TOPWRAP 2-World markets swoon as US slumps to bank aid

Published: 24 Feb 2009 01:49:48 PST

* Stocks battered on fears rescue will fall short

* Japan to consider buying stocks directly

* U.S. to launch bank rescue program Wednesday

TOKYO, Feb 24 - The United States vowed to prop up ailing banks if needed, but worries that yet more cash injections would fail to staunch the global economic crisis weighed on stock markets around the world on Tuesday.

The U.S. government was set to take a bigger stake in Citigroup and inject yet more cash into insurer AIG, sources said, even as a Federal Reserve official urged that such interventions should be short term.

In Japan, Finance Minister Kaoru Yosano said the government would consider a call to buy shares directly to support the stock market, which fell to near 26-year lows on Tuesday, dragged down by banks as worries grew about international financial stability.

Shares fell steeply across Asia and were expected to open sharply lower in Europe, mirroring a big drop in U.S. equities to start the week on fears that Washington's bank stabilisation plan would not be enough to keep the economy from sliding into a deeper hole.

U.S. government bond prices rose slightly and the dollar gained against a basket of currencies as investors sought safety, while gloom about economic prospects weighed on oil prices.

Amid speculation that the United States may still have to nationalise some banks, the government said it will start examining large firms' capital needs on Wednesday to determine whether a bigger buffer is warranted.

Richard Fisher, president of the Federal Reserve Bank of Dallas, cautioned that interventions should be short term and backed by an exit strategy that can be "realizable very quickly".

But he also highlighted the severity of problems, saying the Fed would do everything it could to combat the financial crisis and that buying long-term Treasury bonds could be helpful.

"Few of us imagined in our wildest dreams that our global economy could have turned so rotten so quickly," Fisher said. "We are duty-bound to apply every tool we can to clean up the mess that has soiled the face of our financial system and get back on the track of sustainable economic growth with price stability."

Tuesday was shaping up to be an anxious day in stock markets, as negative sentiment spread from the United States to Asia and threatened to swamp Europe next.

Asian shares resumed a drop towards five-year lows, with an MSCI index of Asia-Pacific stocks outside Japan down 2.3 percent. Japan's Nikkei average fell 1.5 percent, and indexes in South Korea and Hong Kong dropped more than 3.5 percent.

Among Asian financial shares, Nomura Holdings, Japan's biggest broker, lost 9.3 percent a day after announcing plans to raise $3.3 billion.

GOVERNMENT, GOVERNMENT, EVERYWHERE

Japan was considering direct measures to allay the damage, including a call from the head of a business group for the government to buy shares, Yosano, the finance minister, said.

But, with the world firmly in the grip of the credit crunch, another cabinet minister warned Japanese efforts to boost its stock market faced severe headwinds.

"It is necessary that the U.S. stock market recovers as soon as possible," Chief Cabinet Secretary Takeo Kawamura said.

In Europe, the French government on Monday said it was pumping extra cash into two mutually owned banks, and central European central banks took the unprecedented step of talking up the region's currencies.

Far-reaching efforts to revive economies may bear fruit with a return to growth by the second half of the year, but the United States could be saddled with twin legacies of huge budget deficits and very low inflation, said Bruce Kasman, head of economic research for J.P. Morgan.

"The lingering problems caused by this event are going to be with us for years to come, and therefore I don't think we can close the book on this event in any meaningful way," he said.

Citigroup, whose stock has been pounded by fears the government may seize the bank and wipe out shareholders' investments, was in talks to give the government a larger stake, a person familiar with the matter told Reuters.

The idea under consideration would involve converting a big chunk of the $45 billion in preferred shares the government bought last year into common stock, putting as much as 40 percent of Citigroup into public hands.

American International Group, once the world's largest insurer, may be coming back for its third round of U.S. government aid as losses and writedowns mount, according to a source and a CNBC report.

European Central Bank President Jean-Claude Trichet said on Monday the financial crisis was spilling over into the wider economy and that the euro zone's financial system is under "severe strain."

Latvia's government collapsed on Friday and the currencies of countries such as Poland, the Czech Republic and Hungary have come under severe pressure, hitting millions of citizens who have borrowed in foreign currencies such as the euro.

Emerging European Union central banks coordinated to prop up their currencies on Monday, with Czech central bank Governor Zdenek Tuma saying they had agreed that recent falls were overplayed.