Battle Royale Coming Over Fed Currency Swap Lines?

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.

Print Friendly, PDF & Email


  1. vlade

    Not to mention that attacking the swap lines is cutting off your nose to spite your face.

    If Romney thinks US will get on swimmingly when EU banks crash and burn, maybe he should ask his nanny to stop telling him fairly tales.

    There’s plenty of reasons why to kick Fed, this aint’ one of them (although it’s probably the most appealing to various politicians).

    1. Yves Smith Post author

      “Kicking the Fed” does not mean they can stop it. They’ll just make noise. But the point is they could channel their ire into some warranted measures.

      1. vlade

        Agree – but I believe this is politically acceptable for them (flame the US isolationism and exceptionalism) unlike doing the real thing – say supervising the banks at least as aggressively as say BoE does – and even that’d be in my view just first step, but at least BoE has Haldane who’s pretty vocal, unlike anyone at Fed.

        1. Francois T

          “unlike doing the real thing – say supervising the banks”


          Check The Daily Show segments ( here and here about Senate hearings on JP Morgan recent losses. The arse-kissing fest by senators on Jamie Dimon was so nauseating it takes double dose of Dramamine just to listen to it!

          The idea of US CONgress supervising the banks is a joke whichever way one wants to look at it.

      1. enouf

        the funny thing is;

        One truth is; We could’ve easily let our gov’t (if it were actually Legitimate and Constitutional and Lawful) *mint* a single (16T) $16,000,000,000,000 coin ..and it’d have the full faith and worthiness of WeThePeople behind it …

        The other truth is; All the Global Banks and Corps owe us (1.2Quadrillion)

        I’m still waiting for my first dividend check ;-)


  2. Philip Pilkington

    “…when even a sophisticated financial sector person such as Mitt Romney…”


    1. Clive

      Philip, hi, well… sarcasm is commonly held to be the lowest form of wit and I don’t think it was meant that way !

      But you’ve got a very interesting point there. Romney is the poster-boy of the 1%, friend of money-wielded-as-power, kissing cousin of the too-big-to-fails, would happily LBO his mother etc. Normally someone who I’d quite willing describe as part of the problem and a million miles away from being part of any possible solution.

      Compared, though, with the execrable Obama with his hurl-inducing faux group hug for the dispossessed — or at least, the powerlessly arbitraged against “ordinary person” — I’d probably have to take Romney and succumb to a hopey-changey illusion that he’d at least know enough to face down Wall Street. Kind-of-a “only Nixon could go to China” thing, only maybe better said “only Romney could kick Goldman’s ass”.

      I wouldn’t bet on it though. Fortunately as a non-US’er, it’s not a decision I have to make. Best of British luck to you, America…

      1. Yearning to Learn

        I’d probably have to take Romney and succumb to a hopey-changey illusion that he’d at least know enough to face down Wall Street

        what on Earth would make you think that Romney would face down Wall Street? He IS basically Wall St. His entire platform is pro-Wall St.

        There’s a better chance that Cardinal O’Malley of Boston will face down the Pope than Romney will face down Wall St.

        No, the only people Romney will face down is gays, minorities, the working class, unions, and anybody else who is not part of the 0.1% elite.

        not that Obama is much better, mind you. Sucks to be an American these days. We have a Sophie’s Choice in our political options.

  3. ella

    And ya think that the American Banks and Wall Streetes that benefit from the Swap lines will not ensure that the lines continue? Well take another look at Dimon’s testimony to the Senate. Now, tell me again that Romney will not support the FED and their Swap lines. Tell me again that Congress, most of whom benefit from campaign contrubution from the financial sector, will not support the Swap lines.

    The financial sector is far too powerful to be beaten back by Congress or the Administration. Even if there are issues with the Swap lines, there will be another program that does the same call by a different name. Count on it.

  4. Norman

    Strange how the most powerful man in the game, is nothing more than a shill for the shadow elite, a traitor to the people who depend upon his looking out for their interest, all for what? How soon will the shooting start?

  5. F. Beard

    In theory, this should be uncontroversial. Yves Smith

    Not really. It stinks. What is an arm of the US Government doing lending money to foreigners without Congress’s approval?!

    The Fed is providing dollars to foreign central banks. Yves Smith

    By creating them albeit temporarily IF the Fed is fully repaid. But how long is “temporarily?”

    Those central banks agree to return the currency at the end of the term of the swap. Yves Smith

    How long shall the new money exist, I wonder? Not that it matters from an ethical viewpoint – embezzling is still embezzling even if done for a short time. What is being embezzled is the US population’s purchasing power.

    The foreign central bank takes both the foreign exchange risk Yves Smith

    It’s not much of a risk since the Fed is creating new dollars. The Fed is thus creating the means of repayment. And the swaps are interest-free, no?

    and the credit risk of lending to banks in its purview. Yves Smith

    This is more problematic. Lending during a depression is risky. And if the foreign central banks have to scramble to get US dollars to repay the Fed then that will drive up the strength of the dollar and drive down the strength of their own currencies.

    1. Jack M. Hoff

      Beard said;
      “What is an arm of the US Government doing lending money to foreigners without Congress’s approval?!”

      Since when did the Fed become an arm of the govt? Last time I looked it was still a private entity.

      1. F. Beard

        The Fed and the US banking system in general is a fascist mix of public and private elements but the US government has the upper hand.

        1. stripes

          All they wanna do is take your money..freedom and independence. Not quite what the framers of the U.S.C. intended, right…?

        2. psychohistorian

          Please explain to us less in the know just how the government has the upper hand with our private banking FED.

          Or is that your blind faith in place of serious study showing again? Have you read Secrets of the Temple, for example?

          1. F. Beard

            Can Ben Bernanke order people killed?


