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European Central Bank agrees to buy euro-zone governments' bonds in attempt to halt debt crisis

May 9, 2010 | 10:33 pm

The European Central Bank chose the "nuclear option" on Sunday, agreeing to directly buy government bonds of euro-zone countries in an attempt to keep the continent's harrowing debt crisis from spreading.

The ECB's decision, announced in tandem with a massive new lending and loan-guarantee program from the European Union, is policymakers' most aggressive response yet to the financial debacle that by last week was threatening to engulf the continent's banking system.

The moves had the desired effect, sending the battered euro currency surging in Asian trading and lifting Asian stock markets as well.

In a statement, the central bank said that in view of "current exceptional circumstances prevailing in the market," it would "begin to conduct interventions in the euro area public and private debt securities markets to ensure depth and liquidity in those market segments which are dysfunctional." It didn't put a value on the amount of purchases it's willing to make.

If it chooses, the ECB now could become a buyer of Greek, Spanish and Portuguese government bonds -- securities that have increasingly been shunned by private investors in recent months on deepening fears that the governments might be unable or unwilling to pay their creditors in full. That has pushed market interest rates on the bonds sharply higher, making it more expensive for the countries to borrow and devaluing previously issued bonds.

ECBlogo Debt-ridden Greece, all but closed out of the bond market as rates on its bonds have soared into double digits, a week ago was forced to request more than $140 billion in loans from the rest of Europe over the next three years. Investors have worried that Portugal and Spain might follow.

For weeks, many analysts have been expecting the ECB to step into the deteriorating bond market as a buyer of last resort (dubbed the "nuclear option" by some economists). But the purchase commitment announced Sunday was a move that the central bank -- which prizes its independence -- had been reluctant to make.

As recently as Thursday, ECB policymakers held a regularly scheduled meeting and President Jean-Claude Trichet said afterward that the idea of using ECB funds to buy euro-zone government bonds wasn't even discussed.

That wasn't what sinking financial markets wanted to hear: The ECB's reticence was one of the triggers for the global stock market sell-off Thursday that spread to the U.S. and led to one of the wildest trading sessions in Wall Street history -- including a computer-driven plunge of more than 700 points in the Dow Jones industrial average in the space of a few minutes.

By Friday, the ECB may have realized it had little choice but to bring its firepower to bear in Europe's bond markets. The eroding value of government bonds put banks in Europe and worldwide at risk because financial institutions hold huge amounts of that debt. Late last week interest rates were rising on short-term loans between European banks, suggesting that some banks were becoming leery of lending to others -- similar to what followed the failure of brokerage Lehman Bros. in September 2008.

Lehman's demise, of course, led to a virtual freeze-up of credit markets worldwide, plunging the global economy into a deep recession.

With its decision Sunday, the ECB is taking a page out of the Federal Reserve's book: The Fed last year committed to buying a total of more than $1 trillion worth of mortgage-backed bonds and U.S. Treasury bonds in an attempt to keep long-term interest rates subdued. By providing consistent demand for the debt the Fed sought to help to limit any upward pressure on bond interest rates that might have occurred if few private investors were willing to step up and make purchases.

Critics, however, say central banks are simply printing more money to paper over a crisis rooted in excessive consumer, business and financial-system debts piled up over the last decade.

The ECB, wary of being accused of stoking inflation, said any bond purchases would not lead to more money sloshing around the European economy because the bank would effectively "sterilize" its purchases by reabsorbing the liquidity in other ways.

The European bank also got help Sunday from the Federal Reserve and other major central banks, which pledged to reopen so-called currency swap lines among themselves -- with the goal of making sure that European commercial banks that need dollars to fund themselves can get their hands on those greenbacks.

The swap lines had been one of the critical lending facilities central banks introduced during the 2008 credit crisis to unfreeze the banking system.

-- Tom Petruno

Photo: The European Central Bank's logo. Credit: Hannelore Foerster / Bloomberg News