Central banks move to boost global confidence

Published: Friday September 19, 2008

The Federal Reserve, and central banks in Europe, Canada and Asia, pumped as much as US$180 billion into money markets yesterday to combat shock waves from the worst financial upheaval since the Great Depression of the 1930s.

The move was aimed at boosting waning confidence that governments can stop the crisis from spinning out of control and at getting banks around the world to open their ever-tightening purse strings. Banks have been increasingly reluctant to lend to each other as distrust spread throughout the financial system.

Asian markets closed lower, but the Fed action helped send European stocks higher after three days of losses.
Wall Street initially rallied, but trimmed gains as the morning wore on, after plunging 450 points Wednesday when a government bailout of American International Group Inc, one of the world's largest insurers, failed to settle the markets' frayed nerves.

Worries that other financial companies could fail and further upend the economic system may cast a pall on the central banks' step, which spread billions of dollars around the world in exchange for foreign currencies.

President George W Bush, who cancelled a Republican fund-raising trip to Florida and Alabama to focus on the crisis, said the markets are adjusting to the "extraordinary measures" that have been taken in recent days.

"Our financial markets continue to deal with serious challenges," Bush said in two minutes of remarks - his first on the turmoil since Monday. "As our recent actions demonstrate, my administration is focused on meeting these challenges."

He did not specify what additional actions would be taken. The president was to meet with economic advisers over much of the day, and was seeing Treasury Secretary Henry Paulson at the White House later that day.

For more than a year, investors have watched with growing alarm as the US economy, the world's largest, has struggled to right itself before being tipped over the edge by massive foreclosures, shrinking consumer spending and rising inflation.

The turmoil has swallowed some of the most storied names on Wall Street. Three of its five major investment banks - Bear Stearns, Lehman Brothers and Merrill Lynch - have either gone out of business or been driven into the arms of another bank.

The two remaining - Goldman Sachs Group Inc and Morgan Stanley - were under siege.

On Capitol Hill, lawmakers in both parties are becoming increasingly vocal about their concerns with the Bush administration's handling of the crisis.

Administration officials refused to attend a closed-door briefing with House Republicans yesterday morning, said Rep John A Boehner of Ohio, the Republican leader, leaving their congressional allies in the dark about whether further bailouts are on the horizon.

Republican presidential candidate John McCain said that if he were president, he would fire Securities and Exchange Commission Chairman Christopher Cox.

A sharp rise in borrowing costs has worsened. The total amount of commercial paper fell by US$52.1 billion for the week that ended Wednesday, as banks cut back the short-term loans companies from small garment factories to General Electric Co depend on for their daily operations. At the same time, the interest rate on those short-term loans more than doubled, with rates for seven-day paper jumping to 4.5 per cent from 2.5 per cent.

Russia closed its stock exchanges for a second day Thursday as President Dmitry Medvedev pledged a 500 billion ruble (US$20 billion) injection into financial markets to stem a dizzying plummet in share prices - and quash fears of a repeat of the country's 1998 financial collapse.

In a statement yesterday, the Fed said it had authorised the expansion of swap lines, or reciprocal currency arrangements, with the other central banks, including amounts up to US$110 billion by the European Central Bank and up to US$27 million by the Swiss National Bank.

The Fed also said new swap facilities had been authorised with the Bank of Japan for as much as US$60 billion; US$40 billion for the Bank of England and US$10 billion for the Bank of Canada.

All told, Fed action increased lines of cash to central banks by $180 billion to US$247 billion.

At home, the New York Federal Reserve acted to ease a spike in overnight lending rates by injecting US$55 billion into the banking system in two operations of temporary reserves.

A sharp rise in such borrowing costs makes banks hoard cash, worsening already tight credit conditions that have led to the historic reshaping of the US financial landscape.
On Wednesday, the Dow Jones industrial average, which only two days earlier had suffered its steepest drop since the days after the Sept 11 attacks, lost another 450 points. About US$700 billion in investments vanished.

Shares of the largest US thrift, Washington Mutual Inc, fell 13 percent amid reports that the government was trying to find a buyer for the bank, which has been battered by bad home loans. It lost US$3.3 billion in the second quarter.

And, demand for super-safe Treasurys surged Wednesday, sending the yield on the three-month Treasury bill briefly into negative territory for the first time since 1940, as investors rushed for the closest thing to cash.

After the government bailed out AIG and a money fund "broke the buck", investors were worried about the riskiness of most assets.

It was the fourth consecutive day of extraordinary turmoil for the American financial system, beginning with news on Sunday that Lehman Brothers, would be forced to file for bankruptcy.

The four per cent drop Wednesday in the Dow reflected the stock market's first chance to digest the Fed's decision to rescue AIG with an US$85 billion taxpayer loan that effectively gives it a majority stake in the company. AIG is important because it has essentially become a primary source of insurance for the entire financial industry.

As the stock market staggered, the price of gold, which rises in times of panic, spiked as much as US$90.40 an ounce. Bonds, a traditional safe haven for investors, also climbed.

"The economy is not short of money. It is short of confidence," said Sung Won Sohn, an economics professor at California State University.

"It seems as though banks are hoarding cash, no matter what rate they could be lending it at," said David Rosenberg, North American economist at Merrill Lynch.

Mortgage rates, which had fallen after the US government's takeover of mortgage giants Fannie Mae and Freddie Mac, rose again, removing a glimmer of hope that the housing crisis, the kindling for the broader financial meltdown, was hitting bottom.

And new statistics showed that construction of new homes and apartments fell a surprising 6.2 per cent in August to the weakest pace in 17 years.

The Treasury Department, for the first time in its history, said it would begin selling bonds for the Federal Reserve in an effort to help the central bank deal with its unprecedented borrowing needs.

Treasury officials said the action did not mean that the Fed was running short of cash, but simply was a way for the government to better manage its financing needs.

Separately, the Securities and Exchange Commission tightened rules on short selling, the practice of betting that a stock will fall.

A $62-billion money market fund - Primary Fund from Reserve - on Tuesday saw its holdings fall below its total deposits, a condition known as "breaking the buck" that hasn't happened to a money market fund since 1994, Rosenberg said. Money market funds are supposed to be conservatively invested and almost as safe as cash.

Withdrawals from money market funds have become one factor in the global tightening of credit, as investors and banks hoard their cash.


Source: Jamaica Observer
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