The US Federal Reserve and European Central Bank have set aside more than $100bn (€110bn) for the second day in succession to protect the financial system against a potential credit meltdown, in an implicit confirmation of the worst fears harbored by investors.
The Federal Reserve today added $35bn to the banking system which includes two three-day repurchase agreements of $16bn and $19bn of mortgage securities.
It said it was "providing liquidity to facilitate the orderly functioning of financial markets", after it yesterday injected an additional $24bn in temporary funds into the country's money supply.
It added: "The Federal Reserve will provide reserves as necessary through open market operations to promote trading in the federal funds market at rates close to the Federal Open Market Committee's target rate of 5.25%. In current circumstances, depository institutions may experience unusual funding needs because of dislocations in money and credit markets."
Shares in European blue-chip companies fell further today on investor concerns even after the ECB, based in Germany, lent €61.1bn ($84bn) to banks until Monday, keeping the majority of its record one-day basis $130bn loan yesterday as it again attempted to shore up liquidity in the markets.
The ECB's move yesterday followed the a spike in the London interbank offered rate, the percentage of interest banks charge each other when lending. It jumped to 5.86%, up from the previous day's close of 5.35% indicating banks' fears over possible debt defaults are intensifying.
Yesterday's ECB loan, which matured today, was the biggest loan in its history. The size of the loan is one third more than it had during any point in history including September 12 2001, a day after the attacks. The bank is offering the money at its benchmark 4% rate.
All of the major European indices were down between 1% and 3% in mid-morning trading today, with London's benchmark FTSE 100 index down 1.8% at 6158.3.
Tim Scholefield, head of equity at Baring Asset Management, said: "Investors will remain cautious until a fuller picture of the financial impact of the deterioration in the US mortgage market becomes clear over the next few weeks. Thursday's prompt action by the ECB to fine-tune money markets was successful in ensuring that credit markets functioned smoothly despite the increasing caution in the market."
Scholefield added volatility will remain high, although he said that will offer selective investment opportunities.
Jean-Michel Six, chief European economist at rating agency Standard & Poor's, played down the market swings, telling Bloomberg: "We are seeing something we had been expecting for some time. We are seeing a correction, it is a dramatic correction, but it is one that, in many ways, is helping, in the sense that we are seeing a repricing of risk.
"Central banks have been trying to be aggressive in providing liquidity to show that the flight to quality was justified but had to reach some limit, and that markets had to start operating normally again."
Earlier this week, the Fed kept interest rates steady despite pleas by some market participants to cut rates.
CIBC World Markets analyst Meredith Whitney said Bear Stearns appeared to be one of those calling for a reduction in the cost of debt, after executives at the bank last week called the credit environment the worst they had seen in 22 years, during a conference call with investors in the firm's two imploded hedge funds.
Yesterday, rumors swirled in the markets about Goldman Sachs' Global Alpha Fund, sending the firm’s shares dipping by 5%. A $1.8bn market neutral fund run by Highbridge Capital Management also fell in value.
In Europe, French investment bank BNP Paribas suspended the operations of three of its funds.
Citi brokerage analyst Prashant Bhatia estimated this week that there are $330bn of financing deals in the pipeline, and that the total funding exposure for the five major brokerages is around $75bn. That estimate includes $20bn of exposure for Goldman Sachs, $19bn for Morgan Stanley, $16bn for Lehman, $12bn for Merrill, and $9bn at Bear Stearns.
