James Pethokoukis, one of the most prolific and effective of the growing tribe of conservative policy bloggers, passes along this nugget from investment analyst Ed Yardeni:
Given the ECB’s reluctance to act, I suspect that the Fed will spearhead the formation of a Global Liquidity Facility (GLF) to avert a global financial meltdown. Fed Chairman Ben Bernanke demonstrated that he is a master at putting together such emergency measures back in 2008. In effect, it would act as the world’s central bank. Mr. Bernanke is clearly very worried about the prospect that the European sovereign debt crisis is a contagion that could spread to the US, as evidenced by his bizarre town hall meeting with troops returning from Iraq on November 10. The GLF would receive deposits from the Fed and other participating central banks, including the ECB. The funds would be used to buy the bonds of debt-challenged governments that would be required to accept strict supervision of their fiscal and regulatory policies by the IMF.
You might be thinking that I’ve gone mad. Actually, I’m simply predicting the behavior of our wild and crazy Fed officials. Last Wednesday, Boston Fed President Eric Rosengren noted that the Fed and the ECB worked together during the 2008 global market meltdown, and “if there was a (new) crisis I would expect that there would be some coordinated activities (again). We would want to make sure … that people have access to short-term credit markets.” He added, “We’re not at that point right now, but there are clearly stresses in short-term credit markets.” He said, “We’re watching that very closely, and if it becomes appropriate for us to take more actions to try to relieve that, I fully assume that we would do something.” Mr. Rosengren isn’t on the FOMC, but he is one of Mr. Bernanke’s most supportive colleagues.
The problem here is that if you were a reader and all you knew about what the Fed did with the ECB in 2007 and 2008 was what you get from Yardeni, and then you might think that what Yardeni thinks the Fed might do soon — despite zero actual evidence that the Fed has considered this, planned this or considered planning this — is a plausible scenario.
The problem is that since Yardeni doesn’t know anything about the Fed contingency plans, but still thinks they might do something crazy in response to the slow-motion financial crises in Europe. As evidence for the Fed’s propensity to do crazy things, he points to the foreign exchange swamps with the ECB and several other foreign central banks.
But what Yardeni is referring to — as in, what actually happened in late 2007 — was nothing like the Fed taking deposits and then bailing out sovereign nations so that their debt yields can go down and then can sustainably finance their governments.
Instead, in late 2007, European banks had a lot of dollar-denominated assets, but not a lot of dollars. They usually got dollars in the interbank lending market, but when three BNP Paribas hedge funds suspended redemptions, the interbank lending markets froze up.
This was an especially large problem for European banks who needed to fund their dollar-denominated assets.
American banks were sitting on plenty of dollars from their depositors, but European banks were not. The Fed, of course, has more dollars than them all, so they stepped into the breach and, in order to support interbank lending, opened up swap lines with foreign central banks.
The swaps involved two transactions. At initiation, when a foreign
central bank drew on its swap line, it sold a specified quantity of its
currency to the Fed in exchange for dollars at the prevailing market
exchange rate. At the same time, the Fed and the foreign central
bank entered into an agreement that obligated the foreign central
bank to buy back its currency at a future date at the same exchange
rate. Because the exchange rate for the second transaction was set
at the time of the first, there was no exchange rate risk associated
with the swaps.
The foreign central bank lent the borrowed dollars to institutions
in its jurisdiction through a variety of methods, including variable rate and fixed-rate auctions. In every case, the arrangement was
between the foreign central bank and the institution receiving
funds. The foreign central bank determined the eligibility of
institutions and the acceptability of their collateral. And the foreign
central bank remained obligated to return the dollars to the Fed and
bore the credit risk for the loans it made.
At the conclusion of the swap, the foreign central bank paid the
Fed an amount of interest on the dollars borrowed that was equal to
the amount the central bank earned on its dollar lending operations.
If you didn’t know anything about the Fed’s swap lines, you might read Yardeni and think he was on to something. It seems like journalists with the time and inclinations to actually explain the Fed’s actions in 2007 and 2008 should do so for the benefit of their readers, and not let enthusiastic commentators take advantage of the public’s ignorance.
