Finally, the Federal Reserve’s Bailout of Europe Hits Mainsteam

Two weeks ago, we reported here about the Federal Reserve bailing out Euro land via its recently announced discounted currency swaps. Apparently not too many people seemed to care because little was reported on the subject, and the few who did note that it constituted a Euro bailout, did not fully grasp what it would entail. Most wrote it off as a non-event. But after nearly $100 billion has been drawn from the newly discounted Fed facility in the first two-weeks of operation going straight to European banks and Euro debt purchases, the mainstream is now taking notice.

Reported today from the Wall Street Journal (a bit late, but at least they’ve come around):

“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 dollars.

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.”

The full WSJ article can be found here. The article itself merely scratches the surface, but the point being that it is now reaching a mainstream audience. To those still doubting whether this Fed action amounts to anything, I encourage you to read the testimony of George Mason University Finance Professor, Anthony Sanders given to the House Committee on Oversight and Government Reform in which he warns of Fed bailout lending through these discounted swaps could reach $1 trillion or higher. A good summary and the full testimony can be found here.

James Groth is a research associate at Reason Foundation, a nonprofit think tank advancing free minds and free markets. Prior to joining Reason, where he works on monetary policy reform and financial regulation, he worked as a proprietary trader and asset manager. Groth holds a B.A. in economics from Tufts University.