It's a Small World After All

Location Date: 
June 21, 2011

Canadian Minister of Finance Jim Flaherty warned Canadians on Monday of the dangers associated with a contagion of a Greek sovereign debt collapse.  Canada is not an “island”; of course he is right, but are people aware of how truly widespread these linkages are?

Everyone by now has likely seen the infamous cartoon sketch of how a pension fund in a town in Norway ended up with AAA-rated subprime mortgage debt exposure. Fast forward the next 3 years and we have the reverse situation occurring with the Greek debt crisis.  The collapse of Greek debt has forced many European banks into a jam and perhaps none more so than Dexia SA, the Belgian/French banking concern.  They have roughly €5.4 billion of Greek credit risk (of which €3.5 billion is to the Greek government) against a Tier 1 Capital base of €17 billion – not pretty!!  

Source: The Wall Street Journal

Dexia, as reported in the WSJ this past weekend (Click here to read), has $17 billion of municipal (“muni”) bonds it has backed in the U.S. – including a $72 million piece of debt associated with a local skating rink and arena in Everett, Washington - home of 104,000 proud Americans.  Investors in these bonds are now demanding higher yields as Dexia is under review for a possible two-notch downgrade by the likes of Moody’s (they know apparently a bad situation when they see it).  It gets better - if investors in the bonds do not rollover during the “remarketing process” (maturing), then Dexia has to buy the bonds back – and they have eaten $400 million so far.  But wait, it gets even better for Everett - Dexia has a pseudo ARM arrangement where they can push the interest rate up and shorten the duration on the issuer.  Nice.  Now the municipality can go out and shop for another “backer” (and many are), but costs will go up and further pressure will build on an already-stressed situation for local governments.  For Everett, rates go from 0.65% to 1.75% or over $24,000 per month – that is a lot of ice rental time!


Jim McGovern