Belgium-French Bank Dexia Loaned Money to Buy Dexia Shares

Creating Capital – And Why Banks Need Regulating

Most All Americans are not familiar with Dexia bank.  This is a European bank that was managed so badly that even before the resolution of the European banking crisis, (hopefully taking place as we speak) it had to be taken over by the Belgium and French governments.  It turns out one of its practices is Exhibit A as to why the financial sector needs regulation.

Banks in Europe, like banks in the U. S. need additional capital, that is they need to sell more stock to investors. But investors don't like that, because it means their ownership is diluted or they have to come up with more money (they would prefer the straight forward taxpayer bailout that they think they are entitled to.)   Dexia found a unique way to do solve the dilemma.

Dexia, the stricken Franco-Belgian lender that has been at the centre of recent market turmoil, loaned €1.5bn of fresh capital to its two largest institutional shareholders which then used the cash to buy Dexia shares before 2008, the Financial Times has learnt.

So in order to sell more share the bank loaned money to investors to buy the shares.  But wait, there’s more.

In a further twist, Dexia accepted its own shares as collateral for the loans. The arrangement meant that any falls in the bank’s share price left it potentially nursing large losses. 

So at the end of the day the bank has a loan on its books collateralized by the shares in the bank.  How’s that working out?

Dexia’s market capitalisation has fallen from €21bn in 2006 to about €1bn today.

Ok, not well.

This scheme took place in Europe, and so far nothing of this type of thing has happened in the U.S., at least as far as anyone knows.  But the only reason it has not happened with U. S. banks is that they had not thought of it.  If it's legal (never mind the ethics, that doesn't count) they will.