World on edge as US slumps towards bank aid

The United States vowed to prop up ailing banks if needed, with the government set to take a bigger stake in Citigroup and inject yet more cash into insurer AIG, even as a Federal Reserve official urged that such interventions should be short term.

In Japan, Finance Minister Kaoru Yosano said the government would consider a call to buy shares directly to support the stock market, which fell to near 27-year lows on Tuesday, dragged down by banks as worries grew over international financial stability.

Shares fell steeply across Asia, mirroring a big drop in US equities to start the week, with the Dow Jones industrial average touching an 11-year low on fears that Washington’s bank stabilisation plan would not be enough to keep the economy from sliding into a deeper hole.

US government bond prices rose slightly and the dollar gained against a basket of currencies as investors tried to find safer ground, while gloom about economic prospects weighed on oil prices.

Amid worries that the United States may still have to nationalise some banks, the government said it will start examining large firms’ capital needs on Wednesday to determine whether a bigger buffer is warranted.

Richard Fisher, president of the Federal Reserve Bank of Dallas, cautioned that interventions should be short term and backed by an exit strategy that can be ”realisable very quickly”.

But he also highlighted the severity of problems, saying the Fed would do everything it could to combat the financial crisis and that buying long-term Treasury bonds could be helpful.

”Few of us imagined in our wildest dreams that our global economy could have turned so rotten so quickly,” Fisher said. ”We are duty-bound to apply every tool we can to clean up the mess that has soiled the face of our financial system and get back on the track of sustainable economic growth with price stability.”

In Europe, the French government on Monday said it was pumping extra cash into two mutually owned banks, and central European central banks took the unprecedented step of talking up the region’s currencies.

But Tuesday was shaping up to be an anxious day in stock markets, as negative sentiment spread from the US to Asia and threatened Europe next.

Asian shares resumed a drop towards five-year lows, with an MSCI index of Asia-Pacific stocks outside Japan down 2,3%. Japan’s Nikkei average fell 2,6%, and indexes in South Korea and Hong Kong dropped more than 3,5%.

Among Asian financial shares, Nomura Holdings, Japan’s biggest broker, lost 8,6% a day after announcing plans to raise $3,3-billion.

More broadly, Japan was contemplating direct measures to staunch the damage, including considering a call from the head of a business group for the government to buy shares, Yosano said.

But, with the world firmly in the grip of the credit crunch, another cabinet minister warned Japanese efforts to boost its stock market faced severe headwinds.

”It is necessary that the US stock market recovers as soon as possible,” Chief Cabinet Secretary Takeo Kawamura said.

Government, government, everywhere
Citigroup, whose stock has been pounded by fears the government may seize the bank and wipe out shareholders’ investments, was in talks to give the government a larger stake, a person familiar with the matter told Reuters.

The idea under consideration would involve converting a big chunk of the $45-billion in preferred shares the government bought last year into common stock, putting as much as 40% of Citigroup into public hands.

The British government announced a similar move last month, saying it would convert preferred shares in Royal Bank of Scotland, which is expected to announce more restructuring this week.

France has also reached out to lenders, pledging up to €5-billion ($6,3-billion) in additional aid for Banque Populaire and Groupe Caisse d’Epargne.

The two mutual banks are expected to detail a merger this week and the new aid could give the government a stake of up to 20% in what is set to be France’s second-biggest retail bank behind Credit Agricole.

American International Group, once the world’s largest insurer, may be coming back for its third round of US government aid as losses and writedowns mount, according to a source and a CNBC report.

European Central Bank president Jean-Claude Trichet said on Monday the financial crisis was spilling over into the wider economy and that the euro zone’s financial system is under ”severe strain”.

Latvia’s government collapsed on Friday and the currencies of countries such as Poland, the Czech Republic and Hungary have come under severe pressure, hitting millions of citizens who have borrowed in foreign currencies such as the euro.

Emerging European Union central banks coordinated to prop up their currencies on Monday, with Czech central bank Governor Zdenek Tuma saying they had agreed that recent falls were overplayed. – Reuters

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