Brad Setser

Brad Setser: Follow the Money

Print Print Email Email Share Share Cite Cite
Style: MLA APA Chicago Close

loading...

More extraordinary moves: $620 billion is real money, and it isn’t even for American financial institutions …

by Brad Setser
September 29, 2008

Give the world’s central banks credit for using swap lines to cobble together a global lender of last resort:

The Federal Open Market Committee (FOMC) has authorized a $330 billion expansion of its temporary reciprocal currency arrangements (swap lines). This increased capacity will be available to provide funding for U.S. dollar liquidity operations by the other central banks. The FOMC has authorized increases in all of the temporary swap facilities with other central banks. These larger facilities will now support the provision of U.S. dollar liquidity in amounts of up to $30 billion by the Bank of Canada, $80 billion by the Bank of England, $120 billion by the Bank of Japan, $15 billion by Danmarks Nationalbank, $240 billion by the ECB, $15 billion by the Norges Bank, $30 billion by the Reserve Bank of Australia, $30 billion by the Sveriges Riksbank, and $60 billion by the Swiss National Bank. As a result of these actions, the total size of outstanding swap lines is $620 billion.

All of the temporary reciprocal swap facilities have been authorized through April 30, 2009.

Dollar funding rates abroad have been elevated relative to dollar funding rates available in the United States, reflecting a structural dollar funding shortfall outside of the United States. The increase in the amount of foreign exchange swap authorization limits will enable many central banks to increase the amount of dollar funding that they can provide in their home markets. This should help to improve the distribution of dollar liquidity around the globe.

hat tip: Alphaville

Call this a consequence of the emergence of Europe (and London in particular) as an offshore banking center for the US. A host of European institutions (and probably some US institutions too) without US dollar deposits seemed to have dollar funds to buy dollar-denominated securities during the peak of the boom. And well the boom is turning to bust.

I suspect this activity explains all the risky bonds — including asset-backed securities — that the US sold to investors in the UK during the peak of the boom. And I also suspect the collapse of this activity explains the sharp fall in both inflows and outflows in the United States balance of payments data. Much of the “shadow” financial system was offshore.

These swaps lines — essentially dollar loans from the US Federal Reserve to central banks outside the US with their currency posted as collateral — are a way to provide financing to European and other financial institutions that need dollars.

When the current crisis ends, the regulatory structure for this global market will need to be rethought. And I would hope that the UK would also reconsider its aversion to making the investments needed to collect decent capital flows data — data that might have helped us understand the buildup of vulnerabilities in advance.

34 Comments

  • Posted by Dave C..

    Even the $620 billion Central Bank swap and the $700 billion taxpayer bailout for Wall Street won’t be enough! As per Economist Marc Faber, US Banking institutions require a $5,000 billion taxpayer bailout of their balance sheets. Where the hell are we going to get that amount of money without devaluating the US Dollar into toilet paper? We might as well hang the bankruptcy sign on the entire US Bubble Economy.

    http://www.bloomberg.com/apps/news?pid=20601103&sid=a9woTYK2OKWI&refer=us

    Sept. 26 (Bloomberg) — Marc Faber, managing director of Marc Faber Ltd. in Hong Kong, said the U.S. government’s rescue package for the financial system may require as much as $5 trillion, seven times the amount Treasury Secretary Henry Paulson has requested.

    “The $700 billion is really nothing,” Faber said in a television interview. “The treasury is just giving out this figure when the end figure may be $5 trillion.”

    “The decline in home prices of 20 percent is a relatively minor decline so far and it has created so many problems,” Faber added. “The US is in much worse shape” than Japan was when its stock market crash ushered in a decade-long slump in 1990.

  • Posted by satish

    Everything worse has happened to world economy.
    Only one crisis is left. That of peak oil.
    Oil at 250 to 400 dollars per barrel will be the nail in the coffin for the current world’s euphoria

  • Posted by Twofish

    It wasn’t UK investors. A lot of the purchasers were European banks were buying supposedly AAA-rated securities so that they could meet their regulatory capital requirements under Basel II.

