Tuesday, October 7, 2008

US takes on corporate debt as Europe reels with new rescues

WASHINGTON (AFP) — The US opened up a major new front Tuesday in the global financial crisis, backstopping huge amounts of corporate debt as European governments staged new rescues, but the moves did little to boost market confidence.

The US Federal Reserve said it would buy up short-term commercial paper or company debt in an effort to kick-start credit flows and ease a squeeze in bank lending, a move described as "necessary to prevent substantial disruptions to the financial markets and the economy."

A Fed official said the move is aimed at restoring flows in a market worth some 1.3 trillion dollars needed for corporate day-to-day funding that has been nearly halted by a credit crunch.

Despite the dramatic move by the Fed and new actions in Europe, markets ran into new turbulence a day after a meltdown in most stock markets.

A rebound on Wall Street faded and skittish investors sent the Dow Jones industrials down more than 300 points or 3.07 percent to 9,656 in afternoon trading. European bourses were mixed a day after record falls in many countries.

EU finance ministers agreed at a meeting in Luxembourg to increase an EU-wide savings deposit guarantee to 50,000 euros from 30,000. They said they would coordinate their response to the crisis.

In Russia, the Kremlin pledged 36 billion dollars to strengthen banks, but the move failed to help confidence. The RTS market finished down 0.95 percent after a record 19 percent slide Monday.

Iceland, where the economy is imperiled by debt and the credit crunch, nationalized its second biggest bank, Landsbanki, and gave its biggest institution, Kaupthing, a 500-million-euro (678-million-dollar) loan. Glitnir bank, the third largest, was nationalized last week.

Russia also agreed to negotiate a four-billion-euro (5.4 billion dollar) emergency loan to help Iceland's fight against national bankruptcy.

The credit crunch remained acute with banks desperate to find dollars even at punitive interest rates.

The European Central Bank on Tuesday pumped 50 billion dollars (37 billion euros) back into interbank money markets, but it said banks sought more than twice that amount.

The ECB said 67 eurozone banks had requested more than 109 billion dollars, and paid a whopping 6.75 percent for dollars made available in the daily attempt to keep cash flowing through the financial pipeline.

It announced a schedule for new coordinated action with other central banks to support the provision of dollars to cash-strapped commercial banks.

The Bank of Japan also poured more billions into the system.

In the US, the Fed gave no estimate of how much money would be put into the new campaign, but said the new program to soak up corporate debt would begin rapidly.

The US administration has already committed 700 billion dollars to a bailout of banks' bad debt and the latest move extends the government support.

John Ryding, economist at RDQ Economics, said most of the new funds are likely to go to banks and financial companies that have been trying to roll over debts linked to troubled real estate investments.

"This is basically unsecured lending to the banks," Ryding said.

The market in short term company debt -- commercial paper and short-term securities issued by companies and banks for payrolls and day-to-day expenses -- is worth tens of billions of dollars each day.

The Fed action came a day after the Fed agreed to pay interest on commercial bank reserves with the central bank, a move aimed at helping the central bank keep control of interest rates in a frozen market.

Fed chairman Ben Bernanke said meanwhile the US central bank must consider whether its current interest rate policy "remains appropriate" in view of exceptional market turmoil.

Bernanke, speaking to business economists in Washington, provided a hint that the US central bank could cut rates as part of its efforts to stem a widening financial crisis.

He said the turmoil in markets and latest data suggest "that the outlook for growth has worsened and that the downside risks to growth have increased."

"In light of these developments, the Federal Reserve will need to consider whether the current stance of policy remains appropriate," he said.

Bernanke's comments came amid growing calls for rate cuts by the Fed, possibly coordinated with other central banks, to help augment the exceptional measures undertaken to battle a credit crunch that threatens economic activity.

The current base Fed rate is 2.0 percent, and some analysts have said they expect a cut on or before the Fed's next policy meeting October 28-29.

"There is little to keep the Fed from cutting interest rates as it attempts to protect against a more severe recession," said Ryan Sweet at Economy.com.

"We expect the Fed funds rate to be at 1.5 percent by year's end. The 50-basis point cut will not cure all that ails the economy, however."

Bernanke noted that financial systems in the US and much of the rest of world are "under extraordinary stress," but expressed confidence that the steps being taken would eventually ease the crisis.

US President George W. Bush discussed the global economic meltdown with leaders of Britain, France and Italy, seeking a common strategy ahead of weekend crisis talks.

"I was on the phone with them this morning to ensure that our actions are closely coordinated. We live in a globalized world; we want to make sure that we're effective," he said in a speech outside Washington ahead of a meeting Friday of finance chiefs from the Group of Seven industrialized nations.