This is how it starts: The strongest banks announce bigger write-downs. The weaker banks break into pieces, putting the healthier parts up for sale and looking to create a bad bank to house the worst assets. Governments extend guarantees and promises of guarantees in an effort to calm financial markets. Some governments push to recognize hard financial truths, and other governments go into a defensive crouch.
Yes, this is how preparations for a Greek default begin. So far, the moves are slow and piecemeal, aimed at preventing a panic that would spread destruction across weak and strong European banks alike. And there's certainly nothing yet that resembles a unified eurozone response.
Facing the real danger
The lack of a common response isn't the worst problem in the early preparations for a Greek default. So far, all the effort is aimed at stabilizing the banking sector, with no credible preparation that would keep a Greek default from endangering Portugal or Italy, the two most vulnerable eurozone members. While guaranteeing Europe's banks is necessary to prevent a Greek default from taking down the eurozone's financial system, it is by no means enough to tackle what long ago ceased to be a Greek debt crisis and has become a euro debt crisis.
Jim Jubak
The current danger is that the political and financial leaders of the eurozone will decide that getting the regions' banks ready for a Greek default is enough. If they don't figure out how to build an effective barricade in front of Portugal and Italy at a minimum, and Spain and France as well, then I think a Greek default will quickly lead the financial markets to start pricing in other defaults.
There's still time to put those barricades in place, but the carpenters seem fully occupied with the work of building the scaffolding to protect the banks from a Greek default. It's by no means clear that this effort will be in time or adequate. I see no signs of work on protecting the eurozone's troubled countries. (For my most recent take on when Greece will default, see my Sept. 22 column.)
Let's see what we can learn about the work being done to prepare for a Greek default -- and how much more needs to be done.
For the eurozone's strongest banks, preparing for a Greek default means writing down Greek government debt even further, announcing a big hit to profits, and further tightening costs. For example, Deutsche Bank (DB, news)announced Oct. 4 that it would write down its Greek debt holdings by an additional $250 million. That write-down will be reflected in the bank's third-quarter earnings report scheduled for Oct. 25.
Forget about that full-year target for pretax profits of $13 billion. Third-quarter results will be lower than expected, although the bank would remain profitable for the period, said CEO Josef Ackermann. To cut costs going forward, the bank will eliminate about 500 jobs in its corporate banking and securities division over the next six months.
Not pleasant, certainly, especially for those being let go into a slowing global economy. Most of the job cuts will come from outside Germany.
A look at Dexia
For the eurozone's weakest banks, preparing for a Greek default means breaking up, selling off what can be sold, and creating a bad-bank stump. At least that's the plan being forced on Dexia, the French-Belgian lender. (I say lender instead of bank because most of the company's business is in arranging financing for municipalities. Although it does operate a retail bank in Belgium, a private bank in Luxembourg, a retail lender in Turkey and an asset-management business.)
Dexia needed a government rescue in the dark days after the Lehman Brothers bankruptcy in 2008. Now Dexia is back at the table, looking for government support that would save it from losses in its portfolio of almost $28 billion in debt from Greece and other troubled eurozone countries. That portfolio has made it impossible for Dexia to fund its operations by borrowing in the financial markets. Again.
What went wrong? In a nutshell, Dexia ran out of time to fix the problems left over from 2008.
In the years before the bubble in mortgage-backed assets based on real-estate lending burst in 2008, Dexia had padded its profit margins by funding itself with cheap, short-term money raised from money-market funds and similar sources of short-term cash. That was great. Borrowing cheaply in the short-term markets and lending less cheaply in the long-term markets was very profitable -- until the short-term markets froze and no one would lend Dexia money anymore. At the time of the first Dexia bailout, it needed to tap short-term markets for about $350 billion to fund operations. That was $350 billion that Dexia suddenly found itself unable to borrow.
Dexia wound up borrowing $58.5 billion by the end of December 2008 from the U.S. Federal Reserve (yes, in 2008 the Fed acted as lender of last resort to the world in order to avert a meltdown of the global financial system) and also received an $8.4 billion bailout from France and Belgium.
The new management team brought in after France and Belgium bailed out Dexia in 2008 worked to reduce the lender's reliance on short-term capital. By late June, the funding gap was down to $140 billion. Though that was huge progress, it proved insufficient when the short-term capital markets shut down again this summer.
Now the plan is to put roughly $130 billion in troubled assets (clearly more than the $30 billion in troubled sovereign debt) into a bad bank. The bank would be backed by guarantees from the French and Belgian governments. In addition, the governments would guarantee that customers of the Belgian retail bank won't lose any money.
Additional funding would come from money raised from the sale of Dexia's healthy divisions, such as the asset-management business and the Turkish retail lender DenizBank.
Either the municipal lending business will be allowed to run down or it will be merged with the French sovereign wealth fund or the retail-banking arm of the French post office. (Not so coincidentally, some of Dexia's biggest municipal customers are French.)
