Only Full Banking Separation Can Protect the People

I extend my best wishes for a successful Schiller Institute conference, and applaud the Schiller Institute’s international campaign for Glass Steagall bank separation. I urge parliamentarians from around the world to familiarize themselves with the bank separation motion we have introduced in the Icelandic parliament, and seriously consider taking similar actions.

Common people all over the world are suffering deeply because of the high-risk speculation of the financial world, and now this same financial world is exerting immense pressure on politicians to save their monetary values, by imposing brutal austerity on the constituents. I believe that that is wrong, and that there are other alternatives. One is with re-imposing full Glass Steagall bank separation, which can help protect the population’s savings, and help to rebuild the productive and sound economy

On October 24, 2012, a motion to separate commercial and investment banking was reintroduced into the Icelandic parliament, by 17 MPs from all parties and independents, except the Independence Party, which also announced their support for the idea during the hour-long parliamentary debate held on the subject. The motion reads:

“Parliament resolves to entrust the Minister of Economic Affairs with the task of appointing a committee which is to revise the framework of banking services in Iceland in order to minimize—through the separation of commercial and investment banks—the risk of disruptions within the banking sector for the national economy. The committee is to examine the policy-making of neighboring countries in this regard, and to submit its proposals before Feb. 1, 2013.”

Were our motion passed, as it seems most likely, it should be possible for the proposals to be ready earlier than the Feb. 1 deadline.

During the parliamentary debate, these are some of the points I stressed:

• The aim of the motion is to separate commercial banking and risky investment banking in our country. Right now, investment activity is still low in Icelandic banks, believed to be about 5%, but it had reached a little over 30% before the crash.
• The co-sponsors think that it is appropriate to make this step now, in full, before investment banking takes back all power in the Icelandic banking system. Although the percentage is still small, it is growing.

Why should we separate these activities, one may ask? Separation of these two different types of financial services will reduce the systemic risk of the financial sector for the economy. While some point out that separation does not solve all problems, others stress that this is an absolute prerequisite for economic stability and honest business. Through separation, we actually ensure that public savings would not be re-used as “gambling money” in risky lending by investment banking owners. Through separation, the state can ensure that normal saving deposits would not be misused again, so that the loss due to risky loans and investments would not revert to the taxpayers and the state treasury.

Ordinary deposits, and lending to households and businesses are classified as normal or commercial banking. These deposits are largely protected by government guarantees. Should these protected deposits be put together with a speculation and risk-based investment strategy, a toxic mix is created that can place, and has placed, an entire financial system in ruins, with serious consequences for households and the Treasury, the consequences of which we know so well in Iceland.

The co-sponsors have no doubt in their minds that this toxic mixture has been a traceable cause of our banking collapse.

In a report issued by the Minister of Economic Affairs and presented in April, 2012, it says on page 84-85 that there is no doubt that the very unfortunate relationship between deposits and investment had been part of the roots of the crisis of 2008.

It says, moreover, that financial stability would seem to be strengthened with a clearer distinction between these two aspects of banking, and that currently, there are warning signs about the unfortunate connection between the two segments of the financial system here.

The authors would not preclude differentiation or separation of these segments as a future arrangement, especially if the trend is heading in the direction of the international marketplace.

In a statement accompanying our motion, we discuss how a perfect separation of these two factors was insured among the banks in the United States, after the collapse of the stock exchange in New York, and the crisis that followed. The so-called Glass-Steagall-law was in effect from the years 1933-1999, and the global financial system followed in the footsteps of the U.S. in this regard, but in 1999, it was no longer considered necessary in the United States. The law was abolished, and it took a little less than ten years from the time that financial institutions were again permitted to combine commercial banking and investment banking again, for a new banking bubble to burst in 2007-2008.

It is clear that the recent banking crisis has called for a reassessment of these issues throughout the transatlantic region. Especially since the Barclay’s bank scandal in the U.K., there has been a public debate about reinstituting Glass Steagall in the U.S., the U.K, Europe and Iceland.

The idea of implementing separation again, in the spirit of Glass-Steagall Act, has increasing support throughout the Western world. But, there are also those, especially in the United States and Great Britain who argue that a partial bank separation were better, including the British Vickers Commission’s proposal for ring-fencing – for separate departments within the same bank, or those who favor the weak Volcker-Rule for the U.S.

We, however, believe that only full bank separation would protect the population from the excesses of the speculators. Here in Iceland, we now have a unique opportunity to fully take this necessary step – and lead the way for other countries to implement full bank separation. The co-sponsors think that passing this motion is necessary so that we may continue to build/establish a sound economy of the nation, upon which the future of our nation depends.

