Fed’s Biggest Foreign-Bank Bailout Kept U.S. Municipal Finance on Track
A European bank that got the most Federal Reserve discount window help during the financial crisis received a total of about $300 billion in loans, guarantees and cash infusions from governments and central banks. It also owned subsidiaries implicated in bid-rigging that prosecutors say defrauded U.S. taxpayers.
Details of Fed lending released last week show that Dexia SA (DEXB), based in Brussels and Paris, borrowed as much as $37 billion, with an average daily loan amount of $12.3 billion in the 18 months after Lehman Brothers Holdings Inc. collapsed in September 2008. The House subcommittee that oversees the Fed plans hearings on the central bank’s discount window lending to offshore financial institutions next month.
By lending to Dexia, the Fed kept money flowing into local government projects throughout the U.S. as well as the money market funds that invested in them. Dexia guaranteed bonds issued by entities as varied as the Texas State Veterans Land Board in Austin and the Los Angeles County Metropolitan Transportation Authority.
“If Dexia went bankrupt, it could have been a catastrophe for municipal finance and money funds,” said Matt Fabian, a Concord, Massachusetts-based senior analyst and managing director at Municipal Markets Advisors, an independent research company. “The market has extensive exposure to foreign banks.”
Overseas banks accounted for about 70 percent of discount window loans when borrowing reached its peak of $113.7 billion in October 2008, according to the Fed’s data. The discount window, established in 1914, is known as the lender of last resort.
By law, most U.S. branches of foreign banks have access to the discount window, said David Skidmore, a spokesman for the American central bank. “They are important providers of credit to U.S. businesses and households, and discount window lending during the financial crisis helped support their continued lending in the United States,” he said.
The Fed has kept discount window borrowers secret for 97 years. Last week’s disclosures were court-mandated after legal victories by Bloomberg LP, the parent of Bloomberg News, and News Corp.’s Fox News Network LLC.
Depfa Bank Plc, a German-owned bank based in Dublin, was another insurer of municipal bonds in the U.S. Depfa’s discount window borrowing peaked at $28.5 billion in November 2008.
Loans and Guarantees
Dexia, which borrowed $37 billion from the discount window in January 2009, said its loans from central banks peaked at 122 billion euros ($165 billion) in October 2008. That month, it also obtained up to 150 billion euros ($202 billion) in debt guarantees from France, Belgium and Luxembourg, of which it tapped a maximum of about 96 billion euros ($130 billion) in May 2009. The countries and existing shareholders provided Dexia about 6 billion euros ($8.4 billion) in capital.
Dexia stopped issuing guaranteed debt in June 2010, said Alexandre Joly, a member of the bank’s management board and head of strategy, portfolios and market activities.
“It’s apples and oranges to mix central bank loans, debt guarantees and capital infusions to come up with a big headline number,” Joly said in a phone interview from Brussels. “It’s not accurate and it can be damaging to Dexia.”
Other Fed Programs
The bank availed itself of other Fed lending programs too. Its total borrowings from the U.S. central bank’s Commercial Paper Funding Facility ranked third among users of the emergency program created to support the market for short-term debt issued by banks and corporations. Dexia used the program 42 times for a total of $53.5 billion, according to data the Fed released in December.
Dexia also tapped the Term Auction Facility, the lending mechanism the Fed established in December 2007 to augment the discount window. Dexia received 24 TAF loans totaling $105.2 billion, the largest of which was $16.7 billion on Jan. 17, 2008, Fed data show. The lender used TAF about twice a month from December 2007 to September 2008, then once in August 2009 and once more in November 2009. The interest rates it paid ranged from 4.65 percent in December 2007 to 0.25 percent for the two loans in 2009.
The Fed loans have been repaid, said Ulrike Pommee, a Brussels-based Dexia spokeswoman. The bank used the Fed’s emergency lending facilities to finance U.S. assets only, Pommee said in an e-mail statement.
“We have always been very transparent in our communications about the wear and tear on us in the market during the crisis,” Pommee said.
In 2008, Dexia was hit with buyback provisions in municipal bonds, Pommee said. The bank was one of the biggest backstops of the bonds, providing letters of credit or so-called standby purchase agreements -- guarantees to buy the bonds if investors wanted out. Dexia’s so-called credit enhancement made it possible for money market funds to buy the bonds.
Dexia provided $14.7 billion in standby agreements and letters of credit in North and South America, excluding Mexico, in the first half of 2008, a six-fold increase over the same period a year earlier, the bank said in its first-half 2008 report.
“This growth was the direct result of a dwindling number of market participants able to offer such financial products combined with the urgent needs of issuers to restructure their debt,” Dexia said.
Over most of the last decade, thousands of cities, counties, hospitals and universities issued long-term floating- rate bonds and paired them with interest-rate swaps to try to protect against higher borrowing costs. The strategy, which relied on banks such as Dexia to guarantee a market for the variable-rate notes, collapsed when investment firms and bond insurers lost their top-credit ratings.
Interest-rate swaps are derivatives, or contracts whose values are derived from assets including stocks, bonds, currencies and commodities, or from events such as changes in interest rates or the weather. Swaps are private contracts and the market for them isn’t regulated.
Redemptions sapped Dexia so much that the bank was “two days from bankruptcy,” Pommee said, citing the French ministry for the economy.
Interest-rate swaps have cost U.S. taxpayers billions. The Denver public school system is borrowing $800 million this week to escape a wrong-way bet on rates. A Dexia unit that had provided a standby purchase agreement on the school district’s swap declined to renew its credit protection this month. The cities of Detroit and Pittsburgh also have restructured debt after Dexia decided not to renew its insurance.
Dexia’s lifeline from U.S. taxpayers came as federal officials were investigating allegations that the bank’s subsidiaries colluded with others to defraud state and local governments.
Two former Dexia units were among more than a dozen financial firms that conspired to pay below-market interest rates to U.S. state and local governments on so-called guaranteed investment contracts, or GICs, according to documents filed in a U.S. Justice Department criminal antitrust case.
Municipalities buy GICs with money raised by selling bonds, allowing them to earn a return until the funds are needed for schools, roads and other public works.
An employee of Financial Security Assurance Holdings Ltd., one of the Dexia subsidiaries, agreed to pay kickbacks ranging from $4,500 to $475,000 to a Los Angeles investment broker called CDR Financial Products Inc. in exchange for rigging bids, according to people familiar with the case and public records.
CDR employees fed information on competitors’ bids to FSA, allowing the firm to win deals at a lower interest rate than it would have paid, according to a federal indictment, public records and the people.
Steven Goldberg, a former FSA banker, was indicted in July on fraud and conspiracy charges. He has pleaded not guilty. FSA, which hasn’t been indicted, is facing a lawsuit from the U.S. Securities and Exchange Commission. While Dexia sold the bond insurance unit of FSA, it remained exposed to legal risks because it kept another division of the company, its Financial Products segment, Dexia said in its third-quarter 2010 report.
Joly said Dexia’s funding from the European Central Bank remains at 17 billion euros today. Its borrowing from the Fed “was a temporary situation and now they’re trading just fine,” said Nat Singer of Swap Financial Group LLC in South Orange, New Jersey.
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