US saves the banks

It wasn’t nuclear war, but words like “meltdown,” were being tossed around with fears of a collapse of capitalism and world economies. After the near-bankruptcy of AIG, the world’s largest insurer, was staved off by a last-minute USD 85 billion bail-out from the US government, Washington stepped in and said it was planning an even bigger one: a USD 500-800 million of American banks on the precipice of doing under from the weight of nearly two million possible home foreclosures in the aftermath of the sub-prime lending practices, loaning money to people who couldn’t pay it back.
The sigh of relief didn’t reach all the way to Europe though, as the massive bail-out of banks with bad mortgage debt applies only to American institutions, and not the many European banks who had bought some of those bad loans now going into default. Still, European Central Bank president Jean-Claude Trichet welcomed moves to save tottering investment funds and other institutions, even while American officials said they would call on investment specialists and not set up a new agency to oversee the saving of American banks. And European stock markets generally reacted well, following the lead of Wall Street, which showed a sharp rebound as it seemed the economic world was saved, at least for the time being.

With the world economy at stake and nervously watching the failure of giant American investment banks and mortgage institutions, the US government has now proposed a massive bail-out of the bad debt its major banks have accumulated by lending money to people who couldn’t pay it back, which set off fears of a global near-collapse of the financial system.

The US plan, closely-watched in the European Union, could cost as much as USD 500 billion, Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke told congressional leaders, in what could become the largest-ever intervention in US financial markets. The new move represents a broader approach to dealing with the crisis, as opposed to the ad hoc and stop-gap measures taken since the beginning of this year. While the details of the proposal were still being worked out, it could enable the federal government to buy heavily-discounted distressed mortgages from banks and other institutions, the New York Times reported, describing it as the “most direct commitment of taxpayer funds so far in the financial crisis.” Democratic Senator Charles Schumer, who chairs Congress’ Joint Economic Committee, said he had spoken with government officials about setting up a new government agency that could take over the Federal Reserve’s current role of pumping liquidity back into the financial system. The agency would take on billions of dollars in bad loans of banking firms that have been decimated by the plunging value of mortgage-related assets, and manage those firms already taken over by the government. This would allow the Federal Reserve to focus on its core competence - monetary policy. The idea to buy private and government-guaranteed mortgage-backed securities would be the most expensive ever in US history, CNBC reported. The larger part of the proposal, which would need to be approved by Congress, would involve buying mortgages underwritten by Wall Street. The second part would involve buying governmentbacked mortgages, the report said. This would come under a plan the government announced less than two weeks ago, when it took control of government-chartered mortgage giants Fannie Mae and Freddie Mac and pledged 200 billion dollars to keep them afloat.

SHORT-SELLING
Also part of the comprehensive plan was for the Securities and Exchange Commission to propose a temporary ban on shortselling, a stock trading technique that critics argue helped fuel a furious sell-off of financial stocks on Wall Street after another bailout, this one for USD 85 billion to save the ailing insurance giant AIG was approved. The commission banned the most extreme practices related to short-selling. Short-selling itself is legal, but not if linked with spreading rumours that can help an investor’s cause. Paulson told reporters: “What we’re working on now is an approach to deal with systemic risk in the capital markets. We talked about a comprehensive approach that will require legislation to deal with illiquid assets on financial institutions’ balance sheets.” “This country is able to come together and do things quickly when it needs to be done for the good of the American people,” he said, adding that they had “come together to work for an expeditious solution.” US President George W Bush defended the “extraordinary measures” already taken by the government to shore up a wealth of shaky financial firms and sought to reassure investors fearful that more bank failures could be on the horizon. Speaking after an emergency White House meeting with his economic advisors, Bush promised the government would continue taking necessary actions “to strengthen and stabilise our financial markets and improve investor confidence.”

CASH FUEL INJECTION
In its latest bid to calm investor fears, the Federal Reserve injected nearly USD 250 billion into the financial system through joint action with five other central banks around the world. The Fed added another USD 50 billion in reserves to the US banking system through its existing loan facilities. Inter-bank lending had seized up as struggling banks began hoarding cash. “Our financial markets continue to deal with serious challenges,” Bush said. “As our recent actions demonstrate, my administration is focused on meeting these challenges.” The cash infusion came after six major central banks acted in concert to stop the liquid bleeding of capital markets that had created a worldwide mess and prompted reactions to the Great Depression of 1929, although there are safeguards in place today. European share prices steadied after the joint operation, which was triggered by the growing reluctance of commercial banks to lend one another money in a week where one financial institution after another has succumbed. Commercial banks scrambled for the new money in Frankfurt, with 61 banks bidding for USD 100 billion in an auction quickly organised by the European Central Bank (ECB). The money came from the US Federal Reserve by way of swaps. The Fed said the joint operation had made available USD 247 billion outside the United States to bridge shortfalls of dollars, quadrupling dollar availability. The swap arrangements were to last till January 2009. The biggest taker, the ECB, said its dollar funding operations would more than double from the existing USD 50 billion to 110 billion. The measures were “designed to address elevated pressures in the short-term US dollar funding markets,” ECB officials said. The ECB said it lent a total USD 40 billion in the initial auction, setting the minimum interest rate at four percent. Commercial banks can borrow the central banks’ dollars by using their own financial assets as security. The cash injection was the latest of a several interventions by central banks this year to ward off a crisis. The Swiss National Bank is to pump USD 27 billion into markets and the Bank of Japan (BOJ) valued its part in the currency swap with the Federal Reserve at 60 billion. The Bank of Canada was also involved, and The Bank of England said it would flood 40 billion into the markets. “These measures, together with other actions taken in the last few days by individual central banks, are designed to improve the liquidity conditions in global financial markets,” the Bank of England said.

EU BOURSES REACT
Robert Halver, a markets analyst at Baader Bank, said in Frankfurt that, “The central banks are letting liquidity flood through every crack to stop the domino effect among financial institutions.” He was referring to the series of crises that began with the September 15 failure of Lehman Brothers in New York and culminated in British bank Lloyds taking over mortgage lender Halifax Bank of Scotland for GBP 12.2 billion (15.43 billion Euro). Other bourses in the EU reacted well too, especially in the Nordic region. The Stockholm bourse index opened up over five percent with banking shares posting double-digit increases. Telecommunications equipment maker Ericsson increased five percent while clothes retailer Hennes and Mauritz (H & M) was up four percent. The main Oslo index jumped six percent in opening trading with strong performances from banking sector shares. Shares in Norway’s largest financial services group DnB NOR increased 11 percent while financial services group Storebrand went up about eight percent. State-controlled energy group Statoil Hydro went up four percent. In Copenhagen, the index of 20 leading stocks climbed 3.8 percent. French shares rebounded after straight three days of losses.