New York - For the first time since 9/11, the Federal Reserve has had to step into the financial system with emergency funds to calm roiled credit markets.
The move Thursday followed an injection of capital into Europe's banking system. On both sides of the Atlantic, the central bankers began to recognize a crisis in confidence in the market known as asset-backed securitization, which funds everything from housing to student loans and has outstanding debt of more than $4.2 trillion. The banks' moves are seen as a signal that they're willing to provide liquidity to any bank that needs it.
By acting as lenders of last resort, the world's two largest central banks are trying to keep a liquidity crunch in this sector from spreading to the rest of their economies. If the crunch were to become more widespread, interest rates would rise and banks would have to pay more to fund loans, slowing the economy. In Europe already, interest rates skyrocketed to the highest level in six years after a major French bank froze three funds that had invested in asset-backed securities.
"It's a very significant event to have the Fed inject liquidity into the system," says Mark Zandi, chief economist at Moody's Economy.com. "It indicates a very high level of stress in the financial system."
The Fed acted because investors had stopped buying asset-backed securities following the difficulties in the US mortgage market.
The securitization industry, which involves financial institutions around the globe, provides liquidity that helps fund loans for housing, automobiles, credit cards, and student loans – and anything else where an asset can be bundled into a package and resold to other investors.
The crisis in the industry began to mount after the collapse of many mortgage lenders in the subprime market. That market makes loans to low-income people or those with less than stellar credit ratings. The crisis escalated after the collapse of American Home Mortgage, which was not in the subprime market. By early this week, buyers of overnight debt, which banks use to fund lending activity in the securitization market, had backed away. This caused BNP Paribas, a major French bank, to freeze withdrawals from three of its funds Thursday because it could not value the fund's assets.
The problems at BNP Paribas, a major European bank, caused the European Central Bank to inject $130.2 billion into the financial markets, according to Bloomberg News.
Article 2: Mortgage concerns hit US Markets http://news.bbc.co.uk/2/hi/business/6938072.stm US shares have tumbled amid fears that problems in the mortgage market may prompt a global credit crunch.
The main Dow Jones index fell 387.18 points, or 2.8%, to 13,270.68. The S&P shed 3% and the Nasdaq lost 2.2%.
European indexes had slumped earlier after BNP Paribas froze three funds saying the market for some of the assets they contained had disappeared.
The European Central Bank and Japan have both pumped money into the banking market to boost liquidity.
The Japanese central bank injected 1 trillion yen (US$8.4bn, £4.2bn) into markets in an effort to stop further falls on Friday.
There also were reports that the US Federal Reserve was doing something similar to ensure that there was enough cash available for banks to use.
Analysts said that the markets would remain volatile in the near future.
"Markets are taking this latest news seriously with the risk appetite on the back foot," said David Corbell, analyst at IFR Markets...
American Home says it was the tenth biggest retail mortgage lender.
US lender American Home Mortgage has filed for bankruptcy, after laying off the majority of its staff last week. The demise of one of the country's largest independent home loan providers is the latest case of a business suffering from the US housing slump.
Despite these worries, Wall Street rallied on Monday with leading share indices closing up sharply.
The benchmark Dow Jones industrial average closed up 286.87 points, or 2.1%, at 13,468.78.
Market Volatility - The strong gains reflected continued volatility on the markets, the Dow Jones having fallen by a similar amount on Friday.
American Home Mortgage's woes are the latest to afflict the mortgage investment market.
Earlier this year the firm had over seven thousand employees, but by Friday only 750 staff remained.
Repeated interest rate rises have pushed up loan repayments, leading to a rise in defaults and hitting mortgage lenders hard.
While the sub-prime market - the sector that caters for the riskiest borrowers - has been the most obvious to suffer from defaults, it is not alone.
American Home Mortgage offered loans that were categorised between prime and sub-prime.
It also provided the less common mortgage with adjustable interest rates. Most US mortgages have fixed rates.
As the firm files Chapter 11 proceedings - the US process to seek bankruptcy protection - Deutsche Bank, Wilmington Trust and JP Morgan Chase are American Home Mortgage's three largest creditors.
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