponsored bailouts ...................................................................... 86 V. Epilogue and concluding remarks ........................................................................................................ 88 Acknowledgements ........................................................................................................................................ 91 References ..................................................................................................................................................... 92 2 Introduction At the peak of the global financial meltdown, Franco-Belgian Bank Dexia’s balance sheet reached a record size of €651bn. As a highly systemic financial institution, Dexia could have been the European Lehman Brothers1. If Dexia had actually gone bankrupt, it would have dragged down in its demise much of the European financial system. As opposed to the George W. Bush Administration with Lehman, the three involved states (France, Belgium and to a lesser extent Luxembourg) did not let Dexia fall but bailed it out three times (in September 2008, October 2011 and November 2012) at great expense. Almost two years after Dexia’s breakup was officially sealed, the €85bn financing guarantee provided by the aforementioned governments still represents a major threat for public finances – an issue that is widely unknown to the general public. Belgium alone still guarantees €43.7bn of Dexia’s financing and refinancing, i.e. 11.6% of its 2012 GDP2! How did such a disaster occur? How did a bank whose core business was originally to lend to local authorities become an overleveraged hedge fund3? Why did the European Banking Authority’s stress tests give Dexia a clean bill of health in July 2011, barely three months before Dexia definitively went under? Why was the Board of Directors silent when the business model was so blatantly flawed? Could public authorities have handled matters differently? This paper aims to address these questions while also providing perspective on how Dexia’s bailout was handled with respect to other major bank resolutions (Swedish and Icelandic banking crises, Lehman Brothers, Fortis, Cyprus banks, etc.). Dexia, which has accumulated €16.1bn4 in losses since 2008, is a perfect illustration of all the ill- fated strategic decisions many financial institutions made in the past decades: excessive use of derivatives, toxic loans, risky financing, overpaid investments, unbridled growth alongside excessive compensation packages. When Pierre Richard and François Narmon founded Dexia in 1996, they took pride in building one of the first major transnational European financial institutions – a dream that has been utterly destroyed (mainly under their watch). More generally, Dexia’s collapse contributes to our understanding of why the financial system is still recovering from the impact of the 2008 global crisis. 1 Lehman Brothers reported a balance sheet of $691bn in December 2007 (Source: Lehman 2007 Annual Report) 2 Belgium’s 2012 GDP reached €377bn (Source: countryeconomy.com) 3 When Pierre Mariani took over as CEO in October 2008, he himself stated that Dexia “was not a bank, but a hedge fund” (Source: Bloomberg – “Dexia in 2008 operated as ‘hedge fund,’ chairman says” – October 10th 2011) 4 Including losses of €11.6bn in 2011 and €2.9bn in 2012 (Source: Annual Reports) 3 I. How Dexia conquered the world The following chapter will provide an assessment on how Dexia went from being a Franco- Belgian banking group dedicated to the financing of local authorities to a banking giant, with all the attributes of a “universal” bank. Our objective is to give our reader the necessary background materials to be able to assess the way the Dexia bailout was handled by the various stakeholders. A. Marriage of convenience In 1996, the Crédit Local de France (CLF) and the Crédit Communal de Belgique (CCB) merged to form Dexia1. In Europe,