A plan to buy banking shares flies in the face of Republican party ideology, writes Arthur BeesleySenior Business Correspondent, in Washington

THE AGREEMENT by European governments to recapitalise financial institutions and guarantee interbank lending marks a decisive effort by the international community to forge a common response to the financial crisis, the worst since the 1930s.

After a month of unparalleled turmoil that shook the global money system to its core, the Paris pact goes considerably further than the plan signed off in Washington only last Friday by finance ministers and central bankers from the G7 group of wealthy nations.

With money markets frozen and the shares of many bellwether companies under severe pressure last week, the clamour for a co-ordinated international approach intensified last week in the build-up to the IMF's annual meeting in Washington.

As international stock markets hurtled towards their worst weekly losses for decades, the world's financial elite descended on the US capital in search of a solution to the cascade of volatility that has upended the financial world.

Instead of co-ordinating action upfront, however, the G7 plan outlined a common set of parameters for government intervention in markets. At its core was a pledge of decisive action to use "all available tools" to prevent the failure of systemically important institutions.

Significantly, however, the G7 plan did not specifically set out any concrete actions that governments would take and stopped short of a pledge to guarantee interbank lending.

Such a guarantee had been sought by IMF chief Dominique Strauss-Kahn, whose dire warning that the financial system was on the brink of "meltdown" graphically set out the current threat to the world economy.

The G7 plan met with a very frosty response from former IMF chief economist Kenneth Rogoff, whose prediction that the turmoil would soon fell a "whopper" institution preceded the collapse of Lehman Brothers by a matter of weeks.

"Saying that they'll take all steps necessary leaves hanging the question of whether they know what is best and necessary," Mr Rogoff said. "It was a signature moment for the G7. I think markets are going to be very disappointed." But there was more to come. The G7 statement gave its members considerable latitude to take exceptional measures individually or in concert as they saw fit.

As US treasury secretary Hank Paulson immediately pushed ahead with a radical plan for the US government to buy shares in American banks, French officials were already preparing for emergency summit in Paris of Euro zone leaders.

In a show of unity, the G7 ministers made their way in the pre-dawn hours on Saturday for a meeting in the White House with President George W Bush. "This is a serious global crisis and therefore requires a serious global response," Mr Bush said in a televised address afterwards, surrounded by the G7 group.

With many top European officials in Washington for the IMF and G7 meetings, there was a dash for the airport to make the return trip across the Atlantic in time for the Paris summit. According to a senior political participant in the IMF meeting, many officials who stayed on in Washington spent Saturday on the phone to colleagues at home.

While the clear message in the G7 statement was that the international community will not allow a repeat of Lehman Brothers' bankruptcy, the Paris agreement clears the way for major European governments to make a series of unprecedented interventions in the free market.

French president Nicolas Sarkozy said governments were ready to take stakes in banks and that details would be made public at a national level, starting in Paris, Berlin and Rome tomorrow. The Euro zone leaders have also pledged to help or directly subscribe to debt-raising by banks for periods of up to five years to complement efforts by the European Central Bank to unfreeze inter-bank lending markets.

As markets re-open this morning, investors will be looking to see how much state money governments can mobilise to buy into banks. Given the extent of the crisis, however, hundreds of billions of euro will be involved.

Having raced to secure the Paris agreement before markets reopen this morning, the key question now is whether the initiative will work.

Even before the deal was struck, IMF chief economist Olivier Blanchard had warned that stock markets could yet lose another 20 per cent of their value. While participants in the Washington talks remain on high alert for further outbursts of volatility, the overwhelming sense of uncertainty was vividly illustrated by Italian central bank governor, Mario Draghi.

Immersed in the minutiae of international financial affairs, Mr Draghi said he could not predict how long the crisis will continue or whether it will worsen. While word was already circulating about the Euro zone initiative when he spoke to reporters on Saturday morning, he said he didn't have a crystal ball and added that the depth and length of the credit crisis depends on the "root psychology" of investors. "You cannot change that overnight." Such circumspection was common among delegates. After weeks of instability in the markets, no-one was predicting before the European deal that the combined might of the international community would bring about a quick restoration of stability.

"That's impossible to say," one participant in the IMF talks told The Irish Times. "The objective of the actions is to arrest the deterioration of the situation." By any measure, however, these latest interventions in the European markets will be extraordinary. They follow, of course, a series of similar manoeuvres by the US government.

Long resisted by the Bush Administration - and in outright defiance of Republican party ideology - the plan to buy up American banking shares implicitly recognises that the bailout programme to buy up distressed mortgage assets failed to convince.

The bailout will proceed, albeit in much reduced form as much of the money earmarked to buy up mortgage securities will now be used to invest directly in banks.

Ahead of a much-anticipated speech in Washington this morning by bailout chief Neel Kashkari, there was considerable speculation that the US government would rush out an announcement of investments in a number of banks before markets reopen after the weekend.

That Euro zone leaders have now agreed to follow suit illustrates the extent to which the crisis has led to a fundamental rethink of economic policy throughout the western world.

As Brian Lenihan puts the finishing touches tonight to his first budget, this state of emergency in the international scene serves to magnify the frailties of our own fiscal position.

G7 action plan

• Take decisive action and use all available tools to support systemically financial institutions and prevent their failure.

• Take all necessary steps to unfreeze credit and money markets and ensure banks and other financial institutions have broad access to liquidity and funding.

• Ensure that banks and other major financial intermediaries, as needed, can raise capital from public as well as private sources, in sufficient amounts to re-establish confidence and permit them to continue lending to households and businesses.

• Ensure national deposit insurance and guarantee programmes are robust and consistent so that retail depositors will have confidence in the safety of their deposits.

• Take action to restart secondary markets for mortgages. Accurate valuation and transparent disclosure of assets and implementation of high quality accounting standards are necessary.