David McHugh and Paul Wiseman
FRANKFURT, Germany (AP) -- The central banks of the wealthiest countries, trying to prevent a debt crisis in Europe from exploding into a global panic, swept in Wednesday to shore up the world financial system by making it easier for banks to borrow American dollars.
Stock markets around the world roared their approval. The Dow Jones industrial average rose almost 500 points, its best day in two and a half years. Stocks climbed 5% in Germany and more than 4% in France.
The action appeared to be the most extraordinary coordinated effort by the central banks since they cut interest rates together in October 2008, at the depths of the financial crisis.
But while it should ease borrowing for banks, it does little to solve the underlying problem of mountains of government debt in Europe, leaving markets still waiting for a permanent fix. European leaders gather next week for a summit on the debt crisis.
The European Central Bank, which has been reluctant to intervene to stop the growing crisis on its own continent, was joined in the decision by the Federal Reserve, the Bank of England and the central banks of Canada, Japan and Switzerland.
"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 central banks said in a joint statement.
China, which has the largest economy in the world after the European Union and the United States, reduced the amount of money its banks are required to hold in reserve, another attempt to free up cash for lending.
The display of worldwide coordination was meant to restore confidence in the global financial system and to demonstrate that central banks will do what they can to prevent a repeat of 2008.
That fall, fear gripped the financial system after the collapse of Lehman Brothers, a storied American investment house. Banks around the world severely restricted lending to each other. Investors panicked, resulting in a meltdown in stocks.
In October 2008, the ECB, the Fed and other central banks cut interest rates together. That action, like Wednesday's, was a signal from the central banks to the financial markets that they would be players, not spectators.
This year, investors have been nervously watching Europe to see whether they should take the same approach and dump stocks. World stock markets have been unusually volatile since summer.
The European crisis, which six months ago seemed focused on the relatively small economy of Greece, now threatens the existence of the euro, the common currency used by 17 countries in Europe.
There have also been signs, particularly in Europe, that it is becoming more difficult to borrow money, especially as U.S. money market funds lend less money to banks in the euro nations because of perceived risk from the debt crisis.
European banks cut business loans by 16% in the third quarter. And no one knows how much European banks will lose on their massive holdings of bonds of heavily indebted countries. Until the damage is clear, banks are reluctant to lend.
Banks are also being pressed by European governments to increase their buffers against possible losses. That helps stabilize the banking system but reduces the amount of money available to lend to businesses.
"European banks are having trouble borrowing in general, including in dollars," said Joseph Gagnon, a former Fed official and a senior fellow at the Peterson Institute for International Economics. "The Fed did the Europeans a favor."
Foreign central banks are reducing by half a%age point, to about 0.6%, the rate they charge commercial banks for dollar loans. Commercial banks need dollars because they are the No. 1 currency for international trade. The lower rate is designed to get credit flowing again.
To get the dollars to lend, central banks go to the Fed and exchange their currency for dollars under a special swap program. Foreign central banks pay the Fed whatever interest they earned from commercial banks.
The Fed had offered dollar swaps from December 2007, when world financial markets were weakening because of fear about subprime mortgages, until February 2010. It reopened the program in May 2010, as European debt concerns grew, and planned to end it Aug. 1, 2012. On Wednesday, the Fed extended the program to Feb. 1, 2013.
If it all works, the market rates on dollar loans will drop, and stock and bond markets will calm down.
"It shows that policymakers are on the case," said Roberto Perli, managing director at the International Strategy & Investment Group, an investment firm. He said it has symbolic value even if it does not have a big impact on credit markets.
The decision to cut the interest charged on the dollar swaps was taken by the Federal Reserve following a videoconference held by Fed officials on Monday morning. The Fed's policy-setting panel approved it 9-1. The president of the Fed's regional bank in Richmond, Va., voted no.
In New York, the stock market jumped at the opening bell and added to its gains throughout the day. It finished up 490.05 points, its seventh-largest one-day gain and its best since March 23, 2009, two weeks after the stock market's post-meltdown low.
Wednesday's advance also swung the Dow from a loss for the year to a gain. It closed at 12,045.68, its first close above 12,000 since Nov. 15.
Stocks closed 5% higher in Germany, 4.2% in France and 3.2% in Britain. European stocks had posted big gains earlier this week because investors saw hope that countries would settle on an attempted fix for the European debt crisis.
Stock markets in Asia, which closed before the central banks announced their move, finished lower for the day. The statement came out at 8 a.m., in the middle of the European trading day and hour and a half before the market opened in New York.
Borrowing costs for countries across Europe fell, an encouraging sign. The yield on benchmark 10-year national bonds dropped 0.32%age points in Belgium. It also fell in Spain, France and Germany.
The yield on 10-year Italian bonds fell 0.08 points to 7.01%. The 7% level is significant because it is considered the point at which a country's borrowing costs become unsustainable. Yields above that level forced Ireland, Portugal and Greece to seek bailouts.
In the U.S., the yield on the 10-year Treasury rose to 2.08% from 2% late Tuesday. That is a sign that investors are willing to take money out of assets considered super-safe, such as U.S. government debt, and invest it in riskier assets like stocks.
It is also a sign of increased confidence in the U.S. economy, which is beginning to pick up after it faltered in the spring and summer. It grew at an annual rate of 2% in July, August and September, the strongest since late last year.
It will take more than that to bring down unemployment in the U.S., which has been stuck at about 9% for more than two years, but the U.S. has added jobs for 13 months in a row. The government's next read on unemployment comes out Friday.
In Europe, countries like Ireland, Portugal, Spain, Greece and Italy overspent for years and racked up annual budget deficits that have left them with backbreaking debt. Italy alone owes euro1.9 trillion, or 120% of what its economy produces in a year.
The ECB extends unlimited short-term loans to banks. It cannot lend directly to governments, including by buying their national bonds. It can, however, buy national bonds on the secondary market, lowering borrowing costs for governments.
The ECB has resisted expanding even this indirect support because it believes that would take the pressure off of politicians to cut spending and reform government finances, a concern known as moral hazard.
European leaders have considered other options, including creating a fiscal union - giving a central authority control over the budgets of sovereign nations. That would ease the ECB's concerns.
The ECB has also worried that injecting too much money into the European economy would trigger inflation.
The coordinated action was a demonstration of how interconnected the world financial system is, and that the debt loads of countries like Italy and Greece are everyone else's problem, too.
Germany's economy depends heavily on exports, and if economic output in the rest of Europe collapses, the people of smaller countries couldn't buy as many German goods.
Across the Atlantic Ocean, the United States depends on Europe for 20% of its own exports. And investors in American banks have worried about their holdings of European debt.
Standard & Poor's, the credit rating agency, lowered its rating at least one notch Tuesday for the four largest banks in the U.S. - Bank of America, Citigroup, JPMorgan Chase and Wells Fargo.
China, one of the only places in the world where the economy is growing quickly, needs the U.S. and Europe both to stay healthy. Growth in Chinese exports has declined from 36% in March compared with the year before to 16% in October.
China will reduce the amount of money that its commercial lenders must hold in reserve by 0.5 percentage points of their deposits. It was the first easing of Chinese monetary policy in three years.