G7 pledges action to save banks

World's leading economies agree on programme to part-nationalise all banks
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The Independent Online

In Washington the comings and goings at the IMF conference of the world's finance ministers and central bankers seemed curiously irrelevant against such a tsunami of fear. So far this week, their actions – bank rescue plans, an internationally co-ordinated cut in interest rates and a pledge of billions of dollars in assistance from the IMF for distressed economies – have been met with a raspberry from the markets.

The unparalleled turmoil in the world's financial markets has pushed America and the world's other leading economies to agree a programme of part nationalisation of their banks that would have been considered unthinkable a few months ago.

The US Treasury Secretary, Henry Paulson, confirmed last night that his government is "developing strategies to use the authority to purchase and insure mortgage assets and to purchase equity in financial institutions, as deemed necessary to promote financial market stability." Mr Paulson said he would be buying shares in the banks "as soon as we can", and in addition to the $700bn bailout already announced.

Nor was he alone: his fellow finance ministers in the G7 group of advanced economies, meeting at the International Monetary Fund in Washington, issued an unusually punchy statement at the end of their deliberations – a "plan of action". Crucially, the G7 pledged to "ensure that our banks and other financial intermediaries, as needed, can raise capital from public as well as private sources". This opens the way to a world-wide part-nationalisation of the banks, along the lines announced by Gordon Brown for the UK earlier this week. The G7 also agreed to "take all necessary steps to unfreeze credit and money markets", and to "use all available tools to support systematically important financial institutions". British Treasury sources welcomed it as a "good statement".

The official action is designed to match the scale of the crisis. It has witnessed a destruction of wealth unprecedented in human history: some $25 trillion – that is $25 million million – wiped from the value of the world's stock markets so far this year, and $4.6trn (£2.7trn) of that in the past week alone.

So far this week, and before last night's international commitment to action, the activities of ministers and central bankers have been met with a raspberry from the markets. These actions include bank rescue plans, an internationally co-ordinated cut in interest rates and a pledge of billions of dollars in assistance from the IMF for distressed economies. Yet the money markets remain seized, the stock markets have headed for meltdown, the price of oil is below $80 and sterling is under pressure again, below $1.70 for the first time in five years. Although the 1929 and 1987 stock market crashes were more rapid and dramatic, the cumulative scale of losses seen recently bears comparison, at least.

The Dow Jones index of leading shares has lost almost 40 per cent of its value since its peak almost exactly a year ago, and 20 per cent this week.

Yesterday proved to be the wildest day in the Dow's 112-year history, with unprecedented swings of 900 points. In the final hour of trading, the index recovered from more than 550 points down to almost 350 points up. Cheers were heard across the New York Stock Exchange floor as it moved into the positive, only to close at 8,451, down 1.5 per cent.

Europe's stock markets lost a fifth of their value last week, while London's FTSE 100 index fell by 8.9 per cent yesterday, ending its worst week since Black Monday in 1987, and its lowest close in more than five years.

The breezy confidence born of the longest modern period of growth has given way to despair. The global economy is standing with one foot over a precipice, and on the brink of a catastrophe – the biggest slump since the Great Depression of the 1930s. The West's banks are so weak that they will not even lend to each other for a day; that is the scale of the crisis of confidence and the background to yesterday's call to action among the G7. The wider G20 group, including China, Russia, India and other fast-growing economies, will also be meeting in Washington and will be supportive of the G7's policy.

Faced with what the Chancellor, Alistair Darling, called "turbulence the like of which has never been seen", the G7 group of finance ministers have signalled their determination to rebuild confidence in the financial markets.

In relation to the British plan to provide £500bn of funds for banks, the shadow Chancellor, George Osborne, said: "It is not enough to announce the overall plan – the Treasury must move quickly to conclude the negotiations with individual banks. We need to get the money in and secure the tough conditions on curbing bonuses and encouraging new lending. Time is of the essence."

*William Hague, the shadow Foreign Secretary, will today face questions about his decision to join a lavish trip for Barclays bank executives to Lake Como in Italy yesterday. As world markets slumped, Mr Hague was enjoying a luxury break courtesy of the bank's private wealth division. His wife, Ffion, is an adviser to Barclays.

Market meltdown: What could go wrong?

Every piece of government intervention so far has seen, at best, only a temporary recovery. The danger now is that any action taken, such as even deeper cuts in interest rates, will also have a minimal effect.

What are the prospects?

The problems in the banking system have a direct impact on families' ability to buy homes and consumer goods, on farms, factories and offices buying equipment. At worst, share prices could fall by 50 per cent from their peaks last year and house prices by another 20 per cent. Such a devastation of wealth makes us less liable to go out and spend, dragging economies down further.

What else can go bust?

Countries. Sovereign states, such as Iceland and some emerging economies, could default on their debts, causing more instability. Big companies too; the likes of General Motors has seen its shares crash byalmost 50 per cent in a few days.

What could the endgame be?

If all else fails, governments will have to nationalise their banking systems, but only if they and their currencies are strong enough. We've seen runs on some of the word's biggest banks and insurers and some smaller economies; could a run on the US itself, and a complete collapse of the dollar be ruled out?