What Dexia's troubles can teach us

A man enters a Franco-Belgian bank Dexia's agency on Oct. 5, 2011 in Tournai.

Tess Vigeland: Yesterday, France and Belgium moved to bail out one of the biggest banks in Europe: Dexia. A bank that had previously survived a financial stress test. It was considered healthy. But apparently that test just wasn't tough enough. And there are likely more Dexias in the wings. What's going on?

I'm joined by our New York bureau chief Heidi Moore. Hi Heidi.

Heidi Moore: Hi.

Vigeland: So Dexia is this Belgian bank. Europe bailed it out once already. Why do we care?

Moore: Dexia does play a big role in municipal bonds. So when cities here in the U.S. try to raise money, Dexia helps guarantee that debt; it helps make sure that they can actually get the money that they want. And the other problem is that there are a lot of banks in this same situation as Dexia. They hold a lot of debt from Greece, Italy; these countries that Europe derisively called "P.I.G.S." -- Portugal, Ireland, Italy, Greece and Spain. So you can tell what they think of them, right?

Vigeland: Right. Not flattering, in any way, shape or form.

Moore: And we're probably going to see a lot more of this.

Vigeland: Let me ask you this now: Why would so many banks want this debt?

Moore: It's government debt. Like when you have Treasuries in your portfolio, that's zero risk. It's as good as cash, right? So all the regulators said that this was zero-risk debt. And it's kind of like when you go shopping for drinks, right?

Vigeland: OK.

Moore: So alcohol you know is kind of bad for you -- you know to avoid it. Caffeine isn't too great, and you want to have that in moderation too. But you can have all the water you want and not just be safe, but be healthy. And that's what banks thought too. These government bonds were like water to them -- they were safe, they were healthy, they were pure, they were neutral.

I talked to Doug Elliott. He's a former JPMorgan executive who's now at the Brookings Institution. He explained why the banks piled up this debt.

Doug Elliott: European banks loaded up too much on debt from the weaker countries. If you've got something that you're allowed to treat as risk-free, why wouldn't you just pile up this stuff?

Vigeland: Well OK, so then why didn't we test the 'water,' you know, to see if it was going to make the banks sick? And the 'water' here is government bonds, right?

Moore: Right. Exactly. And we were afraid of the answer, basically. So the tests were cautious. They didn't want to say: 'What happens if Greece defaults and we have a massive panic?' Because they thought if we say that, it's going to happen. It's like saying "Beetlejuice" three times, if you remember that old movie from the '80s. If you say, "banking crisis, banking crisis, banking crisis..."

Vigeland: There's going to be a banking crisis.

Moore: Exactly. And so they were afraid to test for something so extreme and now we're obviously seeing the flaw in that.

Vigeland: Well, you know, as we mentioned up top, this feels a lot like 2008. We've got rumors, we've got signs of panic. It seems like there might be a contagion out there. Is this redux?

Moore: It's redux emotionally, but what's interesting here is that we actually what we're dealing with here. If you think back in 2008, we had no idea what those mortgage securities were worth, who was holding them; even the bank executives couldn't explain them. Now we know what the problem is: it is the debt of these troubled countries. And now we just need to know how to contain it and deal with it. So it's not so complicated. But what the two time periods do have in common is we have to drop this belief that some assets are risk-free. Do you remember those toxic mortgage securities?

Vigeland: Oh yeah.

Moore: Who can forget them? They were rated AAA. They were as safe as U.S. Treasuries, like they had no risk at all. So if we learn anything, it has to be this: There is no such as perfectly safe lending.

Vigeland: Great. Oh, these are just lessons we continue to learn the hard way. Marketplace's Heidi Moore, joining us from New York. Thanks so much.

Moore: Thank you.

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A question to Heidi: You beautifully explain how the banks got into their current mess. In short - debt gone bad.

What I was hoping to hear, is why we should not simply let those banks fail? A bank is like any other business - it can make money or lose money. Why is it such a problem when these banks lose money, even if it means they go under?

BTW: I do not believe that the "financial system" as we know is in jeopardy if some banks fail. And not all banks will fail.

Well, apparently “we” still don’t know what the problem is, because attempting to blame the financial crisis on debtors and debtor nations is a complete mischaracterization of what has taken place, and a theme I still hear regularly in the financial news, usually promulgated by the same right-wing ideologues that created the problem in the first place. The problem, as people are increasingly coming to discover with all the literature out there about it, is the securitization process and a deregulated financial industry, primarily brought to you by ultra-conservatives, otherwise known as neo-cons, and those whose total reading experience seems to be limited to Ayn Rand’s Atlas Shrugged; not the least of which include Alan Greenspan, who publicly recanted his position after the meltdown. Why is it that ordinary people like me have to educate the “experts.” Why don’t you do a special on derivatives, and the way CDOs were constructed so as to invite default? Or a piece about the ratings agencies, and how they were financially incentivized to rate garbage triple A? It isn’t “government,” as you would like to have people believe; it’s financiers who saw it all coming and meant to capitalize on it. The credit default swaps market, which is still unregulated and going strong, is standing proof of it. If government(s) can be blamed for anything, it’s for allowing Wall Street, neo-cons, and financial lobbyists assure them that government needs to stay out of the way of business and finance. How about a piece on the Orange County, a Republican stronghold in California, which declared bankruptcy after being sold complex derivatives that no one could figure out? I believe they have since sued. That’s a great microcosm of the problem and a good place to start.

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