G-7, With `Backs Against the Wall,' Weighs Loan Guarantee Plan

By Simon Kennedy

Oct. 10 (Bloomberg) -- Finance ministers and central bankers from the Group of Seven nations meet today facing a breakdown in investor confidence in their ability to end the credit freeze endangering the global economy.

Threatened by the worst economic outlook in a quarter century, officials arrived in Washington still without the broad- based strategy that investors were seeking, raising the risk of further turmoil if their remedies disappoint. Among the options being considered: a proposal by U.K. Chancellor Alistair Darling for nations to guarantee lending between banks, a suggestion that U.S. Treasury Secretary Henry Paulson hasn't ruled out.

Unprecedented interest-rate cuts and bank bailouts failed to quell panic in markets, leaving policy makers under pressure to pull even more policy levers. The Dow Jones Industrial Average yesterday plunged below 9,000 for the first time since 2003 and credit markets remained frozen.

``Global policy makers have their backs against the wall -- they have nowhere to run, nowhere to hide,'' said Marco Annunziata, chief economist at Unicredit MIB in London. ``Do not underestimate how hard they are going to fight back now.''

The officials from the U.S., Japan, Germany, U.K., France, Canada and Italy are gathering for the first time since the financial crisis intensified last month and spread more virulently beyond U.S. borders.

Emergency Meeting

The International Monetary Fund, which activated an emergency financing mechanism to aid countries that run into trouble, and the Financial Stability Forum held emergency talks yesterday with officials from 27 nations to discuss responses to the turbulence. Paulson helped lead the meeting.

G-7 officials are scheduled to release a joint statement at about 6 p.m. in Washington.

``This is an opportunity to make sure that they're all on the same track,'' said former Federal Reserve Chairman Paul Volcker. He urged that ``all of them now admit or all of them own up to the fact their own banks are going to need support,'' in an interview with PBS Television's Charlie Rose show.

Reflecting the seriousness of the crisis, President George W. Bush will meet with the G-7 in an echo of predecessor Bill Clinton's gathering with the group during a 1998 financial crisis. Officials from the broader Group of 20 will convene for a special meeting tomorrow.

Borrowing Costs

The G-7's dilemma is that even after a battery of policy actions, money markets remain gridlocked as banks shun lending to each other for fear they will lose the money or because they need it for their own funding needs. The cost of borrowing dollars for three months yesterday surged to the highest this year.

``Mistrust is set to persist,'' said Nick Stamenkovic, a fixed-income strategist in Edinburgh at RIA Capital Markets. ``While measures are moving in the right direction, reaction has been lukewarm at best.''

Policy makers are lining up more initiatives, yet run the risk that their new proposals appear piecemeal or lacking in ambition rather than providing the comprehensive and coordinated solution that investors want. Even as he sought an international approach in a news conference two days ago, Paulson said it might ``not make sense to have identical policies'' because each nation's circumstances differ.

``Governments must act now and decisively to restore confidence otherwise we are in for serious trouble and a long-run recession,'' said Moorad Choudhry, head of treasury at Europe Arab Bank Plc in London.

U.K. Plan

Darling wants countries to guarantee lending between banks, either by turning central banks into clearing houses for the loans or having governments back them. That would ``be an effective way of easing the crisis,'' said Marc Chandler, head of currency strategy at Brown Brothers Harriman & Co. in New York.

U.S. officials have played down the idea without dismissing it outright, expressing concern that the step would be biased against financial institutions outside the banking sector. France also questions the need to adopt Darling's plan, according to a French official.

Paulson already plans to follow Darling in another way by purchasing stakes in a wide range of banks within weeks, tapping authority included in the $700 billion rescue package passed by Congress last week.

Paulson and advisers were yesterday considering options on how the purchases would work, including having the government acquire preferred stock, two officials informed of the matter said.

The U.S. was also weighing a proposal to insure all U.S. bank deposits, the Wall Street Journal reported today. The plan was only at discussion stage and would be aimed at preventing an exodus of cash from financial institutions, the newspaper said. To remove the ceiling on deposit insurance government agencies would need to agree there was systemic risk to the economy, thereby invoking the legal power for action, the Journal reported.

Capital Injection

While the Treasury still aims to buy troubled mortgage- backed securities from financial institutions, a direct capital injection would offer more immediate relief by giving banks quick access to funds they could then lend out.

The U.K. is already engineering a 50 billion pound ($87 billion) strategy to partly nationalize at least eight British banks. Japanese lawmakers are also considering reviving a law that expired in March that would allow them to inject public money into regional financial companies.

``The financial system doesn't need more liquidity it needs more capital,'' said Jim Bianco, president of Bianco Research LLC in Chicago.

Other G-7 nations are wary of taking either step, with German Finance Minister Peer Steinbrueck arguing Germany's banks are sound. He has proposed the G-7 focus on overhauling regulations on executive pay, liquidity buffers at banks and complex financial instruments.

In a report published yesterday, University of California Berkeley economist Barry Eichengreen warned against a disjointed approach. ``The policy response needs to be decisive,'' he said. ``It needs to be global. The stakes could not be higher.''

To contact the reporters on this story: Simon Kennedy in Washington at skennedy4@bloomberg.net;