ANNUAL REPORT 2008 - Polymer Bank Notes of the World

whereby investors’ uncertainty surged especiallytowards the end of the year in the context ofintensified financial strains after the bankruptcyof Lehman Brothers. Moreover, the spreadsbetween the yields on long-term euro areagovernment bonds and those on long-termGerman government bonds continued to widenin 2008, reflecting differences in credit risk andliquidity premia (for further details, see Box 6).At the end of 2008 euro area and US ten-yeargovernment bond yields stood at around 3.6%and 2.2% respectively, which was 75 and184 basis points lower than the levels prevailingone year earlier (see Chart 11).The events related to the ongoing financialturmoil, its further escalation since September2008, and its impacts on the real economycan, at least partly, explain the developmentsin major bond markets. Throughout 2008 thefinancial landscape underwent a dramaticreshaping amid a number of staggering events.As a consequence, governments both in theUnited States and in the euro area announceda number of measures aimed at supportingthe financial system, strengthening consumerconfidence, sustaining economic activity andensuring credit availability for households andcorporations. In the United States, starting withthe takeover of Bear Stearns by JPMorgan Chasein March, the investment bank stand-alonebusiness model disappeared. The financial crisisescalated in late summer/autumn when, interalia, the US government-sponsored enterprisesFannie Mae and Freddie Mac were taken intopublic ownership, Lehman Brothers filed forbankruptcy, and the Federal Reserve extendedan extraordinary loan to the insurance groupAIG in exchange for an 80% stake. By the endof September severe financial distress had spreadto the euro area as well, putting under strainseveral financial institutions. As a consequence,in the euro area, there were a number ofinterventions aimed at bringing relief to thebanking system. As reported by the EuropeanCommission in relation to the declaration on aconcerted European action plan of the euro areacountries made at the 12 October summit, theseChart 11 Long-term government bond yields(percentages per annum; daily data)5.55.04.54.03.53.02.52.0euro areaUnited States2004 2005 2006 2007 2008Sources: Bloomberg, EuroMTS, Reuters and ECB.Note: Before January 2007, long-term government bond yieldsfor the euro area refer to ten-year bonds or to the closest availablebond maturity. Starting from January 2007, the euro areaten-year bond yield is represented by the ten-year par yieldderived from euro area sovereign triple-A bonds.interventions were meant “to coordinate nationalefforts to prop up banks and protect depositorsand to increase the flow of credit. Under theplan, national governments would buy intobanks to boost their finances and temporarilyguarantee bank refinancing to ease the creditcrunch”. Against this background and facedwith the deterioration of the macroeconomicoutlook, both the Federal Reserve and the ECBundertook a series of initiatives to enhance theirliquidity facilities and to provide support tofinancial markets. In addition, the two centralbanks repeatedly reduced their policy rates,thereby affecting bond yields. In particular, on16 December 2008 the Federal Reserve’s actionsculminated with a reduction in policy rates to arecord low. The target for the federal funds ratewas kept within a range, rather than at a point,between zero and 0.25%. Moreover, amongother things, the Federal Reserve announced thepossibility of purchasing longer-term Treasurysecurities, which might have also contributed topushing down bond yields.Against this backdrop, until the beginning ofspring 2008, on both sides of the Atlantic longtermgovernment bond yields continued on adeclining trend that started in mid-2007, when5.55.04.54.03.53.02.52.0ECBAnnual Report200841