Fallout from U.S. rattles world markets

Central banks inject funds to boost shaky confidence

August 10, 2007|By Tom Petruno | Tom Petruno,LOS ANGELES TIMES

Global markets staggered yesterday as a French bank triggered a worldwide financial scare by halting withdrawals from investment funds that have lost money on high-risk U.S. mortgage securities.

The central banks of major economies, including the United States, responded by pumping tens of billions of dollars into their banking systems in an effort to shore up investors' confidence.

On Wall Street, the Dow Jones industrial average plunged 387.18 points, or 2.8 percent, to 13,270.68, its largest one-day point loss since February.

The day's events sharply raised the stakes in a financial crisis rooted in the U.S. housing market's woes: Although the move by Paris-based BNP Paribas was just the latest in a string of shocks stemming from sinking U.S. housing values and rising mortgage defaults, the reaction to this one was serious enough to spur dramatic action by the European Central Bank.

As commercial banks in Europe became reluctant to lend to one another, short-term interest rates surged. That spurred the Central Bank to pour $130 billion into the continent's banking system in an attempt to pull rates back down. The sum was far more than the burst of assistance the bank provided after the Sept. 11, 2001, terrorist attacks.

The U.S. Federal Reserve also sought to calm frightened markets by adding money to the American banking system, but on a much smaller scale than its European counterpart.

Lou Crandall, an economist at investment company Wrightson ICAP, said the central banks "were essentially acting as the lender of last resort" to keep financial markets from seizing up, which in the worst-case scenario could turn into a cascade of brokerages, banks and other financial companies being unable to pay what they owe one another.

Stock markets around the globe, reeling for weeks on worries of spreading credit problems in the financial system, suffered another sharp decline as fearful investors fled. Major European stock markets fell about 2 percent.

"People are getting away from risk in every way they can," said Christopher Sheldon, director of investment strategy at Mellon Private Wealth Management in Boston.

In early trading this morning, Asian stocks fell sharply. The Nikkei 225 index plunged 2.12 percent on the Tokyo Stock Exchange, while the Korea Composite Stock Price Index was down 3.29 percent.

The Federal Reserve injected an extra $24 billion in temporary reserves into the banking system yesterday after the federal funds rate, the rate at which banks make short-term loans to each other, climbed above the 5.25 percent target level set by the Fed, a spokesman said.

But there were indications that neither the Fed nor the U.S. Treasury intended to do much more to help banks and other financial institutions adjust to the turmoil caused by losses on mortgage-backed bonds and other high-risk securities.

After meeting with Treasury Secretary Henry M. Paulson Jr., President Bush went before the cameras for the second straight day to say that the U.S. economy was strong and that credit was plentiful.

Asked about recent market volatility, Bush replied, "I am told there is enough liquidity in the system to enable markets to correct," a clear indication the government wants to see the markets solve their own troubles, analysts said.

Some experts criticized the European Central Bank's decision to pump such a large sum into the banking system, saying it might have fostered more panic by causing investors to question whether things were worse than they thought.

At the heart of global markets' turmoil is the financing that drove the unprecedented U.S. housing boom of this decade. The rise of subprime loans -- mortgages for people of limited means or whose credit was weak -- allowed millions of Americans to buy or refinance homes.

Wall Street financed many of those loans by packaging them into an array of complex securities. And investors snapped them up, lured by the high interest rates they promised.

But as growing numbers of those homeowners now find they can't make their payments, the value of the subprime-loan bonds is plummeting. What's more, few investors are willing to buy the securities now -- which means those who hold the bonds can't unload them or even determine a fair price for them.

BNP Paribas said it had become "impossible to value certain assets fairly," and therefore it couldn't allow withdrawals by investors in three bank-managed funds that held the bonds. The funds, with a total of about $2.2 billion in assets, have about one-third of the total in U.S. securities that include subprime mortgage bonds, a spokeswoman for the bank said.

Wall Street was stunned last month when Bear Stearns Cos., one of the nation's premier brokerages, said two investment funds that it managed had become nearly worthless because of mounting losses on mortgage securities.

More recently, several investment funds in Australia also said they had suffered serious losses tied to such securities.

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