Introduction

In November 1993, worried officials at the French finance ministry replaced the CEO of Crdit Lyonnais, Jean-Yves Haberer, and pledged that the savings of eight million depositors at the bank were safe. While it had been known for some time that state-owned Crdit Lyonnais had problems, the action made clear the dire financial condition of France's largest bank, and the ministry sought to reassure French taxpayers that they would not have to fund a massive bailout of the crippled institution.

Far too much money had been lost for that reassurance to hold true. Crdit Lyonnais had been constructing a financial timebomb for the French taxpayer since at least 1987, when the then newly appointed Haberer had developed a plan to grow the institution into a global banking powerhouse to rival Deutsche Bank and the major US investment banks.

That ambition, and the general largesse of the bank, suited French bureaucrats and politicians. They exerted limited risk oversight over Crdit Lyonnais until cracks began to appear in the bank's strategy in the early 1990s. The bank used its freedom to create a massive portfolio of poor quality assets in every sector from publishing through to film and finance, while underwriting or directly investing in a string of hugely expensive real estate and development projects that never paid their way.

By the time the scandal broke, the bank had become a honeypot for some of the world's least trustworthy businessmen. Poor internal controls left the bank open to fraud from within and without, while deficiencies in financial and risk reporting led to a gross underestimation of the bank's dangerous condition as Europe's economic boom ran out of steam in the early 1990s.

Crdit Lyonnais' near-bankruptcy is easily the most costly failure in the history of bank risk management. The extent of the disaster was disclosed to the French taxpayer only gradually as the French government mounted a series of complicated bailouts in the mid-1990s. By July 1997, French finance minister Dominique Strauss-Kahn could admit that the bank had probably lost around Ffr100 billion, or around $17 billion, in its colossal spending spree. Independent commentators have suggested that the debacle will end up costing the French taxpayer between $20 and $30 billion.

The after-shocks of the scandal continue to reverberate. In recent years US prosecutors and insurance industry regulators have launched a series of billion-dollar court actions against the bailed-out bank as a result of Crdit Lyonnais' activities in the US insurance sector in the early 1990s. This spring, the now-privatised bank, together with officials from the French government and from the CDR (a vehicle set up to manage Crdit Lyonnais' most troubled assets) have been attempting to reach an amicable settlement of the dispute with US authorities so as to avoid any criminal charges.

The seeds of trouble were sown at Crdit Lyonnais long before the run-up to the 1993 crisis. The bank, nationalised in 1945 after World War II, suffered from a deep-rooted confusion over whether it should act in the interests of the French political elite, or treat the state like any other shareholder and make commercial considerations and risk management its primary concerns.

The confusion set the stage for a disastrous escalation of risk between 1988 and 1993 as Crdit Lyonnais attempted to become a global power in banking. Haberer, a highly regarded bureaucrat from the French finance ministry with excellent political connections, was appointed to run Crdit Lyonnais by President Franois Mitterand in 1987. When Mitterand was re-elected for a second term in 1988, Haberer began to enact his long-term strategy of expanding the bank through growing existing businesses, acquiring new subsidiaries, making new investments and opening new offices in France and around the world.

The late 1980s were a time of relative boom in Europe, and the bank had no difficulty amassing a huge portfolio of investments and loans to industry. By the time the economic expansion was cut short by the economic and political shock of the Gulf War in 1991, Crdit Lyonnais had also tied up large amounts of money in a series of poorly judged property deals. Examples include the ill-fated Canary Wharf office and regeneration project in east London, and a major office block development in the northern French town of Lille that helped local politicians to regenerate the town but then proved difficult to let.

Unlike many banks in the US and UK, Crdit Lyonnais took significant equity stakes in businesses, as well as making loans. This is not unusual in continental Europe: German banks, in particular, maintain large equity as well as lending portfolios as a result of long-term relationships with industry. But many of the investments at Crdit Lyonnais were not the natural result of long-term relationships, and the bank repeatedly renewed or increased its support of businesses that were either failing or that had poor management and insubstantial assets.

Later, Haberer, the bank's dominant but aloof CEO, defended his actions by saying the French government knew what he was doing as he expanded the bank and preserved jobs in French industry by extending credit to shaky companies. It seemed that no-one with authority over the bank was able to draw a clear line between the bank's risk capital and the deep pockets of the French taxpayer.

Haberer regularly met the business leaders of Crdit Lyonnais' key subsidiaries, but as an organisation the bank lacked systematic controls over the risk taking and risk reporting of its increasingly complex network of businesses. At least two of these subsidiaries generated major scandals in their own right: Altus Finance in its dealings with the US insurance industry, and Crdit Lyonnais Bank Nederland in its financing of various Hollywood film studio deals.

In 1990 Crdit Lyonnais purchased Altus Finance, a successful finance company, with the intention that the subsidiary would play a key role in the bank's expansion. Altus, which reported directly to CEO Haberer, got off to a profitable start with a string of savvy deals in the US junk bond market. Some of these, however, were too clever by half.