KAV: Good morning Maître Hélène Féron-Poloni, thanks for receiving us. You are an associate lawyer of the Paris Law office Lecoq Vallon & Associates in charge of the legal defense of several municipalities and intercommunal utilities which became victims of the so-called “toxic” loans.

HFP : The toxic loan issue is THE scandal of the years 2000. It is a problem of finance coming down in the day to day reality of our cities, our existence as citizens.

Over the 1990s, early 2000, Dexia came to the conclusion that the demand of municipalities for new loans was shrinking since many had now acquired the infrastructure they needed. You don’t need four or five recreation rooms, you only need one, and once it is build, you pay the loan and it’s finished.

Dexia then got the idea to “do something new with something old” and to restore its profitability by selling to the municipalities what it called “debt management”. For example, a municipality which had an outstanding loan of let’s say 3 million euros to Dexia, and which would have paid it off entirely over the next decade, was pushed by Dexia to refinance the 3 million loan with a new loan, presented as a way to earn some money thanks to what looked as lower interest rates. The first trick involved if you take a new loan which get added to the capital you still owe from the preceding loan, is that you overextend the duration of payments (20 to 30 years). At the end of an old loan, you’re mainly repaying the capital, while if you start any new loan, you mainly are going to pay the interests first on the loan to the bank and less of the capital as such.

In a second phase of commercial prospecting with the municipalities, Dexia would tell them: “We can do even better. You can gain even more substantial margins on the interests of your loans by participating actively on the financial markets: by becoming a player on the financial markets – I never explain you how – but don’t worry, we will take care of everything, we have a solution and instead of paying a 4% interest rate on your loans, we will get you a 3.5% annual interest rate”. Of course the mayors, which try to keep local taxes as low as possible, got understandably seduced by this proposition, while in the same time, as we discover today, most of them didn’t understand what the hell they were signing.

Hence, Dexia, over the years 2000, got huge numbers of people to sign on to what is called “structured loans” which later turned into “toxic loans” because municipalities are incapable of honoring these financial commitments.

Inside these structured loans exists a purely financial mechanism which is a “currency exchange option” which the municipality will SELL to Dexia. In exchange of this sale, Dexia will offer, but only for some initial years, a lower interest rate on its loan. Dexia will extend to the municipality a loan with an interest rate below the rate of the preceding loan and the municipality will profit from a loan which depends of the bet defined by the currency exchange option it sold, via Dexia, on the markets, hoping the bet will work out favorable.

KAV: Do you mean the municipalities were turned into players of the global financial casino economy?

HFP: Absolutely. The municipality, by selling a currency exchange option to Dexia, becomes de facto the guarantee of a bet postulating that a given parity among two currencies, frequently it was the parity between the euro and the Swiss franc, would remain at a given value. The municipality would say: “I take this loan by making the bet that the euro will never drop below the value of 1.44 Swiss francs”. And at the same time, on the financial markets, there are financial firms, in a far better position than the municipality to evaluate the value of that bet, which make the inverse bet! They consider that, regarding the financial crisis that started at least in 2007, the Swiss franc will rise versus the euro and that one will need less than 1.44 Swiss francs to buy 1 euro. The consequence for this municipality is that if it takes a loan from Dexia at 3.5%, it will get the guarantee from the bank that the rate will not increase over the two initial years, but that if the exchange rate between the euro and the Swiss Franc turns against the municipality, as off the third year, the interest rate of the loan will explode. And that is what happened to many municipalities in France.

I got contacted by the municipality of Sassenage in 2011. They had and still have two loans outstanding, one which dates from 2009 and the other from 2010. The amount of both loans is a little bit more than 4 million euros each in terms of capital lent. These are “structured loans”. The index involved is the euro/Swiss franc parity and for the loans to keep their initial rates of 3.5% and 3.7%, the bet was that for 1 euro one would require less than 1.44 Swiss francs. This parity barrier was exceeded in 2011. The current rates on these loans to Sassenage are reaching 15% annually! Of course, the city was contacted by Dexia to find solutions to the situation. The first of these solutions, if one faces an adaptable interest rate that is explosing, is to consider reimbursing the entire loan in an anticipated manner. Yet, the structure of the loans makes it such that the financial compensations required to exit these loans are superior to the remaining capital to be paid.

To reimburse a 4 million euro loan, Sassenage has to come up with over 8 million euros, i.e. 4 millions of the initial capital and over 4 additional millions for the compensation for anticipated reimbursement. Why? Because, as we said before, the structured loan involves the sale of a currency exchange option on the financial markets: there exists a financial firm which bought this option from the municipality and which claims the counterpart of its contract because the value of the Swiss franc increased versus the euro. And to exit the contract, the municipality has to pay the counterpart of the sale of the option which took places months, even years earlier.

KAV: Is it Dexia itself that sells these options or does it involve another financial firm?

