Central Banks Act To Head Off Global Credit Crisis

Source : The Business Times, August 11, 2007

WASHINGTON/FRANKFURT - Central banks around the globe pumped billions of dollars into banking systems on Friday in a concerted effort to beat back a widening credit crisis, and they pledged to do more if needed.

In all, central banks in Europe, Asia and North America have pumped out more than US$300 billion over 48 hours in an effort to keep money flowing through the arteries of the global financial system, hoping to prevent a credit market seizure that could imperil economies.

In a rare statement of reassurance that underlined the seriousness with which it views the current bout of market stress, the US Federal Reserve said it would provide cash as needed to ensure markets functioned smoothly. The statement was the first of its kind since Sep 11, 2001, when terror attacks brought the US financial system to a virtual halt.

The Fed conducted three separate operations on Friday, pumping a total of US$38 billion into the banking system, the largest amount for any single day since Sep 19, 2001.

Markets responded positively. The Dow Jones industrial average ended down 31.14 points at 13,239.54, but in early trade had been off more than 200 points. The Nasdaq Composite Index lost 11.60 points - less than one-half of 1 per cent - to close at 2,544.89.

The US central bank was not alone in its market-bolstering exercise.

The European Central Bank (ECB) injected 61.05 billion euros (US$83.61 billion), less than the record-setting 94.8 billion euros it provided on Thursday but enough to steady panicky euro-zone credit markets.

The Bank of Japan, the Bank of Canada, the Swiss National Bank and the Reserve Bank of Australia also provided funds.

The White House weighed in to say that the Bush administration's top economic officials were on the case and that the economy remained sound notwithstanding market gyrations.

Europe on Watch
Markets have been rocked for weeks by news of problems in banks and funds exposed to risky investments in US mortgage and asset-backed markets. That triggered fears that the cheap credit that has fuelled global growth might dry up.

The tremors that jolted global markets began on Thursday in France, when BNP Paribas closed three funds, sending waves of fear through European credit markets that deepening losses tied to rising US mortgage market defaults could undermine the soundness of European investment firms.

Signs that euro-zone money markets were freezing up sparked the ECB's large-scale action on Thursday.

ECB President Jean-Claude Trichet told a French newspaper that the central bank will 'continue to pay close attention to market developments in the coming period' and act as needed, but he stressed that price stability remained vital for growth.

A sense of panic led financial markets to rethink where interest-rate policy in the world's major economies may be heading. Investors slashed bets on euro-zone and Japanese rate hikes and came to see a one-in-three chance of an emergency cut in borrowing costs by the Fed, while fully pricing in a reduction at the Fed's next scheduled meeting on Sep 18.

While the ECB acted aggressively on Thursday to begin stemming what it saw as a dangerous tide, the Fed provided only US$24 billion in liquidity on that day.

Robert Eisenbeis, who retired as head of research at the Atlanta Federal Reserve Bank in January, said the US central bank had taken the necessary steps to calm markets.

Whether market volatility was worse in Europe or not, the source of much of it had made-in-America written on it as investors worldwide scrambled to assess the fallout from the once high-flying US housing sector's sharp downturn.

Order in US markets
The Fed's efforts appeared successful at wrestling overnight US rates down closer to its 5.25 per cent target.

'The Federal Reserve will provide reserves as necessary through open market operations to promote trading in the federal funds market at rates close to the Federal Open Market Committee's target,' the Fed said, signalling a willingness to do whatever necessary to keep markets from seizing up.

Fed policy-makers had shown limited worry about credit market conditions on Tuesday as they voted to hold rates steady and warned anew about inflation risks.

Many analysts continued to believe the Fed would be able to ride out the storm.

While the central banks' concerted actions in injecting money appeared to be having some calming effect, no one thought the credit market crisis was near played out.

More sub-prime problems are likely to surface in coming weeks, said Moe Ibrahim, a fund manager with The Asia Debt Fund in Singapore, which manages about US$365 million in assets.

'There's a variety of scenarios you can envision, all the way from it being a relatively contained phenomenon to something which has much broader implications that cause the world to collapse like a deck of cards,' he said. -- REUTERS