As Market Tension Builds, World Leaders Ponder Response

As the shock of Friday’s downgrade of United States debt reverberated dangerously with anxiety about European liabilities, central bankers and national leaders were under pressure to try to do something to restore confidence before Asian markets opened, and to prevent an extension of the rout that began last week.

As Group of 20 leaders conferred by phone, the governing council of the European Central Bank was holding an emergency conference call late Sunday. The central bank was likely to discuss whether to buy Spanish and Italian bonds to prevent borrowing costs for those countries from becoming unsustainable. But with signs of slowing growth in the United States and Europe, and government budgets and central bank balance sheets stretched to the limit, the policy options were dwindling.

Some analysts said that the European Central Bank would itself need help from other central banks and nations because of the scale of the problem.

“They just can’t allow the Italian economy to go down the tubes. It would be a Lehman-type situation,” Uri Dadush, a senior associate at the Carnegie Endowment for International Peace, said on Sunday. He was referring to the collapse of the investment bank Lehman Brothers in 2008, which touched off the global financial crisis.

Mr. Dadush put the cost of a bailout of Italy at $1.4 trillion, with Spain requiring another $700 billion. Those amounts would be a challenge for even the most solvent European countries, foremost among them Germany.

Finance ministers of the Group of 7 and Group of 20 nations were conferring on Sunday, Reuters reported, but it was not clear whether there was enough support for a substantial coordinated intervention in the markets — or even whether that would be a good idea.

“I don’t know if there is a policy response that makes sense, except support the banks,” Carl B. Weinberg, chief economist of High Frequency Economics in Valhalla, N.Y., said on Sunday. He said the European Central Bank, which has already expanded its cheap loans to banks, should make even greater sums available so that institutions could survive a decline in the value of their holdings of Spanish and Italian debt.

In a sign of the acute tension after Standard Poor’s lowered the rating for long-term United States debt to AA+ from AAA, stock markets in the Middle East fell in Sunday trading, and the Tel Aviv exchange delayed opening for the first time since the collapse of Lehman Brothers in 2008.

Market circuit breakers kicked in after opening prices were down more than 5 percent. The Israeli benchmark stock index closed down 7 percent.

The European Central Bank on Thursday intervened in European bond markets for the first time since March. But it appeared that the bank was buying only relatively small amounts of Portuguese and Irish bonds. The central bank may have intended a warning shot to signal its resolve, but markets seemed to have interpreted the modest intervention as a sign of weakness.

The move also reopened divisions on the bank’s governing council, with Jens Weidmann, president of the German Bundesbank, and several other members opposing the bond purchases.

“This type of bond market intervention is unlikely to achieve much,” Antonio Garcia Pascual, an analyst at Barclays Capital, said in a note. Even if the central bank starts buying Italian and Spanish bonds, “this begs the question of how far the E.C.B. is ready to go down that route — a proposition that markets may be testing in the weeks ahead.”

Mr. Weinberg said that even the European Central Bank would be hard-pressed to buy enough bonds to hold down yields on Spanish and Italian debt in the long term and to prevent the countries’ borrowing costs from reaching levels that would eventually prove ruinous.

Judy Dempsey contributed reporting from Berlin, and Liz Alderman from Paris.

Article source: http://www.nytimes.com/2011/08/08/business/global/as-market-tension-builds-world-leaders-ponder-response.html?partner=rss&emc=rss