U.S.-based sub-prime crisis rocks Europe's banks

BERLIN — Standing on Berlin's pricey Ku'damm avenue, almost in the shadow of the city's famed Kaiser Wilhelm Gedaechtnis Church war memorial, Andrea Weithoff said she felt very far removed from the U.S. mortgage crisis.

But she rested her hand on the door of her bank — Deutsche Bank, Germany's largest, whose name means German Bank — and said, "The modern reality is that I put my money here, and when people in the United States can't make their house payments, it's a little less safe."

Experts think that her bank will lose as much as 1.6 billion euros — $2.24 billion — in the American sub-prime lending crisis. Deutsche Bank announced this week that because of unexpected losses, it wouldn't be adding 4,000 jobs as it had announced earlier.

Many European financial institutions are feeling the fallout from the downturn in the U.S. housing market. As Charles Goodhart of the London School of Economics explained: "All across Europe, banks are trying to figure out the ramifications of what's happened. We've got a long ways yet to go."

The crisis is rooted in the fact that too many U.S. sub-prime mortgages, those given to people with weak credit histories, are going into default. As those mortgage holders can't repay their loans, banks worldwide that invested in bonds backed by the mortgages are facing big losses.

Banks across Europe — indeed, around the world — seemed to be involved at some level, and no one knows how much bad debt each bank holds. Therefore banks have been unwilling to lend to other banks, lest those loans also turn bad.

Complicating the outlook for European banks is that many of them cut their cash reserves from 30 to 40 percent of assets to 3 to 4 percent over the past decade or so in a rush to make money. Now they're mired in a global credit crisis that's still unfolding, and they lack cash reserves to get through it, according to Viral Acharya, a professor of finance at the London School of Business.

To shore up cash-short banks, the European Central Bank pumped out $130 billion in August, trying to spur them to resume lending in order to sustain economic activity.

It's having mixed success at best.

In England, Northern Rock, the nation's fifth largest lender, suffered the first British bank run since 1866, as depositors demanded their money back despite government pledges to back the bank.

"The irony here is that Northern Rock's assets are high value, with a low default rate," said Diane Coyle, the head of Enlightenment Economics, a London research center. "But the real problem here is that banks are all wondering if this is the thread that unravels the suit. People don't even know enough right now to even understand the risks. This is a crisis we need to get a grip on, quickly."

German banks in particular are being rocked.

Publicly owned IKB (German Industry Bank) is one example. Founded in 1924 to handle World War I reparation payments, it now has 1,700 employees and $1.96 billion in equity. Its business focus had been on financing midsize German companies, but in recent years its managers saw an opportunity to make money from U.S. sub-prime loans.

In the past month German regulators have quietly bailed out IKB with $3.5 billion, and there's talk that perhaps another $11 billion will be needed.

As Matthias Joerss, chief strategist with Frankfurt-based Sal. Oppenheim Bank, explained, a poor investment climate here left banks desperate for ways to make money, so they latched onto sub-prime-financed bonds, some of which had AAA security ratings.

"Small banks trusted ratings, and got involved in areas outside their expertise," he said.

German federal financial supervisor Jochen Sanio has called this the "biggest German banking crisis since 1931." That bank crisis helped bring Adolf Hitler to power.

The losses are shared: Commerzbank, Germany's second biggest lender, announced earlier this month that it had lost about $126 million in the crisis, and this week experts upgraded the estimate to $630 million to $1.7 billion.

Back on the Ku'damm, Weithoff wondered where it would end. She said she used to marvel at how easy it was for Americans to get home loans compared with the hoops Germans must jump through. Now she realizes that the U.S.-based crisis menaces her German savings.

"I've been wondering, with the news, if I should take my money elsewhere," she said. "But it's no different anyplace else, is it? The world is all connected now, for good and bad."