    Also I don’t think that this is a data collection problem. All of the data about who was buying what and why was there. It’s just that no one thought that it was necessary to do anything about it. My point is that it’s no good collecting data, if no one is going to do anything with it, and collecting more data which is not being used just obscures what is going on even more.

    The really important thing to realize is that everything that you’ve been seeing in the last three weeks. All that is just the beginning…….

  • Posted by JKH


    “A host of European institutions (and probably some US institutions too) without US dollar deposits seemed to have dollar funds to buy dollar-denominated securities during the peak of the boom. And well the boom is turning to bust.”

    The Eurodollar banking system has been a major force for a long time – at least since the OPEC crisis of the 70’s if not before. Foreign banks have long been funding hundreds of billions if not trillions of assets in the dollar (i.e. Eurodollar) interbank market. The accumulation of US mortgage assets in this system is just another US dollar asset class to have been funded in part by it. The global nature of the dollar based credit crisis is very much a function of the established global nature of the Eurodollar interbank funding system.

  • Posted by bsetser

    JKH –the scale of offshore intermediation grew dramatically over the last 5 yrs (judging from the increase in US debt held by UK based entities) and i think funding shifted from offshore dollar deposits to the sale of dollar denominated securities … correct me tho if i have that wrong

  • Posted by JKH


    Brad,

    I’ve no doubt you have it right. My point was only that major foreign banks have run large dollar Libor based funding books as part of their core operations for a long time. This was the foundation on which they built their more exotic asset and funding activity over the last several years, in parallel with domestic US banks – hence the requirement now for dollar liquidity from the Fed, in parallel with their domestic US counterparts.

  • Posted by otto

    As I read the bill yesterday, Paulson has a $700m limit at any one time. This (i believe) means that the fund can be used as some kind of clearing station, toxic contents can be first loaded on board and then booted on to some other place, the fund reset to (theoretical) zero and filled with more toxicity ad infinitum.

    Thus Faber gets his $5 trillion (whatever that looks like as a stck of C-notes)

  • Posted by otto

    Fe erratum: make that “700m” above $700Bn.

    With all these million billion trillion squillion numbers floating around, it’s far too easy to get confused.

    This is what they meant as “interesting times”, right?

  • Posted by anon

    Brad, is “interest on reserves” as proposed in the TARP basically admission that Treasury can no longer raise enough funds, via treasury issuance, to sterilize Fed operations ?

    If Fed/Treasury can no longer hit Fed funds in a market-oriented way and must resort to setting Fed Funds by fiat, that’s tantamount to printing money. They are signalling they are going to flood the system with USD (if the bill gets passed) and let the banks do the sterilization themselves.

  • Posted by manch

    How come we are not seeing any sovereign defaults yet? Will this be the only major worldwide liquidity crunch without emerging countries defaulting on their loans?

    Which emerging countries are the most vulnerable now? I know you guys want to say USA but please, let’s be serious here. :)

  • Posted by Twofish

    manch: How come we are not seeing any sovereign defaults yet?

    It’s because the emerging markets learned from the last time this happened and they all have massive cash reserves.

    Also, don’t expect many hedge funds to go under. Their prime brokers have been limiting the amount of leverage they have and have put a lot of effort into fixing borrowing standards.

    manch: Will this be the only major worldwide liquidity crunch without emerging countries defaulting on their loans?

    The first perhaps. Things change, and I’m reminded about the old saying about generals fighting the last war.

  • Posted by gillies

    correction : for $700 billion, read – zilch.

    correction : for same old same old oligarchy, read – democracy.

    correction : for bush legacy, read – bush bankruptcy.

    the crisis has turned political, as it surely had to. 228 is bigger than 225 and that trumps all the other numkbers and all the other cards on the table. deal ‘em out again, pardner.

  • Posted by gillies

    o k 228 is even more bigger than 205. deal them out again.

  • Posted by Twofish

    Oh well…..

    It’s only money….

  • Posted by manch

    It would be a miracle if _ALL_ emerging countries keep clean books… The recent surge in commodity price helps a lot I suppose, but prices have fallen a lot this year. Any country in South America that’s shaky?

