Financial markets near complete freeze

LONDON (Reuters) - Investors will be seeing this week whether policymakers found a way to pull markets away from a deeper collapse as global capital markets faced complete freeze-up.

The global financial system was on the brink of meltdown, the International Monetary Fund warned on Saturday, a day after finance chiefs from the Group of Seven rich nations failed to agree on concrete, joint measures to end the crisis.

In a brief statement after their Washington talks, the G7 stopped short of backing a British plan to guarantee lending between banks, something many on Wall Street saw as vital to end growing market panic.

European leaders then raced on Sunday to produce their own deal at a summit in Paris, the focus fixed firmly on how much state money governments could mobilize to buy into banks if needed, and if they would also underwrite lending between banks, paralyzed for now by fear and distrust.

Analysts say policymakers must avert a wholesale breakdown in cross-border capital and investment flows after the tumult of last week saw investors dumping everything from stocks, bonds, oil and commodities in a panic dash for cash.

Capital markets were already grinding to a halt in many parts of the world with equity trading only briefly or completely suspended in Russia, Iceland, Romania, Italy, Austria, Ukraine, Peru and Indonesia last week.

"The crisis is moving with an astonishing speed and international flows of funds are freezing rapidly," said Lena Komileva, head of G7 market economics at Tullett Prebon.

She said the lack of specific steps from the weekend G7 meeting was likely to disappoint investors, threatening to cause more damage across risk asset classes this week.

"The economic crisis has political and social costs. The backlash of falling equities and disrupted credit channels could possibly result in protectionism taking hold, which would cause severe damage to the global economy," Komileva said.

This week, investors will receive key third-quarter corporate earnings results from major banks and companies which will reveal the scale of damage suffered by the real economy from market turbulence which erupted in August 2007.

JP Morgan , Wells Fargo , Bank of New York Mellon , Citigroup , and Merrill Lynch are among banks which will unveil earnings for the three months ending September, the month when Lehman Brothers collapsed and several U.S. and European financial firms were bailed out.

Results from Intel , Google , Nokia and Philips Electronics are also due.

PANIC AND FEAR

World stocks, measured by the MSCI index, lost a fifth of their value last week, tumbling to a five-year low as investors grew concerned that major economies will sink into recession, wiping out corporate profits and damaging consumption.

Barclays Capital estimates the trailing price-to-earnings ratio of world stocks fell to just under 9 percent from 18 only a year ago and investors are discounting a 45 percent decline in profits.

In Britain, where stocks have fallen 39 percent this year, Barclays says the dividend yield is just over 6 percent, a level that has only been seen three times in the past 108 years.

Compared to long-dated gilt yields, dividend yields have not been this high since the Battle of Britain in 1940.

"It is true that in the de-leveraging and forced liquidations currently dominating price action, there is unlikely to be very much in the way of rational discounting going on," said Tim Bond, head of asset allocation at Barclays.

"However, in the irrationality of individuals there is the rationality of collective behavior. The valuation yardsticks offer us a guide to the extent to which the collective actions of market participants have discounted various economic outcomes."

EMERGING PINCH

Emerging markets are also feeling the pinch as foreign capital drains away from risky assets, sending their shares down 20 percent last week , on top of a 10 percent decline suffered the week before.

Since January, emerging country stocks have lost more than 50 percent.

Investors are demanding emerging sovereign debt to give yields of more than 600 basis points above U.S. Treasuries -- the highest since mid-2004 -- in compensation for holding riskier bonds.

In Iceland, where the government took control of three of the country's biggest banks last week, financial markets are grinding to a halt as traders report hardly any trades in the crown currency and money markets.

The cost of insuring the sovereign debt of Ukraine, Kazakhstan and other Eastern European countries has soared, pricing in a mounting risk of default. Many emerging market currencies are hitting multi-year lows.

A falling currency makes it harder for emerging nations to repay dollar-based foreign debt and exacerbates inflation.

"Large foreign institutional investors are likely to still have very large exposures to some high-yielding emerging market currencies," said Stephen Jen, global head of currency research at Morgan Stanley.

"We believe these positions are in jeopardy. Unwinding of these positions could lead to another wave of selling of many emerging market currencies, unrelated to their economic fundamentals."

(Editing by Greg Mahlich)