Markets are jolted by Lehman aftershock

Sep 17 2008 Bill Gleeson

LONDON’S leading shares plunged to a three-year low yesterday as the world’s stock- markets endured a second day of turmoil in the aftermath of the Lehman Brothers collapse.

The FTSE 100 Index fell 3.4% on top of a near 4% fall on Monday as investors continued to head for the exit.

Meanwhile, the Bank of England pumped £20bn into frozen money markets – following the £5bn injected the day before.

And late last night it emerged that Barclays has agreed to buy at least some of the investment banking and trading operations of Lehman Brothers.

A source close to the talks confirmed media reports that Barclays president Robert Diamond had addressed Lehman investment bankers to inform them of his company’s intentions.

The Bank of England’s move was echoed by the European Central Bank and the US Treasury, amid hopes the US Federal Reserve could ease the pressure on banks with an interest rate cut. However, the Fed last night said it was keeping key interest rates unchanged at 2%.

In a statement, the Fed added that strains in financial markets have “increased significantly”.

The US central bank said it was holding its target for the federal funds rate, the interest that banks charge on overnight loans.

US stocks fell after the Fed's decision, although many on Wall Street expected the Fed to keep its target federal funds rate at 2%, there was some hope the central bank would try calm uneasy financial markets with a quarter-point rate cut.

In a statement accompanying its decision, the Fed sought to give some reassurance by saying it expected its policy moves to foster moderate econ- omic growth over time.

The announcement caused a sharp downwards movement in the direc- tion of New York’s principal market index. The Dow Jones industrials, up modestly before the Fed move, reacted with an immediate 106 points fall to 10,811. It bounced back to close trading up 141.51 at 11,059.02.

The market bail-outs came as the rate at which banks lend to each other for three months rose to 5.791% – the biggest single-day jump since the crisis at US investment bank Bear Stearns in March.

The FTSE-100 briefly dipped below the 5,000 mark for the first time since June 2005 before recovering some ground later to close at 5025.6 points amid late session hopes of a US Govern- ment rescue for insurance giant AIG.

Andrew Morris, investment director at Liverpool-based Rathbones Investment Management, said: “It’s been another day of turmoil as issues continue from the Lehman collapse.

“The markets reacted pretty much as expected and the torrid day on Wall Street has fed into our market.

“Liquidity is still a problem, the only positive is that everything has happen- ed very quickly with Lehman and the way it was handled by the US regulators.

“It’s good to get the problems to the fore and the sooner they are dealt with, the quicker the market can react.

“After everything that’s happened in the US over the past month, and with the jury still out on AIG, the markets are in limbo.”

Carl Cross, investment director at Rensburg Sheppards, said: “We have seen very significant falls in the market and continued problems related to the credit crunch.

“The British Bankers Association has said there is no problem with any UK banks, but, as the crisis continues, the impact and movement in the market will continue.”

“Until confidence and sentiment is restored in the economy, the markets will continue to be down.”

But the two days of losses – the worst for the index since July, 2002 – have wiped a total of £93bn off the UK’s leading shares.

France’s CAC 40 and Germany’s Dax also registered falls after Asian stock markets slumped overnight. Hong Kong’s Hang Seng index was the biggest casualty, losing more than 5%.

AIG – massively exposed to the plunging US housing market – was granted a $20bn (£11.2bn) lifeline to shore up its finances last night.

But the giant, which sponsors Premier League champions Manchester United, has been downgraded by three major ratings agencies, making it more expensive for the firm to raise funds.

AIG, which made a net loss of $13.2 (£7.4bn) in the first half of this year, saw its shares tumble more than 30% in early Wall Street trading.

With thousands of jobs facing the axe at Lehman Brothers, the tumultuous week has also seen investment bank Merrill Lynch seek a safe haven from the turbulence in a $50bn (£28bn) takeover by Bank of America.

In London, banking stocks were the main victims of the financial turmoil, with Halifax Bank of Scotland plunging 40% at one point because of concerns over higher funding costs in tighter money markets.

HBOS – which eventually closed 22% down – was also downgraded by a ratings agency, but sought to reassure worried investors. “HBOS has a strong capital base and continues to fund very satisfactorily,” it said.

Other banking casualties included Royal Bank of Scotland, which has written off billions in losses on invest- ments linked to the US housing market. The NatWest parent saw shares slump 10%.

Until the latest collapse, the blue- chip index had been propped up by miners and oil companies as commod- ity prices soar.

But, as fears over global economic health grow, crude oil has now fallen from mid-July records of almost $150 a barrel to just over $90 – hitting market heavyweights such as BP and Royal Dutch Shell, which fell by 3% and 5% respectively.

Sentiment was also hit by Bank of England Governor Mervyn King’s letter to Chancellor Alistair Darling, which was issued after inflation hit 4.7% in August.

Analysts said the tone of the letter suggested interest rates may not be coming down as soon as some had previously hoped.

It also emerged Mr King met Prime Minister Gordon Brown and Chancellor Alistair Darling yesterday, and discussed “main economic and financial issues” facing the UK and the world.