  • Posted by Anon

    Twofish,

    whats the worst-case scenario if Congress does not pass the bill?

  • Posted by ReformerRay

    The FRB is doing its job to provide liquidity where the private market cannot.

    What is the best case scenario if the bill fails? The cleansing of banks and financial institutions that are heavily into toxic assets will continue. That is a very important job of markets. Japan is the poster child for what happens while banks are not allowed to fail.

    Credit is not going to disappear completely, as some fear. Many banks and insurance firms stayed away from the most toxic assets.
    These responsible banks and new banks will provide the credit needed – at a higher rate of interest and with better lending standards.

    That is the kind of clean up we need, right?

  • Posted by gillies

    money ? – it’s only fiat pixels.

    paulson and bernanke never had to face the electorate. that is one reason why this may have come as a surprise to them. if the people – who seem to have pressured the lesser lawmakers by e mail, letter, and fax – have caused them to rebuff not only bush and bernanke and paulson, but obama, mccain, buffet, and pelosi . . . . . . the people are in the mood to storm the bastille of oligarchy, at whatever cost to themselves.

    is there a guillotine in guantanamo ?

  • Posted by Twofish

    gilles: the people are in the mood to storm the bastille of oligarchy, at whatever cost to themselves.

    It’s both sad and frustrating to see people march themselves off a cliff.

    ReformerRay: Japan is the poster child for what happens while banks are not allowed to fail.

    And the United States in 1932 is what happens when banks are allowed to fail too quickly. The problem is that when a bank fails there is a *huge* amount of cleanup.

    ReformerRay: Credit is not going to disappear completely, as some fear.

    It’s already gone. The only people lending money on the bank-to-bank market right now are the central banks. There are no banks offering loans right now to each other.

    ReformerRay: Many banks and insurance firms stayed away from the most toxic assets.

    They thought they did, but the cancer has spread too deeply and widely for anyone to be untouched.

    ReformerRay: These responsible banks and new banks will provide the credit needed – at a higher rate of interest and with better lending standards.

    No. Noe that banks are all in survival mode, they are going to start refusing to lend to anyone at any interest rate. Why should they? No one knows who has bad assets. Even the people who have bad assets generally don’t know that they have bad assets.

    My hope right now is that either 1) I’m completely wrong about the situation or 2) that if I’m right, the system falls apart slowly. People are very angry right now, but if the system falls apart slowly then there is a chance that people will get less angry and more worried while there is still time to do something.

    If the Dow has two or three more days like today (which is a very real possibility) and we see a continuing stream of bank failures over the next week (which is also a very real possibility), we might have an “oh my God, my job and life savings are at risk” moment (which is also a real possibility).

    One of the more difficult parts of this personally is trying to be constructive and fix the problem while people are screaming that you are a dirty, nasty bastard. Anyone succeed or fail, I did whatever I could.

  • Posted by Michael

    I guess we don’t have to worry any more about a “worldwide glut of dollar liquidity” that Greenspan and Bernanke glibly presented as the total explanation for the colossal underpricing of risk for the last ten years.

  • Posted by Richard

    What if the US Treasury – with TARP, is really just trying to fund it stake at the SWF table. A $750bl stake full of US mortgages. It’s already conserved some of the sweetest fruits the US would have to sell in a post economic disaster scenario. Freddy, Fanny and AIG. Thank you Henry.

  • Posted by APB

    Brad:

    I would highly appreciate your views on the current state of the fed balance sheet, which seems completely out of whack every day, and certainly beyond the understanding of an amateur like me.

  • Posted by gillies

    the irish stock market fell 13% today – closing b e f o r e the vote was taken. the dow only fell 7% or so – afterwards. there are a lot of people going over this cliff. so whatever we say about america from afar – we are all in the same globalised boat.

    - and as for your election : for non stop thrills and spills, human drama, special effects, endless plot twists, and sheer entertainment, it would be hard to beat.

    i am pleased that the bailout fell victim to the people. it was not going to change things enough, or fast enough, anyway – so better that it goes this way.

    i see the entire global financial arrangements being renegotiated starting from a blank sheet of paper. secondly, i suspect that a conference might not even be held in america. maybe in paris ? ? ?

    from being slow moving and financial, the next act could be fast moving and political. they might just have to shut all the markets and talk ?