In particular, in 1991, Altus negotiated a complex deal with the California Insurance Dept, which wanted to sell a massive junk bond portfolio that it had inherited from a collapsed insurance company, Executive Life. As part of the deal, Altus arranged for an investor-owned entity, Aurora, to take over Executive Life's insurance business. As a bank, and as an entity owned by a foreign government, Altus itself was barred from owning a US insurance business.

Much later, in a series of legal actions, US authorities alleged that as part of its efforts to secure the junk bond portfolio - which proved to be a very profitable investment - Altus set up investors to act as front-men for the running of Aurora, guaranteeing to buy back their shareholdings in a series of side agreements. That claim is now being pursued through the courts.

Some of Altus' early deals in the junk bond sector made a lot of money. But the subsidiary began to invest wildly in businesses it did not understand: leisure, waste disposal, golf courses, food distribution and luxury goods. Much later, as they struggled to unwind Crdit Lyonnais' investments, French government auditors suggested that Altus' activities between 1989 and 1993 were responsible for some Ffr20 billion of Crdit Lyonnais' losses.

But the wheeling and dealing of another subsidiary, Crdit Lyonnais Bank Nederland (CLBN), went even more spectacularly wrong. Since the 1980s, this Dutch subsidiary had been developing a business line that lent money to various Hollywood studios and film financiers. Many of these deals were perfectly legitimate. But CLBN officers had also started to lend money to shady financiers without ensuring that the bank's interests were protected.

In particular, in 1987, CLBN funded the takeover of the Cannon Group, a troubled film production company, by Italian businessmen Giancarlo Parretti and Florio Fiorini. The colourful past of these financiers - Paretti had been indicted for fraud while Fiorini was linked to a variety of financial scandals in Italy - was well documented at the time that CLBN officers decided to lend the funds.

In 1990, Parretti and Fiorini somehow persuaded1 CLBN officials to lend them even more money so that they could make the deal of the century: the $1.3 billion purchase of the historic Metro-Goldwyn-Mayer movie studios in Hollywood from film magnate Kirk Kerkorian. But within months of Parretti and Fiorini gaining control of MGM, the film studio suffered a cash crisis and other creditors threatened to force the studio into the bankruptcy courts.

An alarmed Crdit Lyonnais at first offered to lend Parretti and Fiorini even more money, and then spent much of 1991 fighting to oust Parretti from his position as chief executive at MGM. By 1992, Crdit Lyonnais had acquired the assets of MGM, and in July 1996 these were sold back to original owner Kerkorian. The MGM fiasco is thought to have cost Crdit Lyonnais up to a billion dollars, and court cases and revelations surrounding the affair have dogged the bank for many years.

In September 1992, Crdit Lyonnais was placed under administrative control by the French finance ministry as it became ever clearer that the bank's loan and investment portfolios contained massive unrealised losses. By late 1993, the French government realised that it would have to take more definite action to prevent the bank deteriorating further.

In November, the finance ministry replaced CEO Haberer with new broom Jean Peyrelevade. The ministry said it would safeguard the savings of the banks' eight million depositors, that the jobs of Crdit Lyonnais employees were safe and that the taxpayer would not be hit by a huge bill.

Only the first promise could be kept as official loss estimates soared upwards from Ffr14 billion (1994) to Ffr50 billion (1995) and then to Ffr100 billion (1997). A bailout by the French taxpayer in 1994 of some Ffr23 billion proved to be inadequate, and a year later the bank needed another infusion of cash.

The European Commission (EC) competition authorities, meanwhile, became increasingly unhappy about the effect of the massive subsidies on bank competition in Europe. They insisted that Crdit Lyonnais should be prepared for privatisation, and entered into a long-running battle with the French government and the bank to try to establish the ground rules for the rescue of Crdit Lyonnais. In April 1995 the French finance ministry and Crdit Lyonnais agreed a protocol that set out the terms of the creation of the Consortium de Ralisation (CDR), a separate entity intended to take over Ffr135-200 billion of Crdit Lyonnais' troubled assets.

The creation of the CDR was a critical moment in the attempt to prepare Crdit Lyonnais for a more normal future - but the bank was not quite free of its past. Under the protocol, the new Crdit Lyonnais had to finance the CDR by lending it Ffr100 billion at below market rates. The CDR also remained under the control of Crdit Lyonnais' new management until the two were fully separated in August 1995, following EC pressure.

The setting up of the CDR and the final separation agreement gave Crdit Lyonnais a heaven-sent opportunity to relieve itself of its bad loans, and later in 1995 it was able to announce that it was again on track to make an operating profit.

A long-running investigation into the roles of key individuals in the Crdit Lyonnais scandal by the French judiciary began in December 1996. Until this point, there had been little attempt to identify whether anyone might be criminally responsible for the disaster, and only limited attempts to explain to the French public what went wrong. (The 1994 enquiry by the French parliament into the scandal was held behind closed doors, and the evidence presented to it has not been fully published.)

