May 7, 2010, 3:33 PM ET
A Closer Look at Europe and
the Fed’s Central Bank Swap Program
By Jon Hilsenrath
Can the Federal Reserve provide a quick fix to tame Europe’s growing financial crisis? Probably not. But it might be able to help if conditions in Europe worsen.
The Fed is considering whether to reopen a lending program put in place during the financial crisis in which it shipped dollars overseas through foreign central banks like the European Central Bank, Swiss National Bank and Bank of England. The central banks, in turn, lent the dollars out to banks in their home countries in need of dollar funding. It was aimed at preventing further financial contagion.
The Fed has felt that it is premature to reopen this program — which was shut down in February as the financial crisis appeared to wane — because it wasn’t clear that foreign banks were in need of dollar funds. Still, trading floors on Wall Street are abuzz with anticipation today that the Fed might use the program again as Europe’s problems take on a more global dimension.
Reopening the program would come at a cost for the Fed. Critics in Congress could be against the program because of the perception that the U.S. would be coming to the rescue of Greece and other struggling European nations. The Fed is already being pushed on Capitol Hill to be open to more scrutiny than it wants on the details of its international transactions. The international lending lines are known among central bankers as swaps.
Fed officials believe the swap program was one of its most successful interventions aimed at stemming a global crisis, when many banks overseas became strained for dollar funding. In their normal course of business, they borrowed dollars in short-term lending markets and used those dollars to finance holdings of long-term U.S. dollar assets, like Treasury or mortgage bonds. When those markets dried up, the swap lines helped to prevent overseas bank funding crises in 2008.
Strains in short-term funding markets are starting to show up again, but they’re nowhere near as severe as they were after Lehman Brothers collapsed in September 2008, so it’s not clear that the program is warranted.
As they watched European turmoil unfold in the past few days, Fed officials weren’t convinced that funding problems were severe enough in short-term money markets to warrant U.S. involvement. That could change if conditions worsen.
Still, the swaps wouldn’t be a cure-all if they’re reinstated. They only help relieve short-term funding pressures on banks that need dollars. They don’t help banks that need other funding currencies, like euros. And they don’t resolve worries about bigger issues, such as the risk that Greece or other countries might default on their debt, or the inability of banks to unload illiquid holdings of European sovereign debt.
Mr. Crandall said a Fed swap program would only be useful if it was instated as part of a broader European package to calm financial market worries. Two senior Fed officials will be in Basel, Switzerland this weekend for a regularly scheduled meeting of global central bankers — New York Fed President Bill Dudley and Fed Vice Chairman Donald Kohn