  • Posted by Twofish

    gilles: i am pleased that the bailout fell victim to the people. it was not going to change things enough, or fast enough, anyway – so better that it goes this way.

    One of the problems is that people are seeing this as some sort of Hollywood movie that doesn’t affect them. When people go get cash from a cash machine or have a paycheck deposited in their bank account, it’s part of this hugely complex and enormous financial system that is right now in the process of unraveling.

    Whatever thrill there is in “teaching those bastards” a lesson is going to very quickly dissipate once people figure out what an expensive lesson it is.

    gilles: from being slow moving and financial, the next act could be fast moving and political. they might just have to shut all the markets and talk ?

    The problem with shutting down the markets is that it is like shutting down the power grid. It just can’t be done without causing even more widespread chaos than already exists.

  • Posted by KnotRP

    Twofish – the reason all the banks are hurting is because they all drank heavily from the punchbowl last night.

    I have over half a million in T bills right now. I’d lend it, or buy a house, if the cash flow made sense. But it doesn’t. The markets will unlock when the math makes sense again. Stop trying to delay the inevitable – this is a large part of the problem.

    I’m against the current 106 page bail out.
    I’d be behind a new bank with new uncorrupt employees backed by $700B in tax payer capital.

    If you want lending to begin again, the looting has to stop.

    I’m about to move my money out of dollars as it turns over, if this crap continues.

  • Posted by Twofish

    One really sad thing is that politicians have been crying wolf for so long that when the wolf finally comes, no one believes them.

  • Posted by KnotRP

    Twofish – it the real wage growth. If a plan doesn’t fix that, or fix the debt overhang on consumers, it’s just good money after bad. This has been all about wanting a free pony, and throwing a tantrum when said pony is not delivered.

    As I said – I have over half a mill I could put to work tomorrow…I could by a second and rent it, whatever….but you want me to just fling it around to save all the spendthrift looters? Homey don’t play that way.

  • Posted by KnotRP

    Bailout supporters seem intent to jump out of the DJIA frying pan into the Dollar Decline fire….

    Lending has stopped because folks are certain the losses have not hit their final resting place.

    This crisis will not be over until someone takes the full Roubini measure of a hit and the all clear sounds.

    If future “tax payers” are going to take the hit, you can just hear the whoosh of capital flight coming….

  • Posted by Twofish

    KnotRP: As I said – I have over half a mill I could put to work tomorrow…I could by a second and rent it, whatever….but you want me to just fling it around to save all the spendthrift looters.

    The problem here is that very few companies operate on a cash basis. Shoe factories borrow money to buy leather to make shoes to sell to customers that pay money that repay those loans. Once these commercial paper markets start closing down, then shoe factories or anyone else can’t find short term funding to do anything at all. Once you lay off all of the shoemakers then there is no one left to buy shoes or anything else and the math will never work out.

    One misconception here is that you are writing a $700 billion check to pay for new things. It’s not that way at all. What is going on is the same as if you go to your mailbox and see a bill from your credit card companies saying you owe them several hundred billion dollars, and that money has got to be paid one way or another.

    Anyway, I should probably now say much more because it is too depressing for me to think too much about. In any case, no one is going to believe me. It may be that I’m totally wrong about this, which is fine by me. However, if I’m not, then people aren’t going to believe me until they themselves see some real pain hitting them, and hopefully it won’t be too late to do anything about it.

  • Posted by KnotRP

    Two fish – like I said, I have money to lend, if the math makes sense….corporate bonds or otherwise. You seem to want me to be forced to lend via the tax payer route, BECAUSE the math doesn’t make sense.

    How do you figure that’s going to fly?

  • Posted by Hank Roberts

    Was there really a “worldwide glut of dollar liquidity” — or was that an illusion caused by some leverage or multiplier that was out of line?

