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The Widening Crisis

Central Banks Cut Interest Rates, Britain Bails Out Banks

Central banks around the world on Wednesday dropped interest rates in a coordinated effort to combat the growing financial crisis. Britain also announced a 500 billion pound plan to save the country's banks. Stock markets, though, were slow to react and are posting dramatic losses on Wednesday.

On Wednesday, it was Britain's turn. Saying that he wanted to reduce the "fear factor" currently hampering the banking system, UK finance minister Alistair Darling announced that the government was pumping 50 billion pounds ($87.2 billion) into the country's biggest banks. London hopes the partial nationalization will provide shock therapy for a credit system that has virtually frozen up as trust among banks has evaporated.

In addition, the Bank of England has freed up 200 billion pounds for short-term lending to banks in need and has made a further 250 billion pounds available to guarantee mid-term debt held by banks. "This is beginning a process of un-bunging a big problem where banks won't lend to each other for long periods," Darling said.

Also on Wednesday, central banks around the world announced a coordinated interest rate cut, the first such global slash since just after the terror attacks of Sept. 11, 2001. The US Federal Reserve cut its base lending rate by half a percentage point to 1.5 percent. The European Central Bank likewise dropped a half a percentage point, lowering its interest rate to 3.75 percent, as did the Bank of England, moving its rate down to 4.5 percent. Central banks in Switzerland, Canada, Sweden and China all joined in the worldwide cut. The Bank of Japan, with rates of only 0.5 percent, did not make further cuts.

"The recent intensification of the financial crisis has augmented the downside risks to growth and thus has diminished further the upside risks to price stability," the ECB said in a statement. "Some easing of global monetary conditions is therefore warranted."

Prior to the interest rate cuts, British Prime Minister Gordon Brown announced on Wednesday that the UK intends to take legal action against Iceland in an attempt to recover money held by Britons in Iceland's wobbling banks. Reykjavik on Tuesday nationalized the country's second largest bank, Landsbanki, after having taken on Glitnir Bank last week.

On Tuesday morning, the government in Reykjavik announced it had secured far-reaching new powers to intervene in the business affairs of the country's largest banks to prevent a banking collapse from driving Iceland into bankruptcy. Icesave, Landsbanki's Internet banking service, suspended withdrawals leaving British customers without access to millions of pounds worth of savings. On Wednesday, London said it would guarantee British savings with Icesave.

British banks had seemed solid until this week. In the latter half of September, Barclays bought up the US operations of the collapsed US investment bank Lehman Brothers and Lloyds jumped in to help out struggling HBOS. But fears that the credit crisis could ultimately hammer British banking as well led to a vast sell off of UK bank shares on Tuesday, with the price of Royal Bank of Scotland stock plummeting by 39 percent. HBOS shares lost 41.5 percent and Lloyds fell 13 percent. Following Darling's pre-trading announcement, the share-price recovery has been rapid on Wednesday with HBOS up by over 50 percent in morning trading.

The deal to bail out the banks came with strings attached. London required British banks to commit to supporting small businesses and home buyers as well as to address inflated pay deals for bank executives.

In Iceland, the freefall continued on Wednesday despite the drastic government measures taken this week. Share prices in the country's biggest bank, Kaupthing, plunged by 34 percent on the Swedish stock market on Wednesday before trading was suspended and the bank put its Swedish operation up for sale. Stockholm announced it would provide 5 billion crowns ($702 million) of much-needed liquidity to Kaupthing's Swedish arm. Iceland is seeking an emergency loan of €4 billion from Russia.

Stock markets across the globe plunged once again on Wednesday with the Japanese Nikkei Index dropping 9 percent and closing at its lowest point in over five years. Germany's DAX slid under 5,000 points in morning trading for the first time in two years -- a drop of 6 percent -- before recovering slightly. The Paris stock exchange was forced to suspend trading briefly amid the avalanche of sell-offs and Russia shut down its MICEX index until Friday after it dropped 14 percent in the first 30 minutes of trading on Wednesday. Another Russian exchange, the RTS, was likewise shut down until further notice after it fell 11 percent in the first half hour on Wednesday as Russia continues to be battered by the credit crisis.

On Tuesday evening in Berlin, German Chancellor Angela Merkel addressed the German parliament, the Bundestag, once again saying that it was important that Europe coordinate its efforts to combat the credit crisis but repeating her government's rejection of an EU-wide bailout fund.

"From the German perspective, it is not acceptable that 27 member states … all pay into a fund to then manage the crisis in each individual country. I don't think that is conducive to developing a quick response," she said. "That is why we reject this strategy."

Merkel also criticized Ireland's go-it-alone move to guarantee 100 percent of savings in Irish banks last week. She slammed Dublin's decision to protect only Irish institutions, leaving foreign banks out in the cold and skewing competition. "In my opinion, that is not acceptable in the internal market," she said.

Merkel's opposition to a Europe-wide bailout fund led to the torpedoing of such an initiative last weekend at a meeting attended by French President Nicolas Sarkozy and Merkel, among other EU leaders. French Finance Minister Christine Lagarde had favored such a fund. According to the French weekly Le Canard enchaîné , Sarkozy, speaking of the failure to agree on a bailout fund, said "that might have been a mistake, but it wasn't mine. It was Merkel's."

cgh -- with wire reports