How debt-laden French cities avoid Detroit’s fate: sue the banks

By Peter Gumbel
July 22, 2013

Within hours of Detroit filing the biggest municipal bankruptcy in U.S. history on July 18, French TV and other media followed up with the reassuring message that, in France at least, such a turn of events would be impossible. Under French law, municipalities are required to balance their budgets, and the national government can — and occasionally does — intervene to force them to comply.

But take a closer a look at what’s been happening since the 2007 financial crisis, and a rather more nuanced, and surprising, picture emerges. For more than a dozen sizable towns and districts across France have been caught in a vicious debt trap that has seriously imperiled their financial well-being. In turn, they have mounted a furious counterattack that involves suing the banks that financed their credits. At the same time, they have launched an intense lobbying of national government for substantive help to shore up their finances.

On both counts they’re winning, in a way that would turn Detroit green with envy.

The national government has thrown a lifeline to the troubled communities, unveiling an arsenal of new measures — including about $4 billion in extra cash — to help assuage the crisis. And, to their delight, the local authorities have won landmark judgments against the banks that call into question the very validity of the loans they took out.

Similar initiatives have been launched by municipalities in other European nations, including Germany and Italy, with more mixed results.

A prime example of the French counterpunch strategy is to be found in the Seine-Saint-Denis district to the northeast of Paris, population 1.5 million. The first two numbers of its zip code, 9-3, have become synonymous in France with poverty, urban decay and racial tension, akin to the way Detroit is sometimes perceived in the U.S. The unemployment rate is 30 percent higher than the national average, while household income is 30 percent lower, according to official statistics. It was here that the worst of the 2005 civil unrest took place. Since then, local finances have become seriously messed up, in large part because of reckless borrowing by the former communist party officials who dominated local politics for years.

More than 90 percent of Seine-Saint-Denis’ borrowing, totaling about $1.25 billion, was in the form of “structured” loans, about two-thirds of which have turned toxic. These floating-rate credits provided an initial, highly favorable teaser rate for several months, and then were pegged to baskets of interest rates or foreign currency exchange rates that turned out to be highly volatile.

In February, Seine-Saint-Denis won a major victory against its main creditor, the Franco-Belgian bank Dexia. The Nanterre court ruled that the bank had provided insufficient information to the district authorities about three particularly risky loans totaling $260 million, and it ordered that the rates on them be cancelled. Instead of paying between 5 percent and 9 percent, Seine-Saint-Denis was only required to pay a rate of 0.7 percent, the court ruled.

The legal case was just one of 17 different suits filed by Seine-Saint-Denis against its banks, but it has quickly been viewed as a precedent in other afflicted towns, including Saint Etienne, which signed on to loans at a preliminary 4 percent rate that were indexed to the Swiss franc-British pound exchange rate. The rate soared as high as 24 percent at one point, doubling the town’s $160 million nominal debt. Saint Etienne, too, is suing its bankers.

The victory was especially sweet for Claude Bartolone, currently Speaker of the French parliament, who previously served as president of the Seine-Saint-Denis regional authority from 2008 to 2012.  In 2011, he headed a parliamentary investigation commission into the financing of local authorities that likened some of their borrowings to “a time bomb”; overall some $25 billion in local government financing was potentially perilous, the commission’s report found, more than half the total. The report spread the blame among local officials who “lacked competence” in arcane finance, the national government that had been “myopic” about the dangers despite some warnings, and above all, the banks, “which developed a systematic and very aggressive sales policy that was often deceptive.”

Political pressure from Bartolone and others has translated into a slew of new measures over the last year, as the administration of President François Hollande has ridden to the rescue of beleaguered local authorities. In a Nov. 2012 speech outlining the changed policy, Finance Minister Pierre Moscovici talked about how “we inherited a dangerous and greatly deteriorated situation.” The new measures include about $4 billion in a new special savings pool, a revamped national borrowing strategy orchestrated by the government and financed by two state-owned banks, and the help of central government experts both in analyzing troubled loans and in renegotiating them on behalf of troubled municipalities.

In other words, the government has come down clearly on the side of the troubled communities, and against the banks, whose “duty,” in Moscovici’s words, “is to continue lending to local authorities.”

The previous administration of President Nicolas Sarkozy took a tougher line on the issue: in 2009, it intervened directly in the small town of Grigny, just outside Paris, after its budget deficit soared from about $2 million to $18 million between 2006 and 2009. The national government’s representative, the “préfet,” preempted the town council, as he is entitled to do in extreme cases, ordering a 50 percent increase in local taxes and a range of spending cuts.

With Hollande’s government taking a different approach, there is an element of schizophrenia at play, since the most significant lender to local government in France, Dexia, is owned by the governments of France and Belgium, and has itself received $8.6 billion in bailout funds from the French government alone. Paris is thus funding both the troubled municipalities and their troubled bank lender simultaneously.

Compounding its woes, Dexia is also reportedly caught up in the Detroit bankruptcy, one of several European bank creditors to the U.S. city. Among the heavy burdens weighing on Detroit, is the cost of funding the retirement of city workers; that wouldn’t be the case in France, where the national government, not municipalities, are on the hook for retirement funding.

If only it had remained French, as it was until 1760, Motor City’s fortunes might today be quite different.

PHOTO: French high school students shout slogan during a demonstration to protest against higher education reform and reduction of  teaching positions in high schools in Paris April 3, 2008. REUTERS/Philippe Wojazer

2 comments

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This is awesome. So now banks know not to lend anything to French municipalities.

Posted by CarlosFoxtrot | Report as abusive

Now banks know that they must not lend IRRESPONSIBLY to French municipalities. No toxic loans no more, please. Incidentally, Dexia will probably lose more money in Detroit than in all the French municipalities combined.

Detroit is a lose-lose situation for everyone: the banks, the city, and the pensioners, whose pensions will be cut.

Posted by Farang | Report as abusive