>   (email exchange)
>    On Thu, Dec 2, 2010 at 3:51 AM, Mike wrote:
>   It seems it was around 7 trillion notional. Do you know the durations?

No, haven’t read any details. I recall they were relative short but were extended maybe more than once.

>   If they didn’t act would the entire fx market have come to a halt.

Libor setting would have been higher for as long as the BBA kept the weaker banks in the basket.

>   Given that this lending is unsecured, what happens if a foreign central bank doesn’t pay?

The lender has no recourse and takes a loss.

>   Are there any constraints on this lending?

Just political. A nation can lend, spend, or toss down a rat hole any amount of it’s own currency it wants.

>   Finally, would clearing all fx swaps have prevented the fx “run” if the fed had
>   backstopped the clearinghouses?

Not sure which ‘run’ you are referring to?

But getting short a currency, spot or forward, means you are borrowing it, directly or indirectly, and none of the currencies in question are ever ‘quantity constrained’. What triggered the swap lines was the desire of the Fed to get libor settings lowered.

The large dollar borrowing funded by the Fed swap lines was done because foreign banks with presumed credit issues were bidding up libor and driving up the libor settings which was driving up home mortgage and other rate settings in the US. The Fed brought the rates down by facilitating lending at lower rates to those weaker credits via the ECB and other CB’s. (That would have been my last choice on how to get those US rates down, but that’s another story.)

Does this help?

18 Responses

  1. Yes, it does help, and would help more if more of Congress listened, or understood.

    It drives home the fact that our current monetary practices are an operational nightmare – and that the FED is out of control.

    Screw LIBOR! Where do their allegiances lie? Too much complexity & confusion invites mismanagement & outright fraud, innocent or not.

  2. I would say Matt Drudge is not a fan of Ben Bernanke…


    He’s talking about the Fed acting as lender of last resort in the commercial paper market. Actually, keeping GE or Verizon (among others) in business is far more important to the real economy than GS or Citi. Hell, considering that GE is one of our biggest defense contractors and Verizon helps out the NSA in their various good works, President Bush could have issued an executive order for Tsy to take over the commercial paper market under the Defense Production Act (if Paulson was so ignorant of the law he didn’t understand the repercussions of a Lehman bankruptcy filing, there’s no way his team of back of the phonebook lawyers thought to consult with the Pentagon about the DPA).

    The Act contains three major sections. The first authorizes the President to require businesses to sign contracts or fulfill orders deemed necessary for national defense. The second authorizes the President to establish mechanisms (such as regulations, orders or agencies) to allocate materials, services and facilities to promote national defense. The third section authorizes the President to control the civilian economy so that scarce and/or critical materials necessary to the national defense effort are available for defense needs.

    1. National defense? Was America under military attack when all this was going down? I don’t recall Congress declaring war on anyone…exept maybe on drugs and poverty which appear to be two lost wars.

      1. Are you serious?
        All those people in uniform standing behind the President in Afghanistan today weren’t postal workers.

      2. From a recent article by retired Senator Fritz Hollings…

        All we need to do is enforce the War Production Act of 1950 like President Kennedy did in 1961. We brought the witnesses to a Cabinet hearing that found textiles as the second most important to our security than steel. Kennedy saved the textile industry.

        I think a functioning banking system is as least as important to our security as textiles, but your mileage may vary.

  3. It might be good to note that during the intial time of these swaps, the official Libor number and the “on the street” Libor numbers were two different things entirely.

    The BBA puts out a Libor fixing that most people realized was a sham. Yes, some banks could borrow at that rate, but not all. These swap lines were designed – at least in part – to “reliquify” the repo markets which had shut down nearly entirely.

    I would imagine the Fed was in a panic. They could see if the real Libor rates were actually posted it would drive U.S. rates through the roof. The traditional liquidity channels of the major banks were all completely suspect – so giving them trillions would not solve the problem. The lending had to come directly from the central banks for it to have credibility. Hence, the fed steps in.

    Also, because of the institutional constraints of the ECB, it was impossible for them to act like the Fed did. So the fed had provide the liquidity for much of Europe as well.


    I do like the ICAP number a bit better, but it failed once the crisis hit and has never seen any activity since then. There are other numbers out there that may also be interesting to trade. But in some way, if Libor didn’t exist, then it would be invented.

      1. Banks will index to whatever they want to. It’s a private contract between two parties. If they want to index to CPI, or unemployment, or the price of cheese in europe, or CDS swaps, then they will index to that.

        I think they can even use sines and cosines.

      2. Right.

        The Fed will run a regression of loan rates and LIBOR, and if it turns out that the correlation is too high, the Fed does what? Arrest the loan officer? Fine the bank? Cut off discount window access?

      3. the regulators examine the loan contracts and will indeed come down hard on the officers if they violate regulatory direction.

        yes, a loan indexed to fed funds will track with libor most of the time.

        that’s not the point.

  4. There is another LIBOR which can be derived from taking the average of CDS for the 16 banks included in the daily BBA canvassing of LIBOR. The average 5yr CDS spread for these banks got as wide as +220bp over the LIBOR swap curve in mid-March of 2009 and it now stands at around +125bp.

    Before the onset of the credit crisis the average of 5yr CDS for these banks was about 5-10bp over the LIBOR swap curve which makes intuitive sense because it used to be that a prime swap dealing bank could issue a 5yr bullet bond and swap into floating LIBOR flat or plus or minus a few basis points.

    Now one has to wonder how it can be that the average of CDS for the banks that quote LIBOR is +125bp wider (higher) than the term structure of LIBOR itself?

    1. Past time for another cabinet meeting. Reading about such things on WikiLeaks, long after the fact, isn’t quite the same.

  5. “the regulators examine the loan contracts and will indeed come down hard on the officers if they violate regulatory direction.”

    Except that regulators don’t have this power and don’t “come down hard”.

    You are describing a different world than the one in which we live, and I doubt that congress or the supreme court would grant that type of power to an unelected regulator, and certainly not the Fed.

    Currently, the FDIC is the one who examines the books, but for purposes of overall soundness, rather than for purposes of trying to manage lending rates. They can’t close a bank because it lends at rates that are different from FedFunds — it doesn’t have that authority.

    And of course most lending is not done by banks anyway, and is not subject to FDIC or Fed oversight, but SEC oversight. The SEC does not have the authority to do this either.

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