Authorities scramble to avoid meltdown

Billions are pumped into the global banking system and shockwaves from the Wall Street crisis reverberate around the world.

The meltdown on Wall Street continued to reverberate around the globe yesterday, with financial authorities pumping billions of dollars into markets to keep the financial system working as one of the world's largest insurers struggled to survive. Shares in American International Group (AIG), the latest financial titan to be staggered by the subprime mortgage crisis, plunged in New York after ratings agencies warned of a greater likelihood that the insurer would default on its debt. The investment bank Goldman Sachs reported its biggest drop in profit since it went public in 1999. The US Federal Reserve, meanwhile, said it would leave its key interest rate unchanged at 2 percent. There had been speculation that the Fed would cut the rate. US stock markets fell after the decision was announced. "The problem is just the tremendous amount of perceived risk in the marketplace," said David Wyss, chief economist at ratings agency Standard & Poor's in New York. "What we've seen is a big increase in the amount of worry about the health of major financial institutions since the bankruptcy of Lehman Brothers." The wave of credit tightening is coursing through the world financial network, affecting even banks in the Gulf. Lehman's failure on Monday and the sudden sale of Merrill Lynch to the Bank of America touched off the biggest decline on Wall Street since the September 11 terrorist attacks. Only two of Wall Street's independent investment banks remain standing on their own: Morgan Stanley and Goldman Sachs. Worse, Lehman's and Merrill Lynch's failure has exacerbated a vicious cycle of sinking asset prices and deepening losses that have plagued the industry since the subprime mortgage crisis erupted last August. The more banks and other institutions sell assets to stanch the flow of red ink, the faster the value of their assets decline. The latest evidence came yesterday from Goldman, which added to the gloom enveloping Wall Street by announcing that its fiscal third-quarter profit fell 71 per cent, to $810 million (Dh2,975bn). "This is by far the worst financial crisis since the Great Depression, not as severe as the Great Depression but second only to it," Nouriel Roubini, a New York University economics professor, wrote on his blog yesterday. Predicting that the crisis would cost global financial institutions at least $2 trillion, he wrote: "The financial and banking crisis will be severe and last several years leading to a severe and persistent liquidity and credit crunch". In an attempt to prevent that, the Fed pumped $50 billion into the US financial system yesterday, adding to the $70 billion injection on Monday. Worldwide, central banks put more than $200 billion into the wheezing global system. The Bank of Japan threw in 2.5 trillion yen in cash, followed by the European Central Bank with ?70bn and the Bank of England with £20bn. While similar actions helped restore confidence last August and again in March, the concern in markets this time is whether such short-term liquidity would enable the world's financial institutions to stay afloat while they continue to suffer huge losses from mortgage lending and mortgage-backed derivatives. On Monday, Standard & Poor's and other major credit ratings agencies downgraded their ratings on AIG, in response to indications that it might succumb to the same forces that brought down Lehman. After falling more than 60 per cent Monday, AIG's shares dropped 40 per cent more yesterday on concerns that the ratings downgrades would force AIG to pay out billions of dollars in collateral to creditors and other trading partners. If AIG fails, bankers said it could be even more devastating to the broader financial industry than Lehman's failure. Lehman was a key player in equity and debt markets and a critical part of the global trade in derivatives. But AIG insures an estimated $441 billion in assets around the world. New York's governor, David Paterson, said in a television interview that the insurer probably only had a day left to procure the money it needs to avoid collapse. "This is a catastrophic problem waiting if we're unable to contain it," he said. Compounding concerns about the impact of Lehman's sudden disappearance from global markets were worries that many banks stood to lose even more money on contracts they had with the failed firm. Stocks in Tokyo, where the market was closed for a holiday during Monday's global rout, plunged yesterday after reports that some of the nation's biggest banks, including Mitsubishi UFJ Financial Group and Aozora Bank, had exposure to Lehman. The declines by Japanese financial stocks was the steepest since 1987's "Black Monday." Stocks in the Gulf reflected shrinking confidence among investors. Dubai's benchmark index fell 2.2 per cent, led by the UAE's biggest bank, Emirates NBD PJSC. Saudi Arabia's Tadawul index slipped by 0.5 per cent. There were bright spots, however: Abu Dhabi's stock index rebounded by 0.4 per cent while Kuwaiti stocks jumped 1.7 per cent on news that the government planned to start buying shares to prop up prices. Oil prices dropped by more than 5 per cent, to under $93 a barrel. Gold, which had rallied as investors sought a safe haven, retreated by 1 per cent, to $778.75 an ounce. [e-mail]