HFP : This mechanism was never explained by Dexia. The bank never told the municipality: “I’m buying your currency exchange option”. But we know they did, because financial experts examined these structured loans. We know today for sure that Dexia bought these exchange rate options and resold them. It is by this very activity that the bank made profits by on the loan contracts. It bought these options very cheap from the municipalities and sold them with a substantial profit margin on the financial markets.

The municipality, it has to be underlined, had a blind faith in Dexia. So each time any trouble popped up with the loan, Dexia intervened to see how to things could be settled.

It was Dexia each time which sold a new solution to the municipality in order to protect it from paying outrageous interests. But with the solutions sold each year by Dexia, the only way for the municipality to avoid paying too much interest was to take each time more risks on the financial markets.

Dexia abused of the municipality’s ignorance in matters of structured loans.

You can’t find any single document, be it a contract or commercial paper in which Dexia explains to a municipality that it becomes a vendor on the financial markets of a currency exchange option based on the parity between the euro and the Swiss franc. That information doesn’t appear anywhere. And on top, it has to be noted, and in this case we do have written documents, Dexia claimed that the Swiss franc, as a refuge currency, was exceptionally stable while the very nature of refuge currencies is their extraordinary volatility! And if Dexia did so well in reselling these options – because that’s how its profits were made out of structured loans – it was because on the financial markets, while Dexia was telling its clients that the Swiss franc was a very stable currency, there were numerous financial firms that made the opposite bet. Who said “no, no, no, this is not flying! Considering how the crisis is evolving since 2007, and considering the engagements I took in Swiss francs, I absolutely have to cover myself against the currency risk between the euro and the Swiss franc! And lo and behold! Dexia was selling en masse currency exchange options on the euro/Swiss franc parity! Today, one can speak about the quasi-bankruptcy of Dexia, that is to say, without the French and the Belgian state bailing them out for the second time – we’re talking about over 10 billion euros for the bailout of Dexia. This bank is as good as bankrupt but when you see what it has done to its own clients one cannot really say that the bank is well managed.

KAV: The case of Sassenage was examined by the Regional court of accounts. Tell us more.

HFP: One must know that in French Law, the contracts signed between two persons settle the law between these two persons. So, by law, the municipalities have the obligation to pay Dexia. But exceptions do exist. If you consider the contract to be void, if the contract has an inherent vice from the very beginning because of the behavior, in this case, of a banker, the behavior of Dexia, then you have the possibility to solicit the cancellation of the loan in question. And then the judge intervenes and it is only the judge who can allow a municipality not to honor its financial obligations towards a bank. It is according to this approach that in the case of Sassenage we went to the Tribunal of Grand Instance of Nanterre and sued Dexia for invalidity of the loans it contracted with the municipality of Sassenage. And in parallel, the municipality of Sassenage stopped paying interests on these loans. Let me be clear: the capital continues to be reimbursed, but on each yearly loan term, it stopped paying the interest. That’s normal considered where these rates stand today ; the city cannot pay these interests since it would completely destabilize its budget. Confronted with this situation, Dexia called on the Prefect to intervene. The prefect convoked the mayor and told him: “You are going to pay these interests to Dexia!” The mayor refused to do so and the Prefect called on the Regional Chamber of Accounts of the district to inscribe the payment of these interest rates as a mandatory payment.

Now, contrary to all expectations for Dexia, the Regional Chamber of Accounts did rule, in its ruling of May 31, 2012, that in effect this municipality was allowed not to pay the interests on its loan till the Tribunal de Grande Instance of Nanterre made its own ruling about the totality of its complaints notably the invalidity of its loans. This is the first time ever that a Regional Chamber of Accounts makes such a ruling. And this decision is important because we’re talking about a jurisdiction of public finances which is specialized in matters of municipal investments and therefore the ruling has a real weight.

KAV: With everything you just said, you cannot but agree with people like us which are calling for a total separation between deposit banks entitled to finance households, companies and local governments and which are deprived of the right to engage on the financial markets and investment banks on the other side the which when they engage in risky bets should be responsible for their own losses.

HFP : The issue of these toxic loans is really nothing but the illustration of the fact that over the last 20 years, be it loan contracts of financial products sold to clients by financial firms, were merely designed to guarantee profits to the financial world and in no way to their clients. Be it investments, savings or loans as those to these municipalities, the client, which believes making a good deal, which thinks gaining some money for his community and even reduce spending, has no awareness that the profitability is only certain on the side of the financial firm. It is somehow as casinos: to win the game, one has not to gamble but to owe one.

KAV: Yes, but if the entire society is handed over to a casino, we’re going to crash our heads against the wall!

HFP: It is clear that that is not desirable and if I have to be on one side or the other, I prefer to be on the side of the clients of the banks than on the side of the financial establishments.

KAV: Alright, thank you!