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As Contagion Spreads, Moods Abruptly Shift

By Edward Cody and Mary Jordan
Washington Post Foreign Service
Tuesday, September 30, 2008

PARIS, Sept. 29 -- The turmoil that began on Wall Street now spans the globe.

Stock markets around the world cascaded lower Monday, European regulators announced the rescue of four major banks, and U.S. and foreign officials pledged to make hundreds of billions of dollars available to ensure that banks would continue lending to one another.

Yet the contagion continued. U.S. stocks opened weak, then fell off a cliff after the House of Representatives voted against a $700 billion plan intended to restore stability to the nation's wobbly financial system. That sent Brazil's stock market down more than 9 percent, prompting authorities in Sao Paulo to temporarily suspend trading, amid worries of a deep U.S. economic slowdown.

When markets opened Tuesday morning in Asia, the trend continued. Stocks fell by 3 to 6 percent in early trading throughout the region. At midday, Japan's stock market had skidded more than 4 percent.

In the seldom-interrupted cycle of global financial markets, the extraordinary pace and scale of events brought an abrupt end to the confident attitude displayed by European officials as recently as last week, when officials claimed that shareholders and investors there had less to fear than their American counterparts because European banks were not as heavily exposed to the troubled mortgage loans undermining the U.S. system.

That confidence was eroded over the weekend by the emergency bank rescues. By Monday morning, after Asian stock markets had nose-dived, credit markets were seizing up, meaning that the normal flow of trading among banks wasn't taking place. The European Central Bank then announced it was pumping an extra $173 billion into European markets. In Washington, the Federal Reserve said it would make an additional $620 billion available for future lending to nine foreign central banks.

The head of one of those nine, Bank of Japan Governor Masaaki Shirakawa, said Monday that global financial liquidity "has almost dried up."

European banks are strained by the recent collapse of property booms close to home, notably in Britain, Spain, Portugal and Ireland, by exposure to bad U.S. mortgage securities, and by the general drying up of short-term credit. Japan's economy is already suffering from a highly unusual trade deficit, and domestic demand for goods appears to be waning, too, the Tokyo government reported Tuesday. Last month household spending fell 4 percent and factory output dropped 3.5 percent.

The House rejection of the White House's $700 billion rescue plan seemed likely to increase international concern over what might be next.

In Europe, the banking crisis "can hardly spread further -- it is everywhere," said Willem Buiter, a professor at the London School of Economics and former member of the Bank of England's monetary policy committee.

European Central Bank President Jean-Claude Trichet sat down Sunday with several European finance ministers in Brussels to discuss loosening European Union rules on government guarantees for banks in need of quick infusions of capital. Their meeting suggested that European governments feared they would need to intervene again.

French President Nicolas Sarkozy, who said Thursday that French banks appeared able to overcome the threat, summoned the country's top bank executives, his senior financial aides and the governor of the Bank of France for an urgent meeting Tuesday. His finance minister, Christine Lagarde, renewed her promise that "the government will assume its responsibilities" to prevent losses to French savings and investment account holders.

Sarkozy's office said he had conferred Friday with President Bush, pushing his idea for a meeting of heads of state from the major industrial powers by year's end to envision a top-to-bottom overhaul of the world financial system. The summit could be held at Bretton Woods, N.H., where officials met in 1944 to set the basics of today's world financial system, the Paris media reported.

European markets were closed by the time the House of Representatives voted, but in Brazil, located in a closer time zone, the news sent the Bovespa index on its largest drop in a decade. Trading was halted for half an hour.

Some economists attributed the fall to concerns that economic troubles in the United States could hurt Brazil's commodities trade. "If the United States goes through a huge recession, other countries will suffer," said José Márcio Camargo, an economist at Opus Gestao de Recursos, an asset management firm in Rio de Janeiro. Brazil's treasury, meanwhile, injected nearly $8 billion into the country's national development bank to help companies that are having trouble accessing credit.

Guillermo Mondino, an analyst with Barclays Capital, wrote in a new report that "the global credit crunch seems increasingly to be spilling over to emerging markets. Lines of credit are tightening, disruptions in domestic banking systems are on the rise, and domestic interest rates are increasing. The result is likely to be slower growth."

Mondino wrote that Latin America may feel a credit pinch because foreign banks are such major players in the region. Foreign banks account for 80 percent of the financial system in Mexico, 51 percent in Peru, 29 percent in Chile and 22 percent in Brazil.

