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Europe's zombie debt crisis is stalking Wall Street

Call it the zombie crisis. After the worst January for stocks ever, U.S. investors were battered again on Monday as the eurozone debt crisis reappeared.

Concerns over Europe's banks, which first flared up in 2010, along with fresh bailout troubles in Greece and political turmoil in Spain are adding to an already long list of worries for Wall Street. The Russell 2000 small-cap index has returned to levels not seen since the summer of 2013 for a total loss of more than 26 percent at Monday's low point.

Things are likely to get even worse because of three factors that are in play.

For one, some political risk is popping back up (Spain basically has no government right now, and Greece is having bailout issues again). Second, that's hitting banks because of possible asset value impairment. And third, banks are feeling the worries that Deutsche Bank (DB) doesn't have enough capital to meet new regulatory requirements.

The stress is manifesting in more obscure areas of the European debt market as the value of Deutsche Bank contingent collateral, or "CoCo," bonds plummet on fears of conversion into equity. At the same time, the value of its credit default swaps (a measure of fear) is back to levels last seen in 2011. Deutsche Bank is being singled out after reporting disappointing quarterly results, leading analysts at CreditSights to highlight rising default risks, which pushed DB shares down 10 percent in overnight trading.

The kicker is that recent moves by the European Central Bank and the Bank of Japan to push policy rates into negative territory weaken banks by making their net interest margins even narrower (the gap between loan and deposit rates).

Investors are kind of freaking out about this because it risks undermining the thesis that more monetary policy stimulus is always and everywhere a good thing.

More negative rates now would only further weaken the banks. More asset purchases would further reduce the supply of high-quality collateral banks need for interbank lending. And CoCos were created in the wake of the financial crisis as a way to "bail in" investors should banks get into trouble again, providing a relatively easy way to restructure troubled bank balance sheets by converting debt to equity and keeping taxpayers from having to bail out the banks again.

Deutsche Bank responded late in the New York session by issuing a statement defending its liquidity position in an attempt to reassure investors that it has enough cash (more than $1 billion in 2016 payment capacity) to pay more than $700 million in payments due in April.

Questions linger, however, about how 2016 operating results will hit the bank's $4.5 billion in 2017 payment capacity. This year's results will be made worse if the Spanish political situation deteriorates or Greek bailout talks falter over budget and pension issues.

The stakes have been raised for the ECB's next policy meeting in March as officials keep searching for a solution to an intractable problem.

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