John Dizard of the Financial Times gives an early warning of a potential flashpoint later in the year: that of the Fed’s currency swap lines. In theory, this should be uncontroversial. The Fed is providing dollars to foreign central banks. Those central banks agree to return the currency at the end of the term of the swap. The foreign central bank takes both the foreign exchange risk and the credit risk of lending to banks in its purview.
The reason these foreign banks occasionally need dollars is, mirabile dictu, they make loans in the US, either directly, or as the Landesbanken did in the runup to the crisis, by buying dollar denominated bonds (to their misfortune, subprime mortgage-backed securities), to fund dollar-based transactions in their trading books, and meet swap commitments. And the so-called dollar funding gap has risen. It was about $1 trillion at the time of Lehman’s collapse. Banks skinnied that down to $500 billion near the end of 2010. Even so, some banks faced dollar funding pressure then (which is not as troubling as it might seem; liquidity is scarce at year end since a lot of institutions seek to close their books in mid December). Morgan Stanley pegs the current dollar funding gap at $2 trillion.
The sticking point is that the current Fed swap line program expires February 1, 2013, deliberately after year end in case the Fed needs to facilitate the ECB providing turn-of-the-year dollar liquidity. It would seem to make sense to get a new commitment in place, since the bigger-than-ever funding gap means the desirability of having the swap lines in place is not going away any time soon. But the ECB seems wedded to its “let’s not do anything till we absolutely have to” habits. Dizard sees the potential for the swap lines to become the focus of a huge Congressional food fight, since their renewal and/or use is likely to come up when tempers will already be high over fiscal cliff negotiations. He notes:
So on June 17, Mitt Romney announced on Face the Nation, a national CBS television talk show, that “We’re not going to send cheques to Europe. We are not going to bail out the European banks. We’re going to be poised here to support our economy. Regardless of what is happening in Europe, our banking system is able to weather the storm.”…
However, when even a sophisticated financial sector person such as Mitt Romney finds it useful to take such a shot, we could have a problem come the late fall. I’ve heard from both Democratic senators and senior House Republicans that if there is any large scale use of dollar swap lines at the time of the “fiscal cliff” budget negotiations, the reaction on Capitol Hill would be “volcanic”. As one of them told me last week, “You can expect a lot of demagoguery.”
While Dizard is correct that the currency swap lines are not a great reason for beating up on the Fed, what he is missing is that the central bank is a ripe target. It no longer is a quiet power operating largely in the background; it’s now obvious how much clout it wields via suppressing interest rates and propping up the banks (successfully so far) and the housing market (not so much). It stands firmly behind banks and financial markets, and gives no evidence of being concerned with alleviating the costs banking excesses have inflicted on ordinary citizens. If Bernanke, say, had called a meeting of bank CEOs while Dodd Frank was being drafted, and told them they had better take their lumps, cut pay, and maintain a low profile until the economy recovered, you’d see a lot less anti-Fed sentiment. But the central bank’s insistence on secrecy, its insularity, its lack of accountability, and its knee-jerk allegiance to big financial players have made it a deserving target for public anger. Romney and the pitchfork-bearing Congressmen are simply channeling that sentiment.
So I don’t have any problem with demagoguery and name calling. What I do mind is the wrath of Fed-hostile Congresscritters will probably go to waste. Those who want more accountability from the Fed should use the swap line contretemps as an occasion to revive the Audit the Fed effort, which was cut back late in the game, and to legislate more representation of people who do not have strong ties to the banking industry on regional Fed boards. As the Fed has grown even more powerful, so too does the need for real oversight, and if an opportunity arises sooner rather than later to press for it, we should seize it.