Christine Lagarde, French Minister for Economic Affairs, Industry and Employment, chaired the monthly Ecofin meeting of EU 27 finance ministers in Luxembourg, on Tuesday, Oct 07, 2008.

Global Financial Crisis: The UK and Spain have moved to protect their banks as the European Union member countries continue to struggle to agree a coordinated response to the biggest international crisis since the 1930's.  Meanwhile, US financial stocks slumped to their lowest level since 1997 on Tuesday.

In the UK, the Chancellor of the Exchequer Alistair Darling is expected to announce today a broad plan to inject more than £50 billion of taxpayer funds into the country’s largest banks, including Barclays, Lloyds TSB and the Royal Bank of Scotland, among others.

On Tuesday, the Royal Bank of Scotland, the owner of Ulster Bank, fell 39% on top of a 20% on Monday, after a credit downgrading by Standard & Poor’s. Rival HBOS dropped more than 50% over two days.

Spain announced that it will follow the US in buying assets from its banks to restore liquidity, announcing an emergency fund worth €30-€50 billion.

Also on Tuesday, Russia said it would provide $37 billion in long-term subordinated loans into state-controlled banks, and suspended share trading for a second successive day.

German Chancellor Angela Merkel speaking in the Bundestag, criticised what she called “the Irish way - - stretching a shield over one’s own financial institutions, not including other international institutions that also have long paid taxes in Ireland, and so producing competitive distortions that, from my point of view are not acceptable” in what is meant to be a common European market.

Merkel also reaffirmed her opposition to contribute to a joint Europe fund to rescue banks, a measure favored by Prime Minister Silvio Berlusconi of Italy.

EU Finance ministers on Tuesday agreed not to increase a Europe-wide deposit insurance to €100,000 after smaller countries successfully lobbied to cap it at €50,000 for one year

Willem Buiter, Professor of European Political Economy, London School of Economics and former member of the interest rate setting  Monetary Policy Committee commented on his FT.com blog:"It is time for Ministers of Finance, Chancellors of the Exchequer and Secretaries of the Treasury to act to recapitalise the tottering banking systems of the North Atlantic region.  Statements that “we shall do whatever it takes to safeguard the banking system of (fill in name of country)”don’t cut it any more.  The banks with border-crossing activities in the US, the UK and continental Europe are now all at risk of failing.  They are all cutting back drastically on their lending to the real economy.  Official dithering is exacting a growing price, to be paid by tax payers and the future unemployed.

The main remaining question then becomes who will pay for the bail out, the tax payers or the existing creditors of the banks (including the shareholders and other providers of equity).  I have a strong preference for putting much of the cost of a bailout on the existing creditors.  This is in part for reasons of equity and fairness: the existing creditors made bad investments/loans; they ought to pay for their failures.  They earned a risk premium while the going was good. They ought to eat the risk when it materialises.  It is also for incentive reasons.  Future lending to banks and future purchases of bank obligations will be undertaken with a better appreciation of the credit risk involved.  Another massive over-expansion of the banking sector will be less likely."

In the US, the broad Standard & Poor's 500-stock index fell 5.7% on Tuesday. Its 14.6% five-day plunge is the biggest since the five days that included the October 1987 stock-market crash and the index is 21% lower than it was just one month ago.

The S&P financials index plunged 11.5% to its lowest level in 11 years. It is now 58% down from its peak last year.

Bank of America fell 26% after it reported a big fall in earnings and halved its dividend in advance of pricing of a $10 billion share offering to raise additional capital.

Morgan Stanley ended the day down 25% despite approval by the Federal Reserve of the deal by Mitsubishi UFJ Financial Group of Japan, to acquire up to 24.9% of the voting shares  .

The financial stocks' plunge in New York, also coincided with a hint from Fed Chairman Ben Bernanke of a rate cut, during a speech in Washington.

The Federal Reserve also announced a new program to ease up strains in the bank lending market for short-term business loans - a crucial issue for business far beyond Wall Street.

The program deals with commercial paper, a form of short-term funding that is crucial to many businesses operations.

Commercial paper is issued by major corporations and most of the America's top financial institutions. They use the proceeds to fund day-to-day business operations. It is bought primarily by money market fund managers and other institutional investors.

Before the onset of the credit crisis, there was nearly $2 trillion of commercial paper outstanding and was mostly issued for short term periods - never more than nine months - and had to be renewed frequently.

For investors, it was considered a very safe investment to purchase and one that could be easily resold to other investors.

In the past month, the amount of money outstanding commercial paper loans has fallen 11% to a seasonally adjusted $1.6 trillion on Oct. 1st from $1.82 trillion on Sept. 10th.

Investors have also become unwilling to buy longer-term paper - beyond a week or two - from even companies and financial institutions with top credit ratings.