Britain has entered a second credit crunch, Downing Street said on Wednesday night, as America was forced to intervene to stop the eurozone crisis leading to a global financial collapse.
By Robert Winnett, and Bruno Waterfield in Brussels
9:57PM GMT 30 Nov 2011
The US Federal Reserve spearheaded a scheme by central banks around the world, including the Bank of England, to lend money to ailing European banks that were struggling to borrow.
The emergency action to stop the international financial system from freezing up again was prompted by rumours that a European bank was facing difficulties and could not raise money. Panic started to spread through the German bond markets, which threatened to result in a credit freeze for European banks.
British banks have been warned by the Financial Services Authority, the City watchdog, that they must make preparations for the collapse of the single currency.
Downing Street sources insisted that the global economy was not facing a “Lehman’s moment”, in reference to the collapse of the American investment bank.
However, a spokesman for the Prime Minister said: “Clearly there is a very serious situation in the financial markets at this time.
“We are experiencing a credit crunch and that central bank action is about trying to mitigate the effects of that credit crunch. They are ensuring they have the capacity to take action.” The eurozone debt crisis has led to growing fears in financial markets about the stability of major European banks.
Investors, particularly US money-market funds, are increasingly worried that the European banks are exposed to huge losses on loans they have made in Greece, Italy and other indebted eurozone countries.
The intervention by central banks led to a sharp increase in stock markets around the world. The FTSE-100 closed up 3.2 per cent, and the American Dow Jones index rose by 400 points.
On Wednesday, before the New York stock market opened, regulators invoked special powers that would have enabled them to suspend trading if share prices were to begin swinging wildly. The Federal Reserve said it was intervening even though “US financial institutions currently do not face difficulty obtaining liquidity in short-term funding”, because of fears that the euro crisis could derail markets in America and Asia.
In a statement, the Bank of England said: “The Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, the Federal Reserve, and the Swiss National Bank are today announcing co-ordinated actions to enhance their capacity to provide liquidity support to the global financial system.
“The purpose of these actions is to ease strains in financial markets and thereby mitigate the effects of such strains on the supply of credit to households and businesses and so help foster economic activity.” In another day of turmoil in Brussels, European finance ministers also admitted that they had failed to raise enough funds for a rescue fund to prop up the single currency.
The International Monetary Fund (IMF) is expected to assist in the bail-out plan – and a senior European official warned that there were now 10 days to save the euro.
Olli Rehn, the European Commission vice-president responsible for economic affairs, warned that a summit of Europe’s leaders on Friday Dec 9 was now crucial.
“We are now entering the critical period of 10 days to complete and conclude the crisis response of the EU,” he said.
Herman Van Rompuy, the EU’s president, said that Europe’s governments needed to “confront” a looming catastrophe.
“The trouble has become systemic. We are witnessing a full-blown confidence crisis,” he said.
Alain Juppe, the French foreign minister, raised the stark prospect of a return to violent conflict on the continent.
“It is an existential crisis for Europe,” he said. “We have flattered ourselves for decades that we have eradicated the danger of conflict inside our continent, but let’s not be too sure.”
Following a meeting of EU finance ministers in Brussels on Wednesday, details began to emerge of an ECB and International Monetary Fund deal to help rescue distressed euro countries such as Italy and Spain. The latest measures follow an admission that the eurozone’s bail-out fund would only be half as big as originally promised, €625 billion (£535 billion) rather than €1.2 trillion.
Wolfgang Schäeuble, the German finance minister, signalled that Germany was ready to relax opposition to European Central Bank involvement in protecting the euro via IMF interventions.
“We are prepared to increase the resources of the IMF through bilateral loans. Naturally, the details would have to be discussed. Naturally, it is the central banks in the end,” he said.
The combined eurozone and IMF bail-out funds, not involving Britain, will be up and running for the New Year, to be coupled with longer-term EU treaty changes to enforce closer fiscal union for single currency members.
Jacek Rostowski, the Polish finance minister who chaired the talks in Brussels, said it would be vital for the eurozone to have a “fully credible and powerful firewall” ready by the end of the year. “It will be extremely important to stabilise markets in an extremely forceful way,” he said.
“The very helpful action of the central banks is not in itself sufficient. The root cause and source of the problems is happening with sovereign debt,” he said.
The British authorities continued to develop detailed contingency plans to deal with the possible collapse of the euro. David Cameron is understood to have discussed the crisis with Sir Mervyn King, the Governor of the Bank of England, earlier this week. The Financial Services Authority (FSA), the City regulator, is also working with British banks to prepare for the “Armageddon” scenario.
Heads of government departments, who meet to prepare the agenda for the National Security Council, chaired by the Prime Minister, are expected to consider the fate of the eurozone and the security implications for Britain at their next meeting. The eurozone has previously been dealt with by specialist Cabinet committees outside the realm of the country’s main security policy body.
Mohamed El-Erian, chief executive of Pimco, the world’s biggest bond fund, said: “These monetary institutions feel that, again, they have to move because other entities have continued to be too slow and too ineffective.”
Nigam Agora, an investment fund manager said: “It appears that a big European bank got close to failure. European banks, especially French banks, rely heavily on funding. The cavalry was called in and has come to the successful rescue.”