Monday's bad news in markets began in East Asia. Japan's Nikkei average closed down 1.3 percent, while Hong Kong's Hang Seng index was down 4.3 percent and India's Sensex was off 3.9 percent. The trend continued in Europe: The London exchange's FTSE 100 closed 5.3 percent lower, Paris's CAC 40 was down by 5.04 percent, the DAX in Frankfurt closed down 4.2 percent and Moscow's Micex was off 5.5 percent.

Europe's sense of confidence was particularly undercut by the rescue of Fortis, a Dutch-Belgian banking and insurance giant that once ranked among the world's top 20 financial institutions. The Dutch, Belgian and Luxembourg governments said Monday they had put up the equivalent of $16 billion to buy the group's faltering banking operations, in effect nationalizing them for now.

Fortis's troubles were partly related to its role in a huge takeover deal and fears among investors that, despite their leaders' reassuring comments, European banks are too tightly linked to their U.S. counterparts in a globalized monetary system to escape the crisis. Even after the rescue plan was announced, Fortis stock dropped 12 percent during Monday's trading.

As the possibility of bailouts loomed in Europe, many officials had worried whether the European Union, composed of 27 countries with sometimes opposing points of view, would be paralyzed. Buiter, of the London School of Economics, said the speed of the Fortis rescue showed otherwise.

The injection of funds into Fortis "happened overnight and without anyone needing to consult with parliaments," he said. "The political capability for addressing a crisis like this is significantly greater in Europe than in the U.S. There was doubt, until today really, that multiple national treasuries would be able to agree on sharing rules."

In Britain, authorities announced a bailout for Bradford & Bingley, a bank specializing in mortgage loans. The government put up $90 billion to absorb questionable loans, the announcement said, while the Spanish bank Santander paid $37.8 billion to take over retail and savings bank branches.

Alistair Darling, Britain's chancellor of the exchequer, or finance minister, said his main concern was to protect investors and borrowers. "All of us, wherever we are, in whatever part of the world, need to do what is right in order to maintain stability and get through a period which quite frankly we have never seen the like of for a generation."

The German government, meanwhile, announced that it had orchestrated a bailout of the country's second-biggest commercial property lender, Hypo Real Estate Holding AG. The German Finance Ministry said it arranged an emergency credit line of $50 billion for the bank from several private lenders.

The rescue came four days after Finance Minister Peer Steinbrueck said the country's banking system was "extremely stable" and rejected suggestions that Germany consider a U.S.-style bailout plan for its ailing banks. "More than anything, the finance market is an American problem," Steinbrueck said in a speech Thursday to the German Parliament.

Problems at Hypo Real Estate, which lends primarily to local governments and property developers, had been known for months; the bank had posted big losses on its subprime loans in the United States. But Hypo's access to credit rapidly eroded and other problems with speculative investments emerged in recent days, forcing the German government to intervene, according to government and bank officials.

Analysts said that German banks remained on a stronger footing than those in the United States or Britain and that it was unlikely the government would need to fashion an industry-wide bailout.

In Iceland, the government said Monday it had taken control of Glitnir bank, the country's third-largest, paying about $878 million for a 75 percent stake.

Several analysts said the European banking problems are biggest at institutions with heavy exposure to European property bubbles. Millions of homeowners and developers took out loans against property that is no longer valued at what it was months ago.

Nicolas Véron, a research fellow at the Bruegel center in Brussels, said concern has risen about strains in the banking system spreading to the Baltic countries and Eastern Europe, where several nations also have experienced property bubbles.

"We knew this would happen, because the storm in the U.S. is so powerful," Véron said.

In Japan, veterans of the country's economic crash in the 1990s said Tuesday that it was not a complete surprise that U.S. lawmakers rejected the financial rescue plan. During that crisis, several Japanese banks and securities firms failed before the government gained popular support to inject capital into the financial system.

Hiromichi Shirakawa, chief economist at Credit Suisse in Tokyo, suggested that Americans' "sense of crisis has not yet reached the level where they will approve a big bailout. For this kind of bailout, it is quite important for something to happen that makes people feel really bad about their own finances."

Jordan reported from London. Correspondents Blaine Harden in Tokyo, Craig Whitlock in Berlin, Emily Wax in New Delhi and Joshua Partlow in Rio de Janeiro and staff writer Steven Mufson in Washington contributed to this report.

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