Bold Pledges from Leaders, But Investors Await Details

After a whirl of emergency meetings, government leaders on both sides of the Atlantic made bold promises to rescue the global financial system, but were still racing to work out the details to calm battered stock markets before they opened on Monday morning.

Credit Crunch
Credit Crunch

In the wake of the carnage in last week’s markets, European countries pledged to inject capital into ailing banks and guarantee some forms of bank debt, a step analysts said was critical to restoring lending between banks and easing a crisis of confidence.

Europe's action throws the spotlight back to the United States, where officials said Treasury Secretary Henry M. Paulson Jr. was studying the feasibility of backing up loans between banks here. Lending between banks is considered crucial to the smooth operation of the financial system and the broader economy, but it has slowed considerably because banks are concerned about being repaid should the other bank run into financial trouble.

The Treasury was not expected to announce anything before Monday, officials said. But the government was helping an American financial giant, Morgan Stanley , in its effort to salvage a $9 billion investment by a Japanese bank, Mitsubishi UFJ Financial .

The initial reaction of investors was positive, with stocks up in several Asian markets and stock futures in the United States — which are bets on the direction of the market before its opening — higher as well. The early signs, after one of the worst weeks ever for stock markets, are not a definitive shift in sentiment but were seen as a potential hope that the markets may at least stop their free fall.

“It’s going to take actions more than words at this time, given the extreme distress that the money markets are in and the extreme distress that the equity markets were in,” said Douglas Peta, a market strategist at J.& W. Seligman & Company. He predicted further drops in the stock and bond markets; the Dow Jones industrial average fell 18 percent last week.

But there were some significant steps. In Paris, European leaders agreed to a unified plan that would inject billions of euros into their banks and guarantee bank debt for periods up to five years. President Nicolas Sarkozy of France, who led the talks in the 18th-century Élysée Palace, said governments would announce concrete rescue plans tailored to their national circumstances on Monday simultaneously.

“We need concrete measures, we need unity,” Mr. Sarkozy declared. “That’s what we achieved today.”

Leaders of the 15 countries that use the euro did not put a price tag on any of their promises — contrary to Britain, where last week Prime Minister Gordon Brown announced $255 billion in government funds and other measures to stabilize its banks, or the United States, where a $700 billion bailout plan will now be used partly to infuse banks with fresh capital.

The United States is overhauling its rescue package, which had originally focused on buying distressed assets from banks. Mr. Paulson said on Friday the government would now take equity stakes in banks; the government’s role in the Morgan Stanley negotiations may be an early test of the Treasury’s retooled strategy.

The government has so far been reluctant to guarantee bank loans to other banks out of concern that it could give banks a competitive advantage over other financial institutions, and thus have unintended consequences.

Max Bublitz, chief strategist at SCM Advisors in San Francisco, said the United States should follow the lead of the Europeans, whom he said were proving to be more adroit in their response. Markets, he said, will remain unsettled until policy makers take concrete steps to shore up banks.

“We still need to see some of these capital injections actually occurring and see what impact it has on balance sheets, and does it attract other capital from sovereign wealth funds and others,” Mr. Bublitz said.

Europe may have acted quicker in large part because banks there are facing urgent problems, said Tobias Levkovich, chief equity strategist at Citigroup. Many European financial firms have borrowed more extensively relative to their capital than most American banks.

“The Europeans were sitting with a much closer foot to the fire than we were,” he said. “I don’t think they could sit around and wait a week or two.”

Still, the actions taken by European leaders could aid the United States in an indirect way by helping to lower a critical interest rate, said Douglas A. Dachille, chief executive of First Principles Capital Management, an investment firm that specializes in bonds.

A daily poll of mostly European banks sets the London interbank offered rate, or Libor, which is used as a benchmark to set borrowing costs for corporate and consumer loans. In recent weeks, the Libor has shot up as banks have become increasingly unwilling to lend to each other.

Banks and investors have severely restricted lending to each other because their capacity to do so has been limited by losses that they have suffered and because they are fearful they may not be paid back.


“One of the big themes that people have been worried about is Libor,” Mr. Dachille said. “If they can do something that might have positive consequences in bringing Libor down, the U.S. would benefit.”

For Europeans, the agreement represented a sharp reversal from two weeks ago, when Germany and other countries played down the need for a concerted response to what some characterized as an American problem.

“We are committed in all European states to recapitalize banks if we establish a threat to solvency and a risk to the economy,” the Belgian finance minister, Didier Reynders, said after the leaders met. “The goal is to kick-start the interbank lending market.”

Mr. Reynders said the European Central Bank had also committed to helping to restore trading in the commercial paper market, where companies conduct short-term borrowing. The United States also has agreed to guarantee commercial paper loans in an effort to unfreeze that market.

Officials said action would be taken at the national level, within the framework of a “toolbox.” The idea, they said, is that governments face different challenges and need to act quickly in the face of a crisis and that a common front will avoid the danger that one country may undercut another.

But Mr. Reynders dismissed the possibility of a common European fund for the banks. Germany had opposed the idea because it feared it would end up bailing out banks in other countries.

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“Our goal is to have coordinated action for the euro zone,” said Angela Merkel, the German chancellor, and the meeting “is a very important signal for the strength of the euro zone.”

Officials said France and Germany intended to announce national plans on Monday worth hundreds of billions of euros.

Earlier Sunday, the authorities in Australia and New Zealand announced a blanket guarantee of bank deposits. Australia’s prime minister, Kevin Rudd, called the financial turmoil “the economic equivalent of a national security crisis” because of the danger that funds would flee Sydney’s banks for countries where governments had guaranteed deposits. Australian stocks were up more than 3 percent on Monday morning.

“I don’t want a first-class Australian bank discriminated against because some other foreign bank, which has a bad balance sheet, is being propped up by a guarantee by a foreign government,” Reuters quoted Mr. Rudd as saying.

While the government initiatives agreed to over the weekend are aimed at reassuring the financial markets, some economists fear that the patchwork nature of some of the measures could fuel further instability by tempting investors to move capital around to take advantage of those countries perceived as the safest havens.

“If you build a nice, comfortable ark for the banks, the question is, ‘Who doesn’t get a seat?’ ” said Simon Johnson, a former chief economist of the International Monetary Fund. “The answer is the emerging markets.”

American officials say they are concerned about this, and sought to assure emerging market countries at a meeting of the Group of 20 countries on Saturday that they did not want to undermine their economies.

“We are not pursuing policies that would limit the flow of goods, services or capital, as such measures would only intensify the risks of a prolonged crisis,” Mr. Paulson said to a meeting of the International Monetary Fund.

In Britain, the first major country to announce a recapitalization plan, officials appeared to be speeding plans to inject capital into its troubled banks. At the top of the list is the Royal Bank of Scotland, whose market value fell to below $20 billion, less than what it raised from private investors in June.

It is expected to need about that amount from the government, which would give a majority stake to the Exchequer, the British equivalent of the United States Treasury.

In Washington, where bankers and policy makers wrapped up a weekend of meetings, there was bitter recrimination about the Treasury’s decision to let Lehman Brothers fail — a move that many blamed for helping the crisis of confidence spread globally.

“Quite recently, we saw early signs of a revival of market stability and then, with the unexpected failure of Lehman Brothers, we saw a precipitous unraveling,” said Josef Ackermann, the chief executive of Deutsche Bank, at a meeting of the Institute of International Finance, which he heads.

Bankers said they were surprised that the finance ministers had not each met with the major bankers from their countries to make clear that they were expected to lend to other banks.