Emergency Economic Intervention: Major Central Banks Act to Prevent Global Liquidity Crunch

The world’s leading central banks said on Wednesday that they will take coordinated steps to prevent a global liquidity crunch as the euro zone fights to end the debt crisis.

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The U.S. Federal Reserve has agreed to lower the cost of existing dollar swap lines by 50 basis points from December 5. The Fed will coordinate with the European Central Bank, as well as the central banks of Britain, Canada, Japan, and Switzerland in a move meant to ease strains in markets and boost the central banks’ capacity to support the global financial system.

The central banks will also be able to tap additional liquidity in their own currencies through bilateral swap arrangements set up between them “should market conditions so warrant.” The swap arrangements are good through February 1, 2013.

The cost for European banks to fund in dollars rose to the highest levels in three years today after finance ministers failed to boost the region’s bailout fund as much as planned, igniting concerns about a possible breakup of the euro area.

While the Federal Reserve notes in its statement that U.S. banks are not currently having difficulty getting funds in short-term finding markets, if conditions deteriorate, the U.S. central bank said it has “a range of tools available” to use as a backstop and would deploy them as necessary.

“The purpose of these actions is to ease strains in financial markets and thereby mitigate the effects of such strains on the supply of credit to households and businesses and so help foster economic activity,” the banks said in their joint statement.

U.S. stocks soared soared in morning trading Wednesday after the central banks’ move to support the global financial system. The Dow Jones industrial average jumped 392 points, or 3.4%, to 11,948 at 10:20 a.m. The Standard & Poor’s 500 index climbed 39 points, or 3.2%, to 1,234, while the Nasdaq composite gained 78 points, or 3.1%, to reach 2,594.

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Markets in Europe also got a boost form the news — Germany’s DAX index jumped 4.9% — though the move by the central banks does not address the fundamental problem posed by heavily indebted European nations. European finance ministers meeting in Brussels continue to debate over how the single-currency union should proceed.