Fed throwing unsecured $ loans at the world to keep libor down.

They are all in this way over their heads.

On Sun, May 9, 2010 at 9:09 PM, wrote:


32 Responses

  1. I’m sorry for asking such a basic question, but why is the London Interbank Offered Rate the problem of anyone other than, well, London?

    The US banking system already has its own interbank market rate, using LIBOR seems to be like driving to another state to use the Post Office (come to think of it, the only people who do THAT generally end up in FBI custody sooner or later).

  2. IIRC, the Fed used to have a regulation the capped interest at 5% or so. When market clearing rates rose dramatically in the late 70’s, large depositors took their money off shore to get market clearing rates. Small depositors had to satisfy themselves with free toasters …

    Another example of well thought out government regulations.

  3. the swaps are secured by “ECB-eligible” collateral, so they aren’t unsecured. The collateral may be worthless at some point, but that’s a (slightly) different argument.

    1. I believe that the ECB will be making dollar loans to European banks secured by ECB-eligible collateral. The Fed’s loan of dollars to the ECB is only secured by an equivalent amount of Euros held in the Fed’s account AT THE ECB. The reason Warren calls it unsecured is that the Fed has to leave the Euros untouched in its account at the ECB. If it tried to do anything with them (e.g. sell them), it would defeat the purpose of the whole exercise. So the collateral that the ECB gives to the Fed is completely under control of the Fed. The dollars that the Fed gives to the ECB are immediately loaned out to banks in exchange for ECB-eligible collateral put up at the ECB. The ECB holds everything.

      In addition, no government actually stands behind the ECB or has direct control over it. As far as I know, it is just a tall building in Frankfurt with a bunch of unelected bureaucrats and a few computers.

      1. “So the collateral that the ECB gives to the Fed is completely under control of the Fed.”

        Sorry, this should read “… completely under control of the ECB.”

      2. Ah yes, you’re right. The press release referred to “operations” which I interpreted as btwn the Fed and ECB but they are between ECB and whomever it is lending to. Agreed that it’s a gray area of collateral if the ECB reserves become value-less. Setting aside the sovereign risk at the ECB, aren’t they getting the same treatment–credits at their account with the Fed which cannot “leave” the Fed but of course can be exchanged with countries and banks that have accounts at the Fed (or accounts with entities that have accounts at the Fed).

  4. so what type of Euro denominated collateral is worth more than a Euro deposit with the ECB?

    if its dollar collateral you prefer, that defeats the purpose of the swap

    so if you’re opposed to the facility, you’re opposed to it because its a swap for Euros, not because of the collateral aspect

    1. Agreed – I don’t see this are more risky than TALF, TAF, PDCF, or any other alphabet soup program. And remember that the Fed lended against the equity of bankrupt business in those programs, and is now fighting tooth and nail against any disclosure of the collateral that it accepted.

      1. Actually I don’t see it as risky at all! I mean depends on what you call “risk” – as RSJ pointed out – its all the lending facilities such as PDCF that were risky.

        A central bank like the ECB cannot go “bankrupt”. The swap lines may have conditions which say that the ECB has to pay back more dollars to the Fed if its not able to pay back on time. The ECB can acquire dollars anytime by purchasing it from the market and increasing its Euro-liabilities.

        Of course if the whole Euro Zone goes down, the ECB will no longer be a central bank, so there is a risk in that sense. I see it as cooperation – helping in bad times.

      2. Agreed — let’s hope the Eurozone goes down the tubes, then.

        The Fed can deal with the loss of dollars, and the Euro-periphery deserves a chance to be more competitive and to consume less without the added consumption hit coming from high unemployment and wasted resources.

        I would be willing to “lose” a trillion USD this way.

      3. Besides, if anyone needs market discipline, it would be the ECB staff. I think Trichet would benefit intellectually from a period of unemployment. So would Bernanke.

      4. Ramanan,
        The ECB yesterday posted an updated Settlement procedure for this go around.

        Link here, does address some exchange risk to Eurosystem in annex(4 pages total). I would again point out that the FRBNY makes deposits into accounts via intructions from the NCBs and European institutions are required to return the funds to the NCB accounts at the FRBNY, ie the “ECB” does not have an account at the FRBNY.

        Looks like first one week operation went for 9.2B, link here.


      5. Matt,

        Not sure about your comment about the ECB’s account. I think you once mentioned that the ECB’s balance sheet is actually the combined balance sheet of the NCBs. I found out however, that the ECB has a balance sheet of its own (and is audited by PWC). The annual report has the BS.

        In fact it has the balance sheet of the Eurosystem as well.

        In fact, you can see the swap lines appearing in the ECB’s balance sheet in the annual report.

        Here: http://www.ecb.int/pub/pdf/annrep/ar2009en.pdf and http://www.ecb.int/pub/pdf/annrep/ar2010annualaccounts_en.pdf

        You can see the reference to back-to-back swaps in the report. Also if I remember correctly, the ECB requires all the NCBs to transfer foreign exchange except gold and SDRs to its books.

