Europeans banks are worse than even the dire reports you read in the papers. Credit Default Spreads are widening and liquidity is drying up. Have you read about Dexia in the papers and wondered what it was?
Dexia is the third-largest retail and commercial bank in Belgium (a country that has received very little mention, if any, as the problems in Europe have been discussed). Just this past week it was announced that Dexia is in trouble. They are running out of cash because it owns so much European debt. They own a lot of Greek debt, a lot of Italian and Spanish debt -- those are obviously not good bets right now. French and Belgian finance ministers said today their countries will guarantee financing for the bank, but Dexia's problems could spread and the bank's failure could also affect many American cities.
Dexia also extends credit lines to American cities. So if a city needs to raise cash, they issue a municipal bond and Dexia guarantees many of those bonds. What's the fallout for those American cities doing business with Dexia? It’s hard to tell the extent right now, but many American cities have found a new bank to guarantee their bonds, but cities that are still stuck with Dexia -- and there are a number of them -- could suddenly have a lot less cash. American investors would get hurt as municipal bonds lose value. And even the possibility of a restructuring for Dexia prompts a deeper worry.
Confidence, or rather, a lack thereof. You could also call the problem more uncertainty. If the problem arises to the level of a crisis of confidence, we could see other banks following Dexia into that trouble zone. Dexia is the tip of the iceberg. Dexia’s trouble actually starts to broach the question about just how much can France do in regards to its bank debt. Will the ECB lend them enough money? We are talking a great deal of debt for a country with serious fiscal deficits and where government spending is already 55% of GDP, with rising health-care and pension costs. Think French politicians will try and get their unions and public workers to take a 15% pay cut? The French will not be civilized and stoical. They will take to the streets, just as they have in Greece.