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Reserve's Covert Bailout of Europe
by Gerald P. O'Driscoll Jr.
The Wall Street Journal
When is a loan between
central banks not a loan? When it is a dollars-for-euros currency swap.
Dallas, TX -- America's central bank, the Federal
Reserve, is engaged in a bailout of European banks. Surprisingly, its
operation is largely unnoticed here.
The Fed is using what is
termed a "temporary U.S. dollar liquidity swap arrangement" with the
European Central Bank (ECB). There are similar arrangements with the central
banks of Canada, England, Switzerland and Japan. Simply put, the Fed trades
or "swaps" dollars for euros. The Fed is compensated by payment of an
interest rate (currently 50 basis points, or one-half of 1%) above the
overnight index swap rate. The ECB, which guarantees to return the dollars
at an exchange rate fixed at the time the original swap is made, then lends
the dollars to European banks of its choosing.
Why are the Fed and the ECB
doing this? The Fed could, after all, lend directly to U.S. branches of
foreign banks. It did a great deal of lending to foreign banks under various
special credit facilities in the aftermath of Lehman's collapse in the fall
of 2008. Or, the ECB could lend euros to banks and they could purchase
dollars in foreign-exchange markets. The world is, after all, awash in
The two central banks are
engaging in this roundabout procedure because each needs a fig leaf. The Fed
was embarrassed by the revelations of its prior largess with foreign banks.
It does not want the debt of foreign banks on its books. A currency swap
with the ECB is not technically a loan.
The ECB is entangled in an
even bigger legal and political mess. What the heads of many European
governments want is for the ECB to bail them out. The central bank and some
European governments say that it cannot constitutionally do that. The ECB
would also prefer not to create boatloads of new euros, since it wants to
keep its reputation as an inflation-fighter intact. To mitigate its euro
lending, it borrows dollars to lend them to its banks. That keeps the supply
of new euros down. This lending replaces dollar funding from U.S. banks and
money-market institutions that are curtailing their lending to European
banks—which need the dollars to finance trade, among other activities.
Meanwhile, European governments pressure the banks to purchase still more
The Fed's support is in
addition to the ECB's €489 billion ($638 billion) low-interest loans to 523
euro-zone banks last week. And if 2008 is any guide, the dollar swaps will
again balloon to supplement the ECB's euro lending.
This Byzantine financial
arrangement could hardly be better designed to confuse observers, and it has
largely succeeded on this side of the Atlantic, where press coverage has
been light. Reporting in Europe is on the mark. On Dec. 21 the Frankfurter
Allgemeine Zeitung noted on its website that European banks took three-month
credits worth $33 billion, which was financed by a swap between the ECB and
the Fed. When it first came out in 2009 that the Greek government was much
more heavily indebted than previously known, currency swaps reportedly
arranged by Goldman Sachs were one subterfuge employed to hide its debts.
The Fed had more than $600
billion of currency swaps on its books in the fall of 2008. Those draws were
largely paid down by January 2010. As recently as a few weeks ago, the
amount under the swap renewal agreement announced last summer was $2.4
billion. For the week ending Dec. 14, however, the amount jumped to $54
billion. For the week ending Dec. 21, the total went up by a little more
than $8 billion. The aforementioned $33 billion three-month loan was not
picked up because it was only booked by the ECB on Dec. 22, falling outside
the Fed's reporting week. Notably, the Bank of Japan drew almost $5 billion
in the most recent week. Could a bailout of Japanese banks be afoot? (All
data come from the Federal Reserve Board H.4.1. release, the New York Fed's
Swap Operations report, and the ECB website.)
No matter the legalistic
interpretation, the Fed is, working through the ECB, bailing out European
banks and, indirectly, spendthrift European governments. It is difficult to
count the number of things wrong with this arrangement.
the Fed has no authority for a bailout of Europe. My source for that
judgment? Fed Chairman Ben Bernanke met with Republican senators on Dec. 14
to brief them on the European situation. After the meeting, Sen. Lindsey
Graham told reporters that Mr. Bernanke himself said the Fed did not have
"the intention or the authority" to bail out Europe. The week Mr. Bernanke
promised no bailout, however, the size of the swap lines to the ECB
ballooned by around $52 billion.
Second, these Federal Reserve swap arrangements foster the moral
hazards and distortions that government credit allocation entails. Allowing
the ECB to do the initial credit allocation—to favored banks and then, some
hope, through further lending to spendthrift EU governments—does not make
the problem better.
the nontransparency of the swap arrangements is troublesome in a democracy.
To his credit, Mr. Bernanke has promised more openness and better
communication of the Fed's monetary policy goals. The swap arrangements are
at odds with his promise. It is time for the Fed chairman to provide an
honest accounting to Congress of what is going on.
Mr. O'Driscoll, a senior fellow at the Cato Institute, was vice president at
the Federal Reserve Bank of Dallas and later at Citigroup.
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