French towns launch debt strike over "toxic" Dexia loans

French towns that say they were tricked into taking out risky loans from rescued lender Dexia are refusing to repay them in full and are asking President Francois Hollande for a bailout.

Franco-Belgian municipal bank Dexia was propped up with billion of euros of public money last October, when it become the first banking victim of Europe's debt crisis after its strategy of using short-term borrowing scheme to finance long-term lending came unstuck.

Those loans included an estimated 13 billion euros of risky structured products that went sour after the 2008 financial crisis, saddling thousands of French towns with crippling interest rates.

Frustrated by what they perceive as government inaction over the mounting repayments, mayors in a handful of the towns are tearing up their contracts rather than pay the state-rescued bank with money raised from tax hikes or spending cuts.

"I was not elected to raise taxes and to have those taxes go directly into banks," said Xavier-Martin Le Chevalier, mayor of the northwestern coastal town of Tregastel. "Directly or indirectly, the state will end up having to pay the bill."

The payments strike is an unwelcome distraction for Hollande as he battles to bring France's public deficit back below European Union limits against a backdrop of economic slowdown and rising unemployment.

The French, Belgian and Luxembourg governments initially stumped up 45 billion euros of guarantees to cover Dexia's debts, a sum that was raised to 55 billion in June. On Saturday, the bank's chief executive warned it may need recapitalizing soon.

Dozens of municipalities have already sued Dexia for allegedly mis-selling them the "toxic" debt products, which were indexed to everything from foreign currencies to U.S. loans.

Le Chevalier said he had opted to continue paying his town's Dexia loan at the initial fixed interest rate - in his case, 3 percent - rather than the new variable Swiss franc-pegged rate, which at end-July stood at 13 percent.

He is not alone.

"We will repay the principal and the previous interest rate, nothing more," said Sebastien Pietrasanta, mayor of the Paris suburb of Asnieres which, having recently ploughed millions of euros into an urban facelift, faces a doubling of loan repayments to Dexia out of its 182 million-euro debt pile.

"Otherwise it means no more staff in schools and no more daycare centers."

SPOOKING THE STATE

In its handing of the rebellious mayors, the state has so far tended to toe the line of least resistance - understandable given the size of its own exposure to Dexia's government-guaranteed loan book.

Responding to the Asnieres case, junior minister Anne-Marie Escoffier said municipalities "must honor their debt repayments" unless there has been a breach of the rules.

"The amount of money at stake is no doubt spooking the state at a time of pressure on the public purse," said Christophe Faverjon, mayor of the central town of Unieux. "But are we going to let cities fail?...It is fair that the state should step in."

Some mayors believe the debtors' strike has yet to peak, given a recent ruling in the Paris Court of Appeal that upheld the central-eastern city of Saint-Etienne's refusal to reimburse interest-rate swaps bought from Royal Bank of Scotland pending a final resolution of the case.

But in the case of Unieux, the Lyon Court of Appeal ruled last month the town had broken contract law by unilaterally deciding not to repay in full.

Dexia said it had "acknowledged" the legal ruling against Unieux and the statement by Escoffier. The bank declined to comment further.

As they battle the higher interest rates, many municipalities have started raising taxes.

"Most of us (mayors) have been building up provisions... And this has already started to cost municipalities," said Maurice Vincent, mayor of Saint-Etienne.

"There has been a slight increase in taxation ... between 1 and 4 percentage points, depending on the case."

(Reporting by Lionel Laurent; Editing by John Stonestreet)