IMF warns of financial meltdown as crisis rages

Sat Oct 11, 2008 12:26pm EDT
By Lesley Wroughton and Emily Kaiser

WASHINGTON (Reuters) - The International Monetary Fund warned on Saturday that debt-ridden banks were pushing the global financial system to the brink of meltdown and rich nations had so far failed to restore confidence.

The United States appealed for patience as world leaders raced to stabilize financial markets and avert the deepest global recession in decades, but the IMF said more steps would be needed in the coming months.

"Intensifying solvency concerns about a number of the largest U.S.-based and European financial institutions have pushed the global financial system to the brink of systemic meltdown," IMF chief Dominique Strauss-Kahn said.

President George W. Bush huddled with Group of Seven economic chiefs and officials from the IMF and World Bank, and said top industrial nations grasped the gravity of the crisis and would work together to solve it.

"I'm confident that the world's major economies can overcome the challenges we face," Bush said, adding that Washington was working as fast as possible to implement a $700 billion financial bailout package approved a week ago.

"The benefits will not be realized overnight, but as these actions take effect, they will help restore stability to our markets and confidence to our financial institutions."

Confidence has been in short supply and panic has swept through global markets, driving stocks to a five-year low on Friday and prompting banks to hoard cash. That has choked off lending to businesses and households, threatening to turn a global economic slowdown into a dangerously deep recession.

U.S. Treasury Secretary Henry Paulson said risks to the global economy were "the most serious and challenging in recent memory."

NEXT STEPS

The world's rich nations vowed on Friday to take all necessary steps to unfreeze credit markets and ensure banks can raise money but they offered no specifics on a collective course of action to avert the recession threat.

In a surprisingly brief statement after a 3-1/2 hour meeting, the G7 stopped short of backing a British plan to guarantee lending between banks, something many on Wall Street saw as vital to end growing market panic.

Kenneth Rogoff, a Harvard University professor and former IMF chief economist, said the G7 would have been better served adopting some version of the British plan so that banks would feel confident enough to loosen their grip on lending.

"Saying that they'll take all steps necessary leaves hanging the question of whether they know what is best and necessary," he told Reuters. "It was a signature moment for the G7. I think markets are going to be very disappointed."

European Central Bank President Jean-Claude Trichet said markets needed time to digest a series of dramatic steps taken by world central banks in recent days, including pouring billions of dollars into financial markets and lowering interest rates in the broadest coordinated cut on record.

An emergency meeting of euro zone leaders on Sunday will discuss a bank rescue package taking Britain's initiative as a reference point, a source close to the French presidency said, even though as a non-euro member Britain would not attend.

French President Nicolas Sarkozy said euro zone countries were working on a joint solution, and he planned to meet with British Prime Minister Gordon Brown shortly before Sunday's euro zone gathering.

Britain's rescue plan, launched last week, makes available 50 billion pounds ($86 billion) of taxpayers' money for injection into its banks and, crucially, to underwrite interbank lending which has all but frozen around the globe.

Germany was also considering injecting capital into its banks, Chancellor Angela Merkel said on Saturday.

WORKING AROUND THE CLOCK

The U.S. government was scrambling to put together a plan to buy direct stakes in American banks to shore up balance sheets riddled with heavy credit losses from the 14-month crisis that began with failing U.S. mortgage loans.

U.S. Treasury's Paulson said it was "naive" to think that the G7 would endorse a one-size-fits-all approach to ending the credit crisis because there were major differences between the countries and their financial systems.

But even as Paulson and his fellow finance ministers insisted that they were working as fast as possible, there were signs the economy was credit-starved and deteriorating fast.

The U.S. auto sector has been particularly hard-hit. General Motors has had talks with smaller rival Chrysler LLC about a merger that would combine the No. 1 and No. 3 American automakers at a time when both are struggling to cut costs and shore up cash, according to a source briefed on the matter.

Financial weekly Barron's reported that GM was preparing to approach the U.S. Federal Reserve about borrowing money directly from the central bank because the logjam in credit markets had shut it out of other kinds of borrowing.

Paulson said the U.S. government would buy shares of financial institutions if necessary to halt market turmoil that has wiped out trillions of dollars of wealth.

"We're going to do it as we can do it in a proper way that will be effective. Trust me, we're not wasting time, we're working around the clock," Paulson said late on Friday after the G7 meeting broke up.

(Reporting by G7 team; Writing by Emily Kaiser; Editing by Tim Ahmann)