        “The ECB simultaneously entered into back-to-back swap transactions with euro area NCBs, which used the resulting funds to conduct US dollar liquidity-providing operations with Eurosystem counterparties in the form of reverse and swap transactions. The back-to-back swap transactions between the ECB and the NCBs resulted in intra-Eurosystem balances between the ECB and the NCBs reported under “Other claims within the Eurosystem (net)”. ”

        My point is that ECB, being a central bank of developed nations will always manage to return the dollars to the Fed.

      6. Btw – I also found how TARGET2 settlements are settled EotD.

        Intra-ESCB balances/intra-Eurosystem balances

        Intra-ESCB transactions are cross-border transactions that occur between two EU central banks. These transactions are processed primarily via TARGET2 – the Trans-European Automated Real-time Gross settlement Express Transfer system – and give rise to bilateral balances in accounts held between those EU central banks connected to TARGET2. These bilateral balances are then assigned to the ECB on a daily basis, leaving each NCB with a single net bilateral position vis-à-vis the ECB only. This position in the books of the ECB represents the net claim or liability of each NCB against the rest of the ESCB.

      7. Ramaman,
        Thanks for the links (I never found them).

        ECB balance sheet looks pretty small compared to the Euro system’s operations.

        My point was that based on info in the settlement procedures, it looks like the “ECB” doesnt have an account with the FRBNY. I would think if they had one, it would be used in this case (Fed could focus the reponsibility to one entity). Maybe there is a requiremnt that to have an account with the FRBNY, you have to be the domestic US Treasury, a depository institution, or a central bank of a recognized sovereign government? the “ECB” wouldnt qualify.

      8. Matt,

        I think The ECB doesn’t do much and asks the NCBs to carry out the operations, so its BS size is small. Also, there is some netting going on in the balance sheet. The actual size – depending on how you count – may be huge. The intra-Eurosystem balances are netted. For example if the Bank of Greece owes €50B to the ECB and the ECB owes €100 to German Bundesbank, its reported as €50 in liabilities instead of €50 in assets and €100 in liabilities.

        According to the swap agreement released by the Fed, the ECB has an account at the FRBNY See 4(c) here http://www.newyorkfed.org/markets/FRBNY_ECB_Swap_Agreement.pdf

      9. Ramanan,
        Great find! It looks like the Fed may have demanded that the ECB set up an “account” for them at the “ECB” for this go around in Section 2a. This may give them more confidence.

        4(c) reads like the the Fed is going to “account on the books” (asset account? sort of “USDs Receivable?”) in the name of the ECB but the settlement procedures that the ECB posted on May 10 identify the following: “On the settlement date, market counterparties are required to deliver eligible euro-denominated collateral to their local NCB by 16:00 Frankfurt time for operations with a duration of approximately 7 or 84 days. …. On receipt of such collateral, the NCB will submit the corresponding US dollar payment instruction to the Federal Reserve Bank of New York (FRBNY) as soon as possible thereafter and ideally before 20:00 Frankfurt time on the settlement date. On the maturity date, market counterparties are required to pay back US dollar funds to the accounts of NCBs at the FRBNY by 16:00 Frankfurt time….”

        so consider that perhaps the ECB does not have an “operational account” if you will or maybe the correct term is a ‘system account’ at the FRBNY, the tranfers seem to be made to the NCB accounts.

        But the document you posted does have the signatures af all the major players, and looks like it lays out the general agreement that the ECB is supposed to guaranty the Fed against losses. (not withstanding Warrens above observation that they may be able to just roll over any defaults?)

      10. Matt,

        Good detail about the NCBs role in the document. I would imagine that the NCB will make a SWIFT transfer because the ECB would have done a back-to-back swap with the NCBs in the meanwhile. If the NCBs were directly involved, the balance sheet of the ECB would not have grown so much as shown in the annual accounts of the ECB pdf(2008 column). So depending on how the credit institutions in the Euro Zone bid, the NCBs will notify the ECB about this and they do a swap between themselves in the meanwhile before the settlement between the NCBs and the CIs.

      11. lending to fdic insured, regulated, supervised member banks that qualify for gov insured deposits in any case adds no risk to the US gov.

        lending dollars to any other central bank carries risk. in fact, all govt defaults have been in foreign currency denominated debt, and mainly dollar debt (or fixed fx blowups which are similar).

        And i didn’t say the US should not do it. I did say the Fed being able to unilaterally do it would not be the case if Congress understood what was happening. Congress is about fiscal transfers, which is what this could be worst case.

        Last but not least, it’s all being done only to keep libor settings i check. it’s not ‘aide’ to anyone for any other purpose but to keep dollar interest rates down.

      12. “lending to fdic insured, regulated, supervised member banks that qualify for gov insured deposits in any case adds no risk to the US gov.”

