Europe idle as US battles meltdownBy Ambrose Evans-Pritchard
The US Federal Reserve has resorted to the nuclear option in its ever-more depleted arsenal, invoking a Depression-era clause to shoulder the risk of losses stemming from the collapse of Bear Stearns, and to lend money directly to broker dealers.
It is the first time since the Great Depression that the Fed has stepped in directly to absorb credit losses, crossing a line deemed unthinkable just months ago. The dramatic late-night move on Sunday required dredging up Article 13 (3) of the Federal Reserve Act, which allows the Fed to shower money on almost anybody it wishes by a vote of five governors in "unusual and exigent circumstances".
The Fed also took the extraordinary step of cutting the Discount Rate a quarter point to 3.25pc just two days before its scheduled policy meeting in Washington, a move underscoring the high drama of the crisis. The markets have priced in an emergency 100 basis point cut in the key Fed funds rate to 2pc today.
"These are massive, unprecedented actions," said Hank Calenti, from RBC Capital Markets. "Their gravity is likely to scare the markets to death, but the Fed is trying to inhibit a margin-meltdown."
Bernard Connolly, global strategist at Banque AIG, said invoking a 1930s-era emergency clause was a "very big deal".
"We have moved one step closer to the direct purchase of assets by the US authorities. I'm afraid this has horrible implications but it may be the only way to avoid a serious risk of Depression. This is a Greek Tragedy set in motion by Alan Greenspan a long time ago," he said.
The Fed's hyperactive coups are in stark contrast to the wait-and-see policy of the European Central Bank, which has held rates steady at 4pc since the credit crunch began - despite a jump in the (market-driven) three-month Euribor rate used to price mortgages.
Dominique Strauss-Kahn, the head of the International Monetary Fund, suggested yesterday that Europe had misjudged the severity of the crisis that now threatens to engulf the world economy. "Obviously the financial market crisis is now more serious and more global than a week ago," he said. "It will have significant implications for many countries. At this time, the priority for European governments should be containing the economic damage from the financial market crisis."
The hard-line policy of Europe's key central banks has been a major factor in the dollar's precipitous fall over recent weeks. The euro rocketed to an all-time high of $1.59 in Asian trading after the Fed's latest move. It is being lifted by the ever-wider yield gap between the two sides of the Atlantic. The dollar slide has now reached the point of disorderly rout, causing an investor flight from US bonds and aggravating America's banking crisis. There is a growing fear that these forces are now feeding on each other in a self-reinforcing spiral.
BNP Paribas said the ECB's unwillingness to take pro-active measures to head off a severe slowdown was now contributing to the mood of global crisis. "As long as the Fed is on its own trying to calm money markets, the dollar will fall and this will work as a catalyst to spread weakness," it said.
Jean-Michel Six, chief Europe economist at Standard & Poor's, said the Europeans were in no mood to rescue America. "There is monetary war going on. The ECB view is that Fed is a victim of its own mistakes and should pay for its past crimes. Frankly, they don't see why they should be cutting rates when inflation (3.3pc) is accelerating," he said.
There are now echoes of October 1987 when the German Bundesbank (and therefore Europe) refused to ease monetary policy, even though the dollar was in freefall and Wall Street was fragile. The spat was the backdrop to the Black Monday crash.
Once again the S&P 500 index of US stocks is clinging by its fingernails to a crucial support, now at around 1274. Traders warn that any sustained break below that level could set off a hair-raising decline.
Jacques Cailloux, Europe economist at the Royal Bank of Scotland, said the ECB was waiting too long to act. "They are betting that there is no big risk from the credit crunch, but it may be too late by the time they move. They need to signal a shift towards monetary easing," he said.
Others are blunter. AIG's Mr Connolly said the ECB was making the sort of catastrophic error that led to the Depression. "The ECB represents the 1930s element in world central banking right now. It is adding to the atmosphere of panic in the foreign exchange markets and ensuring that the collapse of the credit bubble in southern Europe and Ireland will be even worse," he said.