Major central banks swept in to calm credit markets spooked by mounting losses on Thursday, with the European Central Bank injecting record amounts of cash to prevent a financial system seizure.
U.S. President George W. Bush also sought to calm fears that a credit squeeze would shake economic growth, telling a news conference both the global and U.S. economy were strong.
I'm told there is enough liquidity in the system to enable markets to correct, Bush said.
The ECB pumped a record 94.8 billion euros ($130.6 billion) into Europe's money markets after France's biggest listed bank, BNP Paribas, froze withdrawals from three funds hurt by problems in the U.S. subprime mortgage market.
BNP's action made European banks fearful of how far U.S. subprime credit problems had reached and they essentially stopped providing short-term funds to one another, sparking a scramble for cash and forcing the central bank to step in.
After North American markets opened, the Bank of Canada said it was in contact with other central banks on the global situation and stood ready to add money as needed.
The Fed and the Bank of Canada both pumped money into financial systems through regular operations aimed at bringing benchmark overnight interest rates back to target.
The Fed injected $24 billion and the Bank of Canada C$1.64 billion ($1.55 billion). While the operations were larger than normal, analysts said they did not amount to an emergency injection of liquidity.
The important thing to know is that we add reserves to the (U.S.) banking system the vast majority of business days in substantial volume, Minneapolis Federal Reserve Bank President Gary Stern told a gathering of local business people in Billings, Montana.
Michael Darda, chief economist at MKM Partners in Greenwich, Connecticut, said the Fed's operation was a normal response to bring the overnight federal funds rate, which was trading at 5.5 percent, back toward its 5.25 percent target. The rate retreated to 5.375 percent but returned to 5.5 percent late in the day.
It's a mini-panic, and we are seeing demand for short-term credit, he said. We are not seeing a so-called 'credit crunch' in the U.S. money market.
Nonetheless, financial markets were spooked.
U.S. interest rate swaps, a measure of market risk appetite, widened sharply. Stocks fell and investors piled into the safety of bonds, pushing down yields on U.S. Treasuries and European government debt.
In the United States, the blue-chip Dow Jones industrial average closed down 387 points, or 2.8 percent.
In Europe, traders said cash markets were seizing up until the ECB acted. There appears to be a dash for cash both in dollars and in euros, said Nick Parsons, head of market strategy at nabCapital in London.
The ECB said its aim was to assure orderly conditions in the euro money market. It routinely holds quick market operations when there is a cash imbalance, but not since after the terror attacks on the United States in September 2001 had the size neared Thursday's level.
The BNP problems had sent jitters through European markets already rife with rumors of worsening troubles in Germany. The Bundesbank hosted a meeting with banks involved in the rescue of Europe's highest profile subprime victim yet, lender IKB, to arrange details of its 3.5 billion euro bailout.
Nobody wants to lend any money. It's safety first. said Karen Birzler, a money market trader at HVB in Munich.
The cost for banks to borrow money overnight in the euro zone, the world's second-largest economic region, shot up to 4.62 percent, the highest since shortly after the 2001 attacks, and above the ECB's 4 percent target.
Only when the ECB offered banks extra cash to assure orderly conditions did rates return to normal.
A Zurich-based money market trader called market conditions crazy since Fed Chairman Ben Bernanke has given no signal of concern that credit markets could undo the real economy.
The market is acting like a yo-yo. It's all very psychological. The possibility of a credit crunch returning is starting to spook everyone, he said.
(Additional reporting by David Milliken, Eva Kuehnen and Catherine Hornby in Frankfurt; Thomas Atkins in Zurich; Natsuko Waki, Sumeet Desai, Mike Dolan in London; Emily Kaiser in Washington; Tamawa Kadoya in New York; and David Lawder in Billings, Montana)