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. Last Updated: 07/27/2016

Subprime Loan Crisis Claims More Victims

It looks official: The subprime loan crisis is banging on Russia's door.

The latest symptoms spread outside the United States to France's largest bank on Thursday, when BNP Paribas announced it was freezing three funds backed by shoddy U.S. mortgage loans. This brought on a selling fit among international traders, convincing many that the sickness is going global.

With Russian bourses now taking their cues from abroad, the RTS sank by 2.43 percent to 1939 points, and grazed the 1900 mark at noon on Friday. Combined losses for the MICEX stood at 4.76 percent for the last two days of the week.

"Current market turmoil is a reaction to an iceberg," James Beadle, portfolio manager at Pilgrim brokerage, wrote in a note to investors Friday. "There have already been some clearly observable issues, but most of the problem remains hidden under water."

Central banks around the world took steps to keep it from surfacing. On Thursday, the European Central Bank injected 94 million euros ($128 million) of short-term liquidity into the credit market, acting as a lender of last resort. The Reserve Bank of Australia made a similar move Friday, and central banks in Indonesia, Malaysia and the Philippines sold dollars to prop up their currencies.

Historical precedents made the moves look like a pretty good idea. After the Wall Street Crash of 1929, central banks were criticized for not stepping in with cash injections between the initial crash and the deeper one of Black Tuesday, which came five days later and is thought to have sparked the Great Depression.

Liquidity on the Russian market remained vibrant, however. Thursday saw $4.5 billion worth of trades on the MICEX, nearly double the usual levels, meaning that much of the stock being sold still looks like a bargain to someone. Indeed, aside from external worries over the credit market, fundamentals are strong by nearly all accounts. A number of blue chips, such as Unified Energy System (EESR) and Norilsk Nickel (GMKN), are still significantly undervalued, and the growing wealth of the population is creating a lot of upside for domestically focused stocks.

But last week, "fundamentals once again took second place behind the need to eliminate risk," Kim Iskyan, co-head of research at UralSib, said in a market note Friday.

This fear of risk soared after people realized the size of the bubble in the U.S. home-loans market, more often called the crisis in subprime mortgages.

From on top of the home loans granted to poor Americans, a complex system emerged over the last twenty years of buying these loans and reselling them to investors. Each time the debt was repackaged and sold, a solid institution guaranteed it wouldn't fail, often without knowing much about the underlying credit.

But as U.S. interest rates ticked up to 5.25 percent, the low-income borrowers at the bottom of the pile started defaulting. The lofty structure above them then started to collapse, as did investors' trust in risky assets.

The fact that Russia participates in this system on a very small scale matters little. Russian stocks belong to the risky emerging market asset class, and will be among the first to be dropped as investors get anxious.

"That's how the system works," said Alexei Morozov, co-head of research at UBS. "Even though it's clear that Russia doesn't deserve this ... we are still part of the global economy."