ECB injects cash as EU struggles with US stock crisis

The European Central Bank has injected billions of euro into financial markets in order to prevent a liquidity shortage, following a major downturn of Wall Street stocks caused in part by a crisis in the US sub-prime mortgage sector. It remains unclear whether the bank will raise interest rates in September as originally planned.

• Selling frenzy

Throughout the summer, the US housing market began to cool and many sub-prime lenders were no longer able to pay the increasing payments on their loans. As house values declined rather than increased, mortgage refinancing became impossible, and many lenders were forced to foreclose on their homes, according to press reports.

Wall Street investors from around the world became increasingly concerned and began selling off the packaged securities that contained sub-prime mortgages in large numbers. 

• The money belt tightens

The mass sell-offs led to a lack of liquidity – cash – in the market as investors shied from financing risky investments and preferred to pour funds into more traditionally secure holdings such as US treasury bonds and eurozone backed government bonds.

As a result, many companies faced a lack of short-term financing as funds in the so-called commercial paper market began to freeze up.

• The Fed and ECB step in

In an apparent acknowledgement of the severity of the liquidity crisis and to calm investor fears, the US Federal Reserve Bank (Fed) cut interest rates and injected more than $40 billion into the financial markets.

The European Central Bank (ECB) surprised investors on 09 August when it offered an unlimited amount of funds to the banking system, according to the Wall Street Journal. The ECB has so far poured some €200bn – more than after the terrorist attacks of 11 September 2001 – into financial markets in order to stave off a wider crisis. 

On 6 September, the ECB Governing Council will meet to decide whether or not to raise the eurozone benchmark interest rate from the current 4% to 4.25%. A rate increase was anticipated before the crisis, but according to press reports there is now wide speculation that the bank will be forced to maintain the current rate in order to prevent a slow-down of the economy.

• Rating agencies: culprits or scapegoats?

In July, EU Internal Market Commissioner Charlie McCreevy met with senior executives from Standard & Poor’s and criticised the role of this and other rating agencies in encouraging investment in questionable securities. McCreevy has called for a meeting of European securities regulators in September.

Press reports indicate that many investors are also pointing their fingers at rating agencies for classifying poor investments as “A” grade securities, a classificiation usually reserved for only the best investments. 

But other observers point out that the “blame” for the crisis must be spread to include hedge fund managers, large mortgage companies and banks, and officials in the US government who adopted an excessively hands-off approach to the managment of US financial markets.

The Commission is not expected to consider any new legislation to prevent future market instability until after an April 2008 review of the International Organisation of Securities Commissions’ code of conduct.

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