Wall Street Journal
December 28, 2011
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. A currency swap with the ECB is not technically a loan.
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