Leading financiers yesterday called for drastic policy action to prevent a wave of market carnage this week from cascading into a fresh global financial crisis.
World markets were hurled into tailspin Thursday as traders and investors rushed to dump stocks amid a radical reassessment of risk.
Mohamed El-Erian, co-CEO of bond fund Pimco, told Emerging Markets in an interview that global financial markets had reached a tipping point as “a sense of concern and fear” had set in over increasingly dismal economic prospects for the developed world.
He said panic had spread quickly because “Europe – and to some extent the US – are now dealing with three distinct crises: a growth and unemployment crisis, a sovereign debt crisis and a banking crisis.”
“When you have these three things going together it becomes a significant policy challenge.”
The market rout was triggered by an exceptionally bleak assessment of US economic prospects by Federal Reserve chairman Ben Bernanke, who warned on Wednesday of “significant downside risks to the economic outlook.”
The Fed this week embarked on a $400 billion securities programme aimed at boosting risk appetite, but El-Erian said: “There’s a realization that the Fed is running out of effective instruments.”
Add to that “concern about the European banking system, and the result was a selloff that started here, that accelerated in Asian time, then accelerated again in the US...[with] everyone looking to the policymakers asking ‘where is the circuit breaker?’”
El-Erian said the solution to the crisis lay in the hands of the ECB, US and European politicians, and the IMF. “You need these three circuit breakers to be coordinated and to speak coherently and hopefully that is what will happen during the next few days in Washington.”
In an earlier interview with Emerging Markets, billionaire investor George Soros had warned that a failure to contain Europe’s crisis would precipitate “a banking crisis in which the global economy would be pushed into a serious depression.”
Speaking at an event in Washington, former Fed chairman Alan Greenspan said yesterday that markets were “fearful something will break and clearly Greece is weeks away from default unless there is a new tranche.”
IMF managing director Christine Lagarde said there was still time to avoid a fresh global crisis but “the path is narrower” than in 2008.
Policymakers were quick to pledge bold action. European economic affairs commissioner Olli Rehn said the EU would stop at nothing to keep the eurozone intact.
“An uncontrolled default or exit of Greece from the eurozone would cause enormous social damage, not only to Greece, but to the European Union as a whole and would have serious spillovers for the whole world economy,” Rehn said yesterday in a speech at the Peterson Institute. “We will not let this happen.”
Rehn also insisted progress was being made on major structural reforms and he expressed confidence that proposed changes to enlarge the scope of the EFSF currently being voted on by all 17 eurozone parliaments, would be approved and in place “by the second half of October”.
“We have to ensure that we have sufficient magnitude and flexibility for the European Financial Stability Facility (EFSF) to operate effectively,” he said, stressing in particular the importance of the ability to intervene in secondary markets.
But El-Erian said: “Europe needs a moment of truth. It needs to make a political decision and it needs to implement it.
“No one can make that decision on behalf of the politicians. The only thing the politicians should realize is that the longer they wait, the more that decision is going to be taken out of their hands.”
He added: “In the US it’s a political problem so I worry less about the US. Europe requires both a political decision and an engineering solution. I worry more about Europe.”
The S&P 500 yesterday fell 3.2%, the FTSE 100 and the Eurofirst 300 fell 4.7%, and the Nikkei 225 fell 2.1%.