European Banks and Dexia Breakup: The Scary Math Behind Them

On the heels of the French-Belgian bank Dexia breakup, German Chancellor Angela Merkel and French President Nicolas Sarkozy announced a promise to come up with a plan by month-end to recapitalize European banks and deal with Greece's debt burden.

They were thin on details, including how large the bailout will be. Merkel spokesperson Steffen Seibert said the parties want to negotiate in confidentiality, according to Reuters.

That amount, however, may need to be very large, judging by the circumstances surrounding Dexia's breakup.

Dexia, the product of a merger between the biggest municipal lender in France and the biggest municipal lender in Belgium, had 518 billion euros in assets in June, according to Bloomberg. Its exposure to Greek debt in June was just 5.4 billion euros.

Dexia relied on wholesale funding but was supported by consumer deposits. It also passed the recent European Union bank stress test.

In fact, regulators portrayed Dexia as one of the strongest banks in Europe, according to BBC business editor Robert Peston.

The scary thing, therefore, is that exposure to 5.4 billion euros of Greek debt brought down a supposedly healthy bank with 96 times the assets (518 billion euros). Exposure of 5.4 billion euros to Greek debt does not even cause a loss of 5.4 billion euros because Greek debt is worth more than zero.

But if the funding market and investors are that scared in Europe, the European debt crisis could get a lot uglier unless Merkel and Sarkozy come up with something big.

At the end of 2010, U.S., French, German, and UK banking exposure to Greek debt totaled about $165 billion, according to DoubleLine Capital, citing Bank for International Settlements data.

Ninety-six multiplied by $165 billion is about $16 trillion. The authorities, presumably, will step in way before damages reach anywhere near that neighborhood.

U.S., French, German, and UK banking exposure to the debt of Greece, Ireland, Italy, Portugal, and Spain totaled $2.6 trillion, according to DoubleLine.

Ninety-six multiplied by $2.6 trillion? That kind of losses will never manifest, of course, but it is still a scary thought.

The bottom line is that Dexia showed just how much damage 5.4 billion euros worth of Greek debt can do. The potential damages of the European debt crisis could be astronomical. Any bailout to prevent those damages, therefore, may need to match them in size and scope.

E-mail Hao Li at hao.li@ibtimes.com.

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