    There must be a “lessons learned” for this and I assume it’s like an aviation accident — the first mistake happened hours (years) ago, and then a series of other things had to go wrong, be done wrong, or be ignored for the eventual controlled flight into terrain (financial crash).

    No black box recorder to be found though.

    And I suppose they can’t pick up all the pieces and arrange them carefully in some huge hangar, label them all, and look for the place someone put in a counterfeit bolt that lost its head under stress, or the like.

    Pity.

    Seriously, for us ordinary folks out here — who wondered at the “awash in liquidity” idea when it was so prominent because it never trickled down — was that the first place there was an illusion relied on??

  • Posted by qingdao

    I am illiterate. I have deposited my savings in the bank year after year. When the salesman (at the bank) recommended me the minibonds as the most suitable financial product for retirement, promising higher interest rate and low risk, I invested HK$500,000, all the money I have saved from decades of manual work…”, said an old man in trembling voice on a meeting organized by the Consumer Council of Hong Kong.

    Together with the old man, hundreds of ordinary citizens, mostly elderly, seeing their lifesavings evaporate along with the collapsed US investment bank, were accusing the banks’ mis-selling, and the Securities and Futures Commission (SFC) and the Hong Kong Monetary Authority (HKMA)’s ineptitude.

  • Posted by Lyle B.

    Twofish: There are no banks offering loans right now to each other.

    Are you in a position to *know* that? It’s a pretty extreme statement.

    ReformerRay: These responsible banks and new banks will provide the credit needed – at a higher rate of interest and with better lending standards.

    Twofish: No. Now that banks are all in survival mode, they are going to start refusing to lend to anyone at any interest rate. Why should they? No one knows who has bad assets. Even the people who have bad assets generally don’t know that they have bad assets.

    I know what assets I have, and my banker knows too. He does not refuse to lend to anyone at any interest rate. Bankers who know their customers will, as ReformerRay says, provide the credit that is needed, at least to some people and some companies. Incidentally it is interesting that ReformerRay introduces the idea of new banks – as people get more and more nervous about their current banks, and wonder where to keep their money safely, there is a huge opportunity for somebody to start new banks unencumbered by mortgages and derivatives.

  • Posted by Twofish

    Lyle B: Are you in a position to *know* that? It’s a pretty extreme statement.

    Yes I am in a position to know this.

    Lyle B: I know what assets I have, and my banker knows too.

    People *think* they know what assets they have. A owns B. B owns C. C owns D. D owns E. People just know B, but if E blows up, the dominos go back and will hit A.

    Lyle B: He does not refuse to lend to anyone at any interest rate. Bankers who know their customers will, as ReformerRay says, provide the credit that is needed, at least to some people and some companies.

    They know their customers well, but if you have just lost a huge amouont of capital, and you are facing a credit crunch, you aren’t in a position to loan out money even if you want to.

    Lyle B: Incidentally it is interesting that ReformerRay introduces the idea of new banks – as people get more and more nervous about their current banks, and wonder where to keep their money safely, there is a huge opportunity for somebody to start new banks unencumbered by mortgages and derivatives.

    And here is the problem. To deposit money into a new clean bank you have to withdraw money from an old broken bank. If you don’t have enough assets to cover deposits, then you have a problem. Lehman Brothers, WaMu and Wachvoia have already died because people were starting to withdraw their money. This is a good thing. The problem is that after a bank has failed and you still have some huge problsm that you have to deal with. One of which is compensating the depositors.

    People bring up FDIC as if it is a magic wand. The money from FDIC has to come from somewhere.

    One problem is that people think “let the banks fail” ends the story. It doesn’t.

    Lyle B: there is a huge opportunity for somebody to start new banks unencumbered by mortgages and derivatives.

    Sure, and someone will think of some innovative financial system that will work for about ten years before it goes too far and creates another crisis, at which point things go crazy and the cycle starts over again.

    I’m all for “creative destruction” but you are not going to get any creative destruction if you don’t recapitalize the bad banks. If you recapitalize the bad banks, then depositors can take money out and move them to other uses. If you don’t recapitalize the bad banks, then people will do whatever they can to keep depositors locked into those banks, and you end up with a Japan situation.