Stock markets in Europe and the US surged yesterday after the US Federal Reserve took emergency steps to limit the effects of market turmoil on the economy, making direct loans available to cash-strapped banks on favour-able terms and signalling that it would cut interest rates if necessary to limit the effects of market turmoil on the economy.
The US central bank said financial market conditions had deteriorated to the point where "the downside risks to growth have increased appreciably".
Stock markets around the world roared back to life, with the biggest rise in the UK FTSE 100 index since 2003, and early gains in the US. This followed a dramatic overnight fall in Japan's Nikkei index.
It said it was monitoring the situation and was "prepared to act as needed to mitigate the adverse effects on the economy arising from the disruptions in financial markets".
In a separate statement, the Fed outlined steps intended to ensure that banks unable to secure funding in the markets against mortgage and other collateral could get hold of the cash they needed.
It said it was halving the interest rate penalty on its discount window, allowing banks to borrow directly from the Fed system against a wide range of collateral, including most mortgages, at only 50 basis points above the federal funds rate.
It also said that it was extending the period for which these loans were available from one day to up to 30 days, renewable at the bank's request.
The Fed's statements followed a video conference of its policy-making open-market committee on Thursday.
They were unanimously endorsed by committee members, although Bill Poole, the president of the St Louis Fed who has argued publicly against an emergency rate cut, did not take part in the vote.
John Lonski, chief economist at Moody's Investors Service, said the discount rate cut was "welcome news for a jittery credit market".
However, he added: "It would be premature to state with confidence that cutting the discount rate will serve to stabilise markets."
By midday, the S&P 500 was trading up 1.5 per cent for the day at 1431.89, although it was 1.5 per cent lower over the week.
The yield on the two-year Treasury note tracked lower - as it has all week. By midday, it was 4.16 per cent, five basis points lower on the day and 30 basis points lower on the week.
The Fed hopes the attractive terms for discount window operations will overcome the stigma traditionally associated with borrowing directly from the Fed, and help liquidity to flow into the financial system.
If banks know that they can always access cash at not too punitive terms against mortgages and other securities, they will start buying and selling again in the frozen commercial paper, asset-backed and jumbo (large) mortgage markets.
Neal Soss, chief economist at Credit Suisse, said: "This is a masterful move because it doesn't actually feed some of the concerns about moral hazard of bailing out investors who took risks."
