Fed Intervenes in European Debt Crisis
After months of quietly watching from the sidelines, the United States finally intervened in the European debt crisis on Sunday night.
The Federal Reserve announced that it would open currency swap lines with the European Central Bank — in essence, printing dollars and exchanging them for euros to provide some liquidity for European money markets and banks.
The step came after a hectic week in which Washington began to fear that the sovereign debt crisis threatened to infect the American economy and hamper its recovery, according to several United States officials.
The Federal Open Market Committee, the Fed’s policy-making arm, approved the swap lines in a vote taken by videoconference on Sunday morning. The European Central Bank’s president, Jean-Claude Trichet , asked for the Fed’s help in a telephone call on Saturday with the Fed’s chairman, Ben S. Bernanke .
The intervention, which also involves the central banks of England, Switzerland, Canada and Japan, is part of a colossal package intended to quell the restive credit markets with a show of force and resolve that American policymakers had quietly believed was lacking. The package has two other elements: about $950 billion in loan guarantees from the European Union , and a decision by the European Central Bank to intervene in the bond markets through a series of refinancing operations.
An initial rescue package for Greece, totaling around $140 billion, failed to calm investors last week. The sudden plunge in the stock market on Thursday exacerbated the worries of American officials.
Mr. Trichet had a series of conversations over the past week with Mr. Bernanke, who in turn received assurances from the Obama administration that the Fed’s actions had the president’s support, according to officials involved in the discussions, who spoke on condition of anonymity.
“It became increasingly clear that, if they were willing to take very strong measures, that it would be in the interests of the United States to encourage and support that,” one American official said.
The official added, concerning the Europeans, “Clearly they understood that both the European Central Bank, in the first instance, and then the global community was much more likely to try to help them if they were first willing to do something big themselves.”
In a statement, the Fed said the currency swaps were intended to make it easier for European companies, institutions and governments to borrow dollars when they need them, “and to prevent the spread of strains to other markets and financial centers.”
The statement said the action was taken “in response to the re-emergence of strains in U.S. dollar short-term funding markets in Europe.” The statement added: “Central banks will continue to work together closely as needed to address pressures in funding markets.”
The program announced Sunday night is broadly similar to one that the Fed introduced in December 2007, as the United States entered a recession caused by the collapse of its housing market.
Under that program, the Fed provided dollars to central banks in exchange for an equivalent amount in foreign currency, based on prevailing exchange rates. The parties agreed to make the same exchange in reverese at a later date — anywhere from one day to three months later — using the same exchange rate as in the initial transaction.
The swap operations do not carry any exchange rate risks or credit risks, the Fed said. The Fed would not be a party to whatever dollar-denominated loans the European Central Bank may make to European financial institutions.
(An equivalent program was announced in April 2009 to give the Fed the ability to provide liquidity to American institutions in foreign currencies, but the Fed did not end up having to use that program.)
The Fed actually made money from the previous dollar swap program. The foreign central banks paid the Fed interest equivalent to what they made from lending the dollars. The Fed, however, did not pay any interest on the foreign currencies it took in exchange, having agreed to hold them instead of lending them out or investing them in the private markets. The new program is designed the same way.
In December 2008, at the height of the previous swap program, the Fed held $582.8 billion through the central bank liquidity swaps. That number fell to zero by the time the program ended in February of this year.
The swaps are likely to produce a significant, if temporary, expansion of the Fed’s already giant balance sheet, which now totals around $2.3 trillion. The balance sheet grew as the Fed purchased mortgage-backed securities and longer-term Treasury debts as a way of holding down long-term interest rates.
http://www.nytimes.com/2010/05/10/business/global/10swap.html
A number of countries, including China and Russia, have suggested replacing the dollar as the world's reserve currency