        Assuming the banks are perfectly regulated, that the distribution of risks, including tail risks, is 100% understood and perfectly accounted for, and assuming no operational risk on the part of the borrower, I agree. That set of assumptions will swing you to a riskless model.

        Back in reality, the Fed is losing money on its Maiden Lane venture as well as AIG bailout, and has lost money on loans it made to the smaller TARP banks, while the FDIC lost tons of money in the RTC bailout. Moreover Treasury is losing money hand over fist with the Agencies, with Fannie just asking for another 8 billion and saying that it would not be profitable in the forseeable future.

        As far as I can tell, all of these were insured, regulated, and supervised entities.

        Meanwhile, I’m not aware of any money lost via swap lines to foreign central banks.

        So what can be the definition of “risk” in which real losses can and do occur in the activity that “carries no risk”?

      13. RSJ,

        I think Warren’s point (although perhaps not 100% correct) is that Fed lending to FDIC insured institutions adds no NEW risk to the US govt. The US govt is already on the hook for the liabilities of these institutions, so bailing them out is not putting additional dollars at risk. In fact, a TARP-like bailout could have just as easily been accomplished by providing regulatory relief on capital requirements.

        The point is not 100% correct for two reasons. First, the US govt is not on the hook for 100% of the liabilities of FDIC-insured banks, and second, sometimes you end up throwing good money after bad when you keep a bad bank alive long after it should have been wound down.

        I supported TARP because the banks that were saved had valuable franchises, and it was in everybody’s interest to not see that value evaporate. It would have been nice to see bank shareholders lose a bit more than they did and to see bank bondholders take a bit of a haircut, but I guess that’s easy to say with 20/20 hindsight.

        I would have liked to see Fannie and Freddie bondholders and MBS holders take a haircut too. Not a big one. Maybe just 5% or so. Would have been a nice lesson in the difference between an implicit and an explicit guarantee.

      14. ESM,

        I can see how a banker would believe that the USG is on the hook for the banks liabilities, and the political realities may be such that this is true, but the legal realities are different.

        The government is only on the hook for about 30% of the bank liabilities — those covered by deposits. The remaining 70% of bank liabilities are to bondholders and equity holders, and the government is not on the hook for those. This is a long running dispute that I have with Warren, in that in his mind depositor insurance has been transformed into bondholder insurance.

        But when the government lends to a bank — then the government becomes the bondholder, and indeed there is a new liability.

      15. Again, Warren, your argument, for it to hold, requires that 100% of bank liabilities are held by depositors and are therefore guaranteed. This is not the case — banks have fewer liabilities to depositors than they have to bondholders and equity holders.

        Seriously, is this something that they teach bankers explicitly — that bondholders are FDIC insured — or does it come about through years of bailouts and mental training?

      16. RSJ,
        heres a link to BofA’s latest edgar. (Deposits 1T, Assets 2.3T)

        heres a link to a smaller bank “on the brink” (imo) in my area, (1.2B Deposits, 1.4B assets)

        Perhaps for the giant banks the deposits are less %, but Ive watched some of the failures in my area and these tiny banks seem to rely on high % deposits (probably find it hard to issue/sell their own securities).


      17. You are absolutely right Matt, that the bigger banks rely more on selling bonds and the smaller banks rely more on deposits. The distribution is not uniform. But in general there are about 7 Trillion of Deposits, and about 16 Trillion in financial sector debt. It’s complex, as a lot of that debt is issued by ABS issuers that are SIVs created by the banks as off-balance sheet liabilities, etc.

        But in any case it is not the small banks that were the recipients of extra-ordinary interventions and CB loans.

        This is part of the notion that the government is responsible for 100% of bank liabilities, which seems to be tightly woven into the DNA of bankers. Only in that context can argue that a loan to a FCB is more risky than a loan to a domestic bank — you are just assuming that 100% of domestic bondholders will be bailed out regardless of what happens.

      18. Banking 101 question: Why do banks sell bonds in the first place if they can borrow from the FED or in the federal funds market?

    2. NCBs, ECB, and ESCB all have different but intersecting balance sheets.

      ECB includes intra-system entries, but not all NCB entries.

  5. thanks, Matt!

    so does the ecb keep its dollars and other currencies, if it has any, all at the ncb’s?

    seems it would have a dollar acct at the Fed even if it isn’t using it for the swap lines?

  6. jcm,

    Not sure how your Q is related to the swap lines, so taking it out if the thread….

    It all depends on how accomodating the central bank is. If the central bank discourages borrowing from the discount window or whatever its called in other countries, banks will keep more reserves with themselves and more government bonds. When someone needs to borrow, the banks will sell the bonds to non-banks and get a deposit reduction and since loans make deposits, the new loan made will bring back the deposits to the original level, so that banks are still satisfying the reserve requirement.

    This used to be the case in many countries in the 70s and the 80s and doesnt apply any longer. banks do not need to sell government securities to make loans.

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