Banks must quickly disclose losses on investments hit by a global credit squeeze and governments will intervene if the market fails to sort itself out, European Union leaders said on Friday.
The leaders agreed at the end of a two-day summit that state-backed sovereign wealth funds - which have pumped huge amounts of capital into banks hurt by heavy writedowns - have played a useful role but should sign up to a transparency code.
Last August, defaults on US home loans escalated into a global credit squeeze as banks turned wary about lending each other money, fearing they may not get it back. Economists say the crisis will dent economic growth in the EU.
Markets were further rattled on Friday when J.P. Morgan said it and the Federal Reserve Bank of New York had agreed to provide funding to investment bank Bear Stearns. Shares in Bear Stearns lost half their value at one point.
"There is real reason for confidence in our ability to weather the storm but there is no room for complacency," European Commission President Jose Manuel Barroso told a news conference after the summit. EU leaders agreed on the need for greater transparency in complex financial market products that lost their value, stronger cooperation between national supervisors and tougher rules on bank capital.
"The fact is that these products circulate on markets and between markets are of such opaqueness that one can hardly see them and nobody knows what they consist of," Luxembourg Prime Minister Jean-Claude Juncker said. "Even the bankers who put them in place always get their content and identity wrong," Juncker said.
The private sector will have a chance to respond to the subprime crisis but governments will step in to take regulatory actions where necessary, EU leaders agreed.
Policymakers are horrified that eight months after the subprime crisis began unfolding, there is still no clear picture of what other losses will be announced, leaving investors with little appetite to step back into markets. EU leaders said "prompt and full disclosure of exposures to distressed assets" by banks was essential.
"I believe the proposals that have come from the European Council today will make for greater stability in what is an unstable and uncertain set of times, but where we are determined by being vigilant to ensure stability in our economy is maintained," British Prime Minister Gordon Brown told reporters.
Banks like Merrill Lynch, Citigroup and UBS have had to write billions of dollars off the value of investment products held off their balance sheets. "There has got to be transparency in the way financial institutions operate particularly when they have had previously off-balance sheet activities and when they are now writing off considerable assets," Brown said. "There has got to be transparency also in the way credit rating agencies operate so that there is no conflict of interest," he added.
Rating agencies have been blamed for being too slow to warn investors about subprime-related investment risks and face a tougher voluntary code of conduct in the hope of avoiding regulation.
The crisis showed up flaws in how financial markets are supervised in the 27-nation EU, with a system of national watchdogs despite the EU market being dominated by large cross-border banks. The leaders also backed efforts by the International Monetary Fund to thrash out a voluntary code of conduct this year for state-backed sovereign wealth funds. The emergence of funds with limited transparency on their investment strategy and objectives has raised some concerns relating to non-commercial practices, EU leaders concluded.
"This is a voluntary code of conduct that sovereign wealth funds across the world should be prepared to sign up to ... there are now indications that they will do so," Brown said. Collectively sovereign wealth funds have about $2.5 trillion to spend and EU states like France and Germany worry some funds seek influence over key sectors rather than just profit.
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