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Subprime inflicts new damage, banks seek cash

NEW YORK/LONDON (Reuters) - New evidence of damage wrought by the U.S. mortgage sector surfaced in the United States and Europe on Wednesday while banks demanded a record amount of cash at a euro zone money market auction.

A foreclosed house for sale is pictured in the Green Valley Ranch development in Denver, July 26, 2007. New evidence of damage wrought by the U.S. mortgage sector surfaced in the United States and Europe on Wednesday while banks demanded a record amount of cash at a euro zone money market auction. REUTERS/Rick Wilking

Rating agencies Moody’s Investors Service and Standard & Poor’s said on Wednesday that banks may suffer double-digit declines in revenue and pretax profits as they write off securities and loans that investors don’t want to buy.

Cheyne Finance Plc, a structured investment vehicle (SIV) managed by British hedge fund Cheyne Capital Management, said it was seeking to restructure after being forced to start selling assets to pay down debt.

Merrill Lynch, meanwhile, downgraded Bear Stearns BSC.N Citigroup Inc C.N and Lehman Brothers Holdings LEH.N to "neutral" from "buy" and lowered estimates for the banks' earnings, due to credit and mortgage market troubles.

“The only thing that is certain is that more uncertainties in the direction of asset prices and volatility are on their way,” Bank Julius Baer said in a report.

Standard & Poor’s downgraded Cheyne Finance’s issuer rating by six notches. Just two weeks ago, the agency said ratings on SIVs -- including the Cheyne vehicles -- were weathering turmoil caused by defaults on U.S. subprime mortgage lending mainly to poor people.

British bank Barclays BARC.L, hit by worries over its exposure to highly leveraged debt vehicles, holds collateral that would limit losses to 75 million pounds ($150.5 million) at most, a source familiar with the matter said.

CENTRAL BANK OPS

Euro zone banks bid for a record amount of money at the ECB’s regular long-term funding operation on Wednesday, reflecting ongoing tightness in the interbank lending market.

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Central banks have poured funds into money markets to tackle a liquidity crisis, stemming from the subprime saga, which has made many banks clam up on normal interbank lending.

The European Central Bank lent out 50 billion euros for 91 days, but with banks bidding for a total of 119.75 billion euros, strong demand pushed up the cost. Later in the day the Federal Reserve added $5.25 billion in temporary reserves to the banking system through overnight repurchase agreements.

European Union officials were cautiously optimistic about the resilience of euro zone economic growth to a credit crisis, but German data suggested wariness at the very least.

A survey by the GfK market research group showed German consumer sentiment was likely to worsen in September due to households’ fears that market volatility may hurt the economy.

In the United States, mortgage applications fell for a second consecutive week, the Mortgage Bankers Association said.

Data on Tuesday showed U.S. consumer sentiment suffered its steepest plunge in nearly two years and a house price index posted the biggest drop in its 20-year history.

“Now the question is not so much where the losses are and how far the cancer has spread but how much of the business and consumer economy are affected,” said Justin Urquhart Stewart of 7 Investment Management in London.

The turmoil has prompted investors to look for a rapid policy response from the major central banks.

A speech by U.S. Federal Reserve Chairman Ben Bernanke on Friday, on “Housing and Monetary Policy,” may bolster expectations of a U.S. interest rate cut next month, while serious doubt has been cast on the chances of a European Central Bank rate rise next week.

The ECB holds its regular monetary meeting on September 6. The Fed follows on September 18.

Minutes of the Fed’s last monetary meeting -- held just before the credit squeeze prompted it to cut its discount rate for direct lending to banks -- showed it recognized financial market wobbles might require further action if they worsened.

“A further deterioration in financial conditions could not be ruled out and, to the extent such a development could have an adverse effect on growth prospects, might require a policy response,” the minutes said.

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