Home Loan Defaults Cause German Bank Collapse

The troubles in the U.S. subprime mortgage market have spilled over to the European financial markets. That has lead to the demise of a German bank, which ran out of cash covering investment losses tied to the crisis.

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STEVE INSKEEP, host:

Now, we talk about your money on Fridays, and today we'll look at the way that your financial decisions may affect people half-way around the world. We're talking about all those defaults on high risk housing loans. It is often said that when the U.S. economy sneezes, the rest of the world catches a cold and that does seem to be happening now.

NPR's Emily Harris reports from Berlin.

EMILY HARRIS: The Sachsen Landesbank dominates one end of the pedestrian zone in central Leipzig. It's housed in a tall glass building symbolizing the shiny optimism of the time when it was founded - 1992 - just two years after Germany had officially reunited. Saxony was the only one of the former communist East German states to create its own bank dedicated to supporting business development in the region.

But after recently running out of cash to cover investment losses tied to the U.S. subprime mortgage market, the bank is to be sold to another state bank in West Germany. That makes Leipzig realtor Hans Von Spartz(ph) gloomy.

Mr. HANS VON SPARTZ (Realtor): It will cost the taxpayer, of course, an amount of money. How much? We will have to wait and see.

HARRIS: The bank was owned by the state government and a consortium of savings banks, which are in turn owned by local governments. But officials in Saxony are busy reassuring taxpayers they won't have to foot the bill. Analysts agree it is likely any losses could be spread thin enough so not to notice.

Still, Leipzig county chief Petra Kopping feels the region has lost something.

Ms. PETRA KOPPING (County Executive, Leipzig): (Through translator) We had a vision in Saxony. After reunification, all the investments would come from abroad and from West Germany and we wanted to have a bank in East Germany that was big enough so medium-sized local businesses could do their banking here. So on the one hand, I think the sale is a good solution. But on the other hand, it's sad.

HARRIS: The sale of the Saxony bank and the bail-out of another German bank has led to calls here for all sorts of reforms. Domestically there is talk of shifting more oversight from a special agency to the trusted central bank. Even louder right now is criticism of rating agencies.

Chancellor Angela Merkel called it unacceptable that bad risk assessments in one place have to be paid for elsewhere in the world.

Chief analysts at Bremer Landesbank, Folker Hellmeyer, predicts the troubles seen in Europe so far are the tip of the iceberg. As more problems emerge, he believes banks will become more conservative.

Mr. FOLKER HELLMEYER (Chief Analyst, Bremer Landesbank): That means that financial markets will come on the more strain, the profits of companies will be squeezed. One other consequence will be that central banking will be viewed differently, that approaches like those of Alan Greenspan will no longer be en vogue.

HARRIS: He's referring to criticism that the Federal Reserve under former Chairman Alan Greenspan helped create the current problems by keeping interest rates in the U.S. too low for too long.

Economist Peter Bofinger hopes the Fed will not return to that strategy at its meeting next month. He says extra liquidity for U.S. money markets at this point would only be treating the symptom, not the real problem.

Bofinger is on the German government's economic advisory board. But he has a suggestion for the U.S. government: help homeowners directly as increasing mortgage payments come due.

Mr. PETER BOFINGER (Economist): I suggested that the government should pay the additional payments that households will have to make starting 2008. Then after 10 years the household should pay back this government credit. Of course, it's a bail-out of households instead of a bail-out of banks. But in my view it would really help to stabilize the situation.

HARRIS: It's an unprecedented situation, he says, calling for an unprecedented solution.

Emily Harris, NPR News, Berlin.

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