Central bankers in Europe held talks with bank supervisors and top financial executives over the weekend to assess the dangers from risky U.S. mortgage debt to the financial system, industry sources said.
Central bankers by late Friday had restored an uneasy calm to panicky financial markets by injecting a massive and unprecedented $323 billion into money markets that had almost seized up in panic over exposure to complex credit derivatives linked to defaulting U.S. mortgages.
They appear to have succeeded in keeping cash flowing through the arteries of finance for now.
The cost of borrowing money overnight in the U.S. federal funds market, a critical measure of conditions in the financial system, tumbled to 1% by late Friday, way below the Fed's 5.25% target rate.
This showed that masses of cash were sloshing around the banking system and markets can keep operating. The first major test comes on Monday when Japan's markets open.
But the fear that overwhelmed markets on Thursday and Friday looks unlikely to fully disappear until investors regain confidence that no major bank or fund is loaded with toxic debt and in danger of collapse -- a problem that could turn a temporary crisis of confidence into a full-scale credit crunch and then an economic slump, analysts said fund managers said.
"Uncertainty has turned to panic the last two days and we have come very close to a self-fulfilling liquidity crisis," said Marco Annunziata, chief economist at Unicredit Markets in a client note.
What is gnawing at investors and traders is not knowing the size of overall credit losses linked to U.S. subprime mortgages that is buried in banks and funds -- and not knowing who holds the risk. This has caused money-market traders to hoard cash and investors to dump riskier assets, especially European stocks which erased all their gains for the year by Friday.
Until more information is available on the scale of exposure to complex debt derivatives created in the U.S. subprime market and sold worldwide, analysts said it will be hard to restore a lasting investor calm.
"Volatility is highest when people realise they cannot figure out what investments are worth," said Frank Partnoy, a University of San Diego professor, in a Financial Times column.
German banks made moves to provide more information this weekend. Their industry is at the center of the maelstrom in Europe, after the bailout of small lender IKB sent shockwaves through the financial community.
WestLB, a state lender which was hit hard by rumors its balance sheet also was in trouble, said on Saturday it has 1.25 billion euros ($1.71 billion) in U.S. subprime-related debt, 98% of which is rated A or better, up from the 93% it had cited last week. That is a relatively small amount for a bank with 285 billion euros in total assets.
But the fact its exposure has changed shows the difficulty in valuing the credit derivatives, which slice up and repackage riskier pieces of debt and resell them, making it hard to know the price of the underlying asset or who has a claim on it.
Deutsche Postbank, with 288 billion euros in assets, also said on Saturday it has 600 million euros in exposure to IKB, which was undone by U.S. subprime problems.
This was accompanied by revelations on Sunday that several major European institutions -- Deutsche Bank, Commerzbank and BNP Paribas -- are creditors of bankrupt U.S. mortgage company HomeBanc. The amount was not cited.
Still, Standard and Poor's ratings agency on Friday said the West European bank problems revealed by IKB was an "isolated event," and it did not expect widespread bank ratings pressure.
Japan will be the first major test of investors' nerves when its money markets open on Monday. If U.S. dollar deposit rates, which hit 6.5% or higher last Friday soar again, central banks may be need to resort to another injection of cash to soothe nerves.
A good sign would be interbank money trade nearer the fed funds rate or lower, reversing the trend seen last Thursday and Friday.
Even if Monday goes well, most analysts expect a long shakeout.
"We'll probably remain very volatile at least until some time in September," said Ira Jersey, credit strategist for Credit Suisse in the United States. "There's too many questions that need to be answered, and we're not going to get the answers to those questions for at least another month," he said.