Europe governments strive to avoid bank meltdown

The Associated Press ,  London   |  Mon, 10/06/2008 10:57 PM  |  Business

European governments struggled to find a coordinated response to the crisis sweeping financial markets Monday, as one country after another announced sweeping deposit guarantees on their own to try and shore up their banks. Stock markets plunged.

Iceland joined Denmark in becoming the latest countries to declare a deposit guarantee Monday after a startling announcement by German Chancellor Angela Merkel on Sunday that her government would guarantee all private bank savings and CDs held in the euro zone's single largest economy. "We want to tell people that their savings are safe," she said.

Failing confidence in the financial system, undermined by a series of bank bailouts, was forcing officials hands, analysts said, since a failure to match the guarantees of varying clarity by Ireland, France, Greece, and Sweden could risk a massive funds outflow from their countries' coffers. Yet the cascading guarantees themselves raised questions about their potential impact on government finances, and showed that European governments were still unable to find on a unified approach despite a weekend summit where they agreed to do just that.

"Governments have no choice but to give the guarantees on deposits, otherwise we will see runs on banks and a complete loss of business and consumer confidence," said Neil Mackinnon, chief economist at ECU Group.

"The stakes have never been higher," he added.

Markets responded to the disarray by sinking rapidly, following selloffs in Asia. Russia shut down both its stock markets after they fell more than 15 percent. Germany's DAX was down 428.04, or 7.4 percent, at 5,368.99, whicle France's CAC-40 was 350.74 points, or 8.9 percent, lower at 3,730.01. The FTSE 100 index of leading British shares was faring slightly better, down 269.30 points, or 5.5 percent, at 4,601.04. The CAC's fall in afternoon trading exceeded the record one-day decline of 7.39 percent from Sept. 11, 2001.

Wall Street took its cue from Europe, with the Dow Jones industrials down 430.81 points, or 4.2 percent at 9,907.55 amid growing fears that the credit crisis is spreading around the world.

Meanwhile, the euro slid below the US$1.36 mark for the first time in over a year.

The crisis engulfing Europe and its markets has fuelled talk of co-ordinated interest rate cuts from the world's leading central banks, possibly as early as Monday.

Analysts said they wouldn't be surprised if the US Federal Reserve, the European Central Bank and the Bank of England instigate the first joint action on interest rates since the Sept. 11, 2001 terrorist attacks on the US.

"I think we will see interest rate cuts this week," said ECU Group's Mackinnon.

Waning confidence that the wider economy could escape serious damage was also contributing to the sense of crisis. ECB President Jean-Claude Trichet gave a downbeat assessement of growth prospects for the countries using the euro at the bank's meeting last week.

So far, the banks have held off pressing the interest rate button and continue to flood the money markets with additional liquidity. On Monday, the ECB injected another US$50 billion into money markets while the BoE added another US$10 billion.

Additionally, the Fed said that 28-day and 84-day cash loans being made available to banks will be boosted to US$150 billion a piece, effective Monday. Those increases will eventually bring the amounts outstanding under the program to US$600 billion.

British Prime Minister Gordon Brown planne a call to Merkel to discuss the crisis, while Alistair Darling, the Treasury chief told lawmakers that European countries must work together to tackle problems in the banking system and that Britain is ready to do "whatever is necessary" to protect banks and depositors. So far, Britain has raised its deposi guarantee only to 50,000 pounds (US$87,900), but remains under pressure to guarantee all deposits.

A statement from the French EU presidency said that the leaders of the EU's 27 member countries have pledged to take "all necessary measures to ensure the stability of the financial system" and stressed th need for a coordinated response.

Meanwhile European Union finance ministers were set to begin two days of talks on the crisis in Luxembourg.

"This is a very serious situation and one that needs to be addressed...but it's true that there is not one single magic bullet that will solve this," said EU sokesman Johannes Laitenberger.

The renewed effort to find common cause came after the the weekend commitment by Europe's four leading economic powers - Germany, France, Britain and Italy - to work in a coordinated manner to address

That commitment was blown apart Sunday when Germany's Chancellor Angel Merkel seemingly announced that all euro568 billion (US$786 billion) worth of private deposits held in Germany will be guaranteed alongside a new euro50 billion (US$69 billion) bailout package for Hypo Real Estate AG, Germany's second biggest mortgage lender.

"The EU is liable to be exposed as a fair weaher construction, lacking the means of swift response and the hold over its citizens' loyalties to survive really adverse conditions," said Stephen Lewis, an analyst at Monument Securities.

In a joint statement Monday, Merkel and her Finance Minister Peer Steinbrueck said the guarantee was "an important tep at the right moment".

In response to the German move, the Danish Economy Ministry said commercial lenders had agreed to contribute up to 35 billion kroner, or about US$6.4 billion (euro4.6 billion), over two years to a fund that will help insure account holders from losses. Austrian officials have inicated that they might join in as well.

That was followed this afternoon by Iceland's guarantee of all deposits after trading was halted in six bank stocks. Icelandic banks' assets dwarfs the rest of its economy and its currency has fallen sharply in the past week.

The markets are sceptical that Europs current piecemeal response to the crisis will work to stem the selling tide.

"The main problem for Europe is that a co-ordinated response has proved impossible to reach, and the case-by-case approach that has so far been applied has clearly failed to restore confidence," said Dragana Ignjatovic, Europan analyst at Global Insight.
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