Governments in the 15-nation eurozone agreed Sunday to use public funds to replenish depleted banking coffers and to guarantee bank refinancing, moves aimed at unclogging blocked credit channels and easing the global financial crisis.
Individual countries, beginning with France, Germany and Italy, will use their own taxpayer funds and will announce specific steps today. "This is not a gift to banks, but (is designed) to help them function," said French President Nicolas Sarkozy, who chaired the emergency meeting in Paris.
The move may increase pressure on the United States to take further actions to bolster its major banks, heavily damaged by losses on mortgage-related securities. "This gives the European banking system a competitive advantage, both in lending and by reassuring depositors," said Adam Posen of the Peterson Institute for International Economics and a consultant to the Federal Reserve.
The U.S. is trying to clear blocked credit channels by having the Federal Reserve buy short-term debt directly from companies. Once it does, officials plan to assess the market impact. "We'll ask ourselves the question: Are there other things we can do? … We recognize we have limited time," said David McCormick, Treasury Department undersecretary for international affairs.
The European guarantee of new bank issuance of debt will be effective through the end of 2009. Sunday's announcement came after two weeks of disagreement on the need for joint action as countries such as Ireland and the United Kingdom moved to protect their own banks.
Tumultuous financial markets are driving policymakers to respond. "Since the demise of Lehman Bros., the crisis has entered into a new and acute phase, where it's really quite scary," said Richard Portes, a professor at London Business School and an economic adviser to the European Commission president.
Asian stock markets rose early today, although Japan's was closed for a holiday.
The European action capped a weekend of feverish effort by world leaders to launch a coordinated approach to the worst financial crisis since the 1930s. Treasury Secretary Henry Paulson said Sunday that the U.S. would not resort to "isolationism and protectionism" and warned about the impact of the crisis on poor countries already hit by high food and fuel prices. Earlier, he confirmed that the U.S. plans to use some of its $700 billion rescue package to buy stakes in major banks.
The refinancing guarantee may not get banks to resume lending. In recent weeks, the European Central Bank has pumped huge amounts of cash into the banking system. But rather than make new loans, banks have deposited the money in low-interest-paying accounts at the ECB. The risk remains that banks will hoard new cash rather than lend it, says Daniel Gros, a banking expert at the Centre for European Policy Studies in Brussels.