The US Federal Reserve will restart its emergency currency-swap tool by providing as many dollars as needed to European central banks to keep the continent’s sovereign-debt crisis from spreading.
The swaps with the European Central Bank, Bank of England and Swiss central bank will allow them to provide the “full allotment” of US dollars as needed, the Fed said late yesterday in a statement in Washington. A separate swap line with the Bank of Canada will support as much as $30 billion, the Fed said, and the Bank of Japan said it approved reactivating its US line. The swaps were authorised through January 2011.
The Fed action was a complement to European policy makers’ announcement of an unprecedented loan package worth almost $1 trillion to stop a crisis that threatened to shatter confidence in the euro. The US central bank on Feb. 1 had closed all swap lines opened during the last crisis, triggered by the subprime- mortgage meltdown in 2007.
“If there is one thing the Fed doesn’t like, it is systemic risk,” said Torsten Slok, an economist at Deutsche Bank AG in New York. “Early signs of systemic risk were brewing in the financial system last week, and if policy makers had not taken action this weekend, then this would also have been a threat to the US financial system.”
In a swap, central banks exchange foreign currency with an agreement to reverse the transaction at a later date. The central banks will then lend the dollars at fixed rates to firms in their countries.
Dollar liquidity tightened in London last week amid concern financial institutions are holding too many assets of Europe’s most-indebted nations.
The action signals that Fed officials are concerned about implications of the Greek crisis for American markets.
“These facilities are designed to help improve liquidity conditions in US dollar funding markets and to prevent the spread of strains to other markets and financial centers,” the Fed statement said.
The London interbank offered rate, or Libor, for three- month loans climbed 5.5 basis points to 0.428 per cent on May 7, the highest level since Aug. 17, according to data from the British Bankers’ Association. It was the biggest increase since Jan. 16, 2009, and the 13th straight gain.
Fed officials aren’t sure what the immediate demand will be for dollars or how much the US central bank’s balance sheet will grow from its current level of $2.33 trillion. The ECB said its first offering will take place tomorrow. The prior incarnation of the swaps peaked at $583.1 billion in December 2008, with deals encompassing 14 other central banks.
‘Exposed’ Banks
“We have a banking system that is fragile, and those banks are exposed to European banks,” said David Kotok, chairman and chief investment officer at Cumberland Advisors Inc., which manages about $1.4 billion in Vineland, New Jersey. Further volatility in Europe would “impact us as well,” he said.
Rising costs in the market for dollar loans between banks began to show “distrust” in the financial system, Kotok said. “As soon as you see that, you know you have systemic risk.”
This time, the Fed’s swaps come amid increasing political scrutiny. Congress could ask why the U.S. central bank is expanding the supply of dollars to help smooth disruptions caused by fiscal imbalances in Europe.
Senator Bernard Sanders, a Vermont independent, wants the Government Accountability Office to look into Fed lending facilities during the crisis, including swap lines with foreign central banks, such as the $20 billion facility the Fed opened with the ECB in December 2007.
Regulatory Overhaul
A vote on the Sanders amendment could come as soon as May 11 as Congress proceeds with the most sweeping overhaul of financial regulations since the Great Depression.
“Many members of Congress are deeply suspicious of the Fed’s interventionist instincts,” said Lou Crandall, chief economist at Wrightson ICAP LLC in Jersey City, New Jersey. “Bailing out Wall Street caused enough resentment; appearing to bail out Greece would be even more problematic.”
“The Fed cannot afford to rile up its congressional critics while the financial reform bill is still in play,” Crandall said before tonight’s announcement.
The weekend’s events had echoes of the financial crisis in 2008. Fed policy makers acted after getting formal requests from the other central banks late on May 8, a Saturday, following informal requests toward the end of last week. The FOMC convened a meeting around midday yesterday and delegated authority, with conditions, for Chairman Ben S. Bernanke to approve the swaps. The vote of Fed policy makers was unanimous.
Political Consequences
Fed officials considered possible political consequences of their decision at their weekend meeting. Bernanke told his colleagues that the Fed had to do what is right for the U.S. economy, while providing more transparency to Congress. The Fed is likely to publish weekly information about the draw-downs on the swap facilities and information about the contracts with the other central banks.
Officials at the Fed saw multiple risks to the U.S. expansion from continued turmoil in Europe, such as crimped trade, declining confidence, and financial volatility.
The Fed’s move may pale next to the agreement by the 16 euro nations to offer financial assistance worth as much as 750 billion euros ($971 billion) to countries under attack from speculators. The ECB said it will counter “severe tensions” in “certain” markets by purchasing government and private debt.
“The Fed action is a fringe development here,” said Axel Merk, president and chief investment officer of Merk Investments LLC in Palo Alto, California. The more important development is that “Europe is getting its act together,” he said.