However, the investigations were hampered by the destruction of crucial bank archives in a fire that began in the main trading room of the bank in May 1996, and devastated much of Crdit Lyonnais' grandiose Paris headquarters. Another fire at a Le Havre depot later destroyed documents that were critical to unravelling the story behind some of Crdit Lyonnais' worst property-linked investments.

Meanwhile, under a third bailout package put together by the French government, Crdit Lyonnais was allowed to begin charging the CDR for its financing at a market rate. This helped to underpin the future of the rescued bank, but made it ever more clear that taxpayers would foot the bill for the fiasco.

In July 1997 finance minister Dominique Strauss-Kahn said that losses from Crdit Lyonnais would likely total Ffr100 billion, or $17 billion. But with the bill for underwriting the CDR still uncertain, other commentators reckoned that the scandal might eventually cost the French taxpayer anything from $20 to $30 billion.

By 1997, the new CEO of Crdit Lyonnais, Jean Peyrelevade, was able to announce that operating profits at the reborn bank were multiplying fast. But trouble was again brewing. At the end of 1998, Crdit Lyonnais says it belatedly realised that back in the early 1990s Crdit Lyonnais subsidiary Altus Finance might have broken regulations in its dealings over the Executive Life junk bond portfolio.

The bank said that as soon as it realised what had gone on, it informed the US Federal Reserve. As a result of ongoing investigations by other US officials, the California Insurance Department sued Crdit Lyonnais in early 1999 for billions of dollars, saying that in the early 1990s the bank had secretly controlled Aurora, an investor in a US insurance company, and thus had contravened contemporary US regulations.

The worries over this were not allowed to derail plans to privatise the new Crdit Lyonnais, which were announced in March 1999 and executed in July of the same year.

In February and March 2002, meetings were held between the bank, the CDR and French and US authorities in an attempt to reach an amicable settlement.

Meanwhile, in recent years, the French judiciary who are investigating top executives at Crdit Lyonnais implicated in the scandal have begun to throw their net a little wider.

In May 2000, formal investigations began into the role of Bank of France governor, Jean-Claude Trichet, in the rescue of the bank. The news caused consternation in Europe, because as a result of an intricate political deal, Trichet had some years earlier become the anointed successor to Wim Duisenberg, head of the European Central Bank. The issue at stake is whether government officials at the time glossed over the scale of the bank's losses in their financial reporting so that the bank appeared less damaged than it really was.

1863: Crdit Lyonnais founded.

1945: CL nationalised after World War II.

1981: Socialist Francois Mitterand elected president of France.

1987: Mitterand appoints Jean-Yves Haberer to run CL.

1988: Mitterand re-elected as Haberer puts into action his plan to expand CL.

1990: CL purchases finance company Altus Finance as part of its expansion plan.

1990: Giancarlo Parretti and Florio Fiorini purchase Metro-Goldwyn-Mayer movie studios for $1.3 billion using money borrowed from CL in a deal that quickly turns sour.

1990: CL buys into property investment funds at a value that soon seems much too high.

1991: Altus Finance buys billions of dollars of junk bonds owned by collapsed insurance company, Executive Life, from the California Insurance Dept in a deal that later turns out to incur serious regulatory risks.

September 1992: CL placed under administrative control by finance ministry as problems start to surface.

November 1993: CEO Haberer is replaced by new broom Jean Peyrelevade as it becomes ever more obvious that the bank is now crippled by its bad loans and bad investments.

1994: Parliamentary enquiry on the scandal held in camera. French taxpayer bails out CL to the tune of Ffr23 billion.

April-May 1995: Consortium de Ralisation (CDR) created to take over CL's troubled asset portfolio.

August 1995: CL relinquishes control of the CDR, following pressure from the EC.

December 1996: French judges begin their long-running investigations into the scandal.

May 1996: Bank archives destroyed in a mysterious fire that begins in the main trading room of the bank and devastates much of CL's grand Paris headquarters.

1996: Another bailout by the French government.

July 1996: CDR sells MGM back to Kirk Kerkorian.

July 1997: Finance minister Dominique Strauss-Kahn says CL probably lost around Ffr100 billion, or around $17 billion.

Late 1998: CEO Peyrelevade realises that the old CL subsidiary, Altus Finance, might have broken regulations in its dealings over the Executive Life junk bond portfolio back in 1991 and he informs US regulators.

Early 1999: California Insurance Department sues Crdit Lyonnais for billions of dollars, saying that Altus Finance secretly controlled Aurora, an insurance company, against US regulations in the early 1990s.

July 1999: Crdit Lyonnais privatised on the instruction of the EC.

April-May 2000: Bank of France governor, Jean-Claude Trichet, head of the French Treasury when Credit Lyonnais' was rescued, comes under judicial investigation.

June 2001: California's attorney general says he will sue Crdit Lyonnais and others for $2.5 billion over the purchase of Executive Life and its bond portfolio.

Notes

[1] Fortune magazine has chronicled the details of the MGM affair, while The Economist has tracked the Executive Life affair.