Fed Pumps Cash Into System as World Financial Markets Fall

By Renae Merle, Howard Schneider and Mary Jordan

Washington Post Staff Writers

Monday, September 29, 2008; 11:22 AM

Stocks took a steep dive around the world today as troubles in the European financial sector offset news that lawmakers had reached a hard-fought consensus on the $700 billion bailout legislation. The Federal Reserve responded by injecting hundreds of billions of dollars into the U.S. and world financial markets.

The Dow Jones industrial average was down nearly 300 points, or almost 3 percent, at one point, while the Nasdaq was off more than 4 percent and the broader Standard & Poor's 500-stock index had declined more than 3.3 percent. In Europe, markets were off anywhere from 3 to 4.5 percent.

By 10:30 a.m., the Dow was down 260 points.

With world credit markets still sluggish and threatening to drag down the broader economy, the Federal Reserve more than doubled, to $620 billion, the dollars available to nine other central banks -- in Europe, Australia, Canada and Japan -- to make short-term loans to banks and other financial institutions. It also tripled, to $225 billion, the amount available for short-term loans to U.S. financial firms.

The sudden lack of access to short-term credit has raised the risk that what began as a problem in the U.S. mortgage industry will crimp economic activity on a broad scale, with companies unable to borrow the money they need to operate and households unable to fund home, auto and other major purchases.

Noting that short-term interest rates have spiked and remain high, the Fed said it was pumping money into the system "to support financial stability and to maintain a stable flow of credit to the economy during this period of significant strain in global markets."

The new Fed action followed a weekend in which U.S. lawmakers agreed on a financial system bailout plan, while a collection of European governments scrambled to bolster three troubled mortgage companies.

After initial concern that lawmakers would not reach consensus on the bill, investors have become concerned that it will not be enough to address the economy's more fundamental problems and would not stop the crisis from spreading further overseas, analysts said. "People are starting to realize that there is danger in Europe, too," said Doug Roberts, chief investment strategist for New Jersey-based Channel Capital Research.

This weekend, U.K. financial authorities took over mortgage giant Bradford & Bingley, and European governments in Belgium, Luxembourg and the Netherlands pumped $11.2 billion into Fortis, a major Belgian financial services conglomerate.

Asian and European markets were down across the board, with indexes in London, Paris, and Germany all experiencing losses close to or in excess of 3 percent.

The House is scheduled to vote today on the bailout. It would allow the government to purchase the bad debt, including risky mortgages, held by financial firms. But even as Congress finalizes the legislation, consumer spending has stagnated and yet another bank has been pushed into the arms of a competitor.

Also today, Citigroup confirmed it is acquiring the banking operations of Wachovia, which holds billions in risky mortgage debts. The deal was facilitated by the Federal Deposit Insurance Corp. and calls for Citigroup to absorb up to $42 billion of losses and the FDIC to cover any remaining losses. The deal also calls on Citigroup to grant the FDIC $12 billion in preferred stock and warrants.

Wachovia is just the latest financial institution set to disappear in this restructuring of Wall Street, following the bankruptcy of Lehman Brothers and purchases of Washington Mutual and Merrill Lynch in recent weeks.

"The morgue of financial institutions continue to get fuller," said Art Hogan, chief market analyst at Jefferies & Co. "The longer we wait for that rescue package, the fuller it gets. The market is pricing in the realization that there are more problems that are not going to be fixed by this rescue plan."

In economic news, consumer spending was flat in August, compared with an increase of 1 percent in July, according to Commerce Department figures released today. It reflects the dwindling impact of the economic stimulus package as consumers pull back in spending.

"The upshot is that consumer spending in the third quarter now has significantly less momentum than previously thought" and could get worse, Brian Bethune, chief U.S. financial economist for Global Insight, said in a research report. "The domestic economy has been battling recessionary forces for many months now, and the recent escalation of pressures in the financial markets to epic proportions is an additional shock that will play out to drive the economy underwater in the second half of 2008."

In London, British financial authorities took over one of the country's major mortgage lenders, Bradford & Bingley, and began selling it off in pieces. It was the second bank nationalization in the U.K. this year after a depositor run undermined Northern Rock.

Bradford & Bingley was a major lender to landlords, but was hobbled by its inability to find the loans it needed to keep operating.

Over the weekend, European governments in Belgium, Luxembourg and the Netherlands pumped $11.2 billion into Fortis, a major Belgian financial services conglomerate. The governments became 49 percent owners of several Fortis units, while other parts of the company were put up for sale.

Germany's Hypo Real Estate Group, meanwhile, announced that "a consortium from the German financial sector" had provided it with a loan needed to weather "extremely challenging conditions." Details and the amount have not yet been announced, but reports from Bloomberg news and the Wall Street Journal said the German government had guaranteed a credit line for the company, a major mortgage lender.

The British government's announcement early Monday that it was nationalizing Bradford & Bingley said the move was needed "to maintain financial stability and protect depositors."

The government will take control of 50 billion pounds ($90 billion) in mortgages and loans while Spanish bank Santander has agreed to buy the lender's 21-billion pound ( $37.8 billion) retail savings and branch network.

Top U.K. officials negotiated through the weekend to resolve the situation at Bradford & Bingley before European markets opened Monday morning. But even with news of the public-private deal hammered out, the London stock market dropped substantially in early morning trading.

"Following recent turbulence in global financial markets, Bradford & Bingley has found itself under increasing pressure as investors and lenders lost confidence in its ability to carry on as an independent institution," a statement from the British Treasury department said.

Shares in Bradford & Bingley dropped by as much as 90 percent in recent weeks and government authorities, concerned that many investors had been withdrawing their money, moved to try to prevent a literal run on the bank with depositors lining up outside to withdraw their cash. In February, the government took over Northern Rock, after frantic depositors formed long lines to make sure they didn't lose their savings.

Alistair Darling, the chancellor of the exchequer, said in a series of radio and television interviews Monday morning that, "My priority was to protect savers and depositors but also to ensure we got a good deal for the taxpayer."

Darling also said the Bradford & Bingley bailout differed from the American rescue scheme now going through Congress.

"That is simply taking the bad debts off the banks into the hands of the American taxpayer," Darling said. "We are doing something similar but different -- we will put money into the system but the risk stays with the banks. So our system actually is putting pro rata more money into the system -- the difference is that banks retain the risk."

Darling also said, "What it comes down to is 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."

Speaking outside the bank's headquarters in Yorkshire, Robert Harrison, president of the Bingley Chamber of Trade and Commerce, said he was fearful for jobs.

"I'm really saddened by the fate of Bradford & Bingley. I think it was a very sad occasion that such an apparently well-run organization is brought to its knees it seems by no fault of their own."

Harrison said he was worried about jobs being lost as Santander takes over its branches.

"I feel the knock-on effects will be felt throughout the town here," he said.

The Treasury department said that Bradford & Bingley's branches, call centers and Internet operations will be open for business as usual.

Jordan reported from London.