            Can Obama?


            So who has the upper hand?

            Bankers are just counterfeiting schmucks without government privilege.

    2. JustAnObserver

      the “exorbitant priviledge” of being the world’s reserve currency comes at a price and that price will always become due – at the worst possible moment – during any global financial crisis.

  6. felix the rat

    Now that’s news you can use! Swap lines are the only thing thing I’m counting on, in a speculative sense. There’s no other risk worth taking. But as with everything in this banana republic, political risk is paramount. Hypothesis for testing: Obama’s used up. Best to let him bear the brunt of kleptocratic dissolution so Romney gets a honeymoon, a window for continuing predation on the masses. That means impending financial destabilization and retrenchment gets front-loaded, early autumn at the latest. It’s centrally-planned collapse, like Grantham’s presidential election cycle in reverse.

  7. wunsacon

    >> The reason these foreign banks occasionally need dollars is, mirabile dictu, they make loans in the US

    If these banks go bust after lending US dollars *anywhere*, who’s going to repay the Fed? And, given the condition of banks all over the world, isn’t that a real concern?

    1. Larry Barber

      The Fed is lending to foreign _central_ banks. They can no more go broke than the Fed can. Like the Fed they can always create enough money to meet their obligations.

      1. tiebie66

        They can’t print dollars though, can they? If they must print their own currency to exchange for dollars, we may need very large ships or more satellites…

  8. Susan the other

    We’re kinda right back where we started from in 1945. How are we going to get paid back? By giving generously of course. And if that doesn’t work we will devise an excuse to go to war in a resource-rich area of the world and loot until our coffers are full again. Or… if we do not want to disrupt peaceful globalization (which is so efficiently enriching the elite), we will just loot pension funds, the equity in property, property itself, any corporation with money in the bank, and any bank with excess reserves. Romney knows all about this.

    For me, the most salient point above by Yves was that the Fed does not have the sympathy of the people. Nor does Obama. If there were an effort to alleviate the current suffering and prosecute all the securities fraud, sympathies might change. So then, we know things will stay the same. And Romney will get away with his pandering. It’s a tragedy for the American people because it could have been different.

  9. Wandering Mind


    I am not sure whether this is the place to make this request, but here goes. Steve Keen has a rather detailed model of how increased borrowing adds to demand and bubbles.

    As you probably know, his argument is that banks make loans, then go look for the reserves they need to cover the loans later. The example he often gives is a bank making a loan to a company which manufactures something. The bank books the loan as an asset, creates an account for the borrower where it credits the customer with the amount of the loan and then, after that, goes out and gets the reserves it needs.

    However, in the subprime crisis, this was not how the process looked. A broker commits to a loan, sells the loan to a bank or other large lender, the loan is transferred a couple of more times and then is added to a pool which is used as collateral for bonds sold various entities. Meanwhile most of the proceeds of the loan go to the person selling the house or to a prior lender.

    So, I was hoping that at some point you or someone familiar with the securitization process can explain how the federal reserve or other central banks figure into the process of created the money used in subprime loans. I consider this important because, in order for Steve Keen’s theory to be correct, a central bank has to create the funds which are added to the system via the lending mechanism in his model. In other words, lenders have to be able to induce the central bank to turn on the money spigot, otherwise, the lenders are only competing for existing money supply.

    Any help which you or others can give will be greatly appreciated.

    1. F. Beard

      In other words, lenders have to be able to induce the central bank to turn on the money spigot, otherwise, the lenders are only competing for existing money supply. Wandering Mind

      Yes, but:

      1) The banks don’t have to borrow the entire amounts of the loans they make since some of the money they create by lending will remain with them in either the borrower’s account or end up in other of their customer’s accounts.

      2) The Fed must provide reserves as needed else interest rates will rise, or worse, checks might not clear.

      1. Wandering Mind

        I think I understand #1 and #2. I am trying to think through the flow of funds on a securitization, where the last entity in the chain is the purchaser of the bonds. Is there evidence that many of those bond purchasers (many of which are now owned by the fed) borrowed the money to purchase them?

  10. Hugh

    When this current round of currency swaps was announced, I said it was a de facto subsidy to European banks and increased Fed exposure to a European blowup. Basically, the Fed is making cheap dollars available to European banks. If those banks had to go out and search for them, they would have to pay more for them. Now you could say that search would drive up the price of the dollar versus the euro, making US exports more expensive. On the other hand, US imports from Europe would become cheaper. But it is not clear how much currency fluctuations would change the dynamics of the swaps deal. More importantly, the Fed is providing a service, a backstop, to foreign banks for which it is not being paid. Now I could support such efforts if the US were taking a leadership role in resolving the world’s kleptocratic institutions, but in this case it is acting to perpetuate them. And why exactly should the Fed be making up for the ECB’s failure to act in this crisis?

    Then too there is the question of what happens if Europe blows up. If the euro falls apart, what becomes of the ECB and its obligations? What does it mean to be the central bank for a currency that no longer exists, or that has become something radically different? Even if you say, the obligations would fall back on the individual countries, what does that mean if the economies of those countries are in chaos?

  11. sunny129

    FED is a cartel for global Banksters which is NO secret. They will do WHAYEVER to survive and also thrive with no regard to cost to rest of the society!

    They did IT(looting) in open day light in 2008. There is NO law or breathing regulators to prevent them from doing again!

  12. roaring mouse

    This printing and passing colorful paper in exchange for real goods and services cannot last forever or end well.

    Having a fast printing press and ‘reserve currency’ are currently pocket aces.

    At some point, surplus producers will demand hard assets.

    Then, a more effective military will represent pocket aces. The USA should be well positioned for another 10 years. . .

Comments are closed.