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US credit contagion infects European banks

By Kai Sandvig, Business Editor
Posted September 4, 2007

     As the U.S. credit contagion continues to roil markets worldwide, the torment and torture continues to filter from European security markets down into individual German banks. Sub-prime mortgages, culpable as the nascent zero-patient of the crisis, have begun to infect other loans, mortgages and even stocks. Central banks have provided monetary support to smaller banks during the crisis, especially in Europe.

    Matthew Cairns, Senior Economist with Moody's Corp. in London, spoke with The European Weekly Online regarding the U.S. housing crisis and its influence on European security markets. Cairns believes there will be a reassessment in what securities European investors seek for investment. However, the long-term relationship will not be affected between European investors and U.S. securities.

    The overwhelming majority of U.S. securities remain attractive to European investors Cairns said.

    In July, the European Central Bank (ECB) allotted around 78 million euro ($106 million) for depressed banks that needed a remedy; two examples include Deutsche IndustrieKreditBank (IKB) and Sachsen Landesbank (SLB), both German government-backed banks. Since then, the ECB has played the obligatory role in providing emergency funds to banks in the euro zone that had exposure to the U.S. sub-prime market.

    Everybody is finding out in the aftermath, Cairns said about the crisis.

    In pandemic metaphors, authorities and experts commenting on the crisis allude to a sickness in worldwide markets, like a disease spreading throughout a population. What begins in one market of the population may spread to otherareas. Sub-prime loans and U.S. households falling behind in their mortgage payments, some defaulting on these loans, have begun to infect European banks and markets. Cairns referred to this as a broader connection.

    According to Cairns, IKB is the one that set off a lot of the losses on the DAX causing a capital flight from local investments into safer assets. IKB, like SLB played an integral role in supplying money to fund short-term debt, particularly in the U.S. The real horror for these banks arose when investors lost their passion to fuel these liquidity funds, thus moving to higher ground and safer assets. These safer assets remain quarantined away from debt securities, mainly in bonds.

    Statistics compiled in a brief by Cairns highlight the losses of German banks, which correlate to similar losses at U.S. mortgage brokers. However, German banks are not on the brink of filing for bankruptcy or being bailed out by wealthy parents, such as Bank of America's (BAC) timely infusion of $2 billion (1.46 billion euro) into Countrywide Financial Corp. (CFC) coffers. According to his statistics, IKB and other German banks took serious losses within hours of opening trade earlier last week. Specifically, IKB lost 16 percent of its stock value in this time frame. In light of IKB and other banks sending the DAX into a tailspin, Cairns noted the global default rate among speculative-grade companies in June 2007 was 1.4 percent, the lowest since March 1995.

    Sub-prime exposure will cost German investors, that is certain, though this exposure will not bring down the house, Cairns wrote in his brief.

Kai Sandvig can be reached at

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