The Federal Reserve's Unauthorized Massive Bailout of Europe (and Possibly Japan)

On Monday of this week, I posted a commentary by Ron Paul calling for the halt of a coming  Federal Reserve bailout out of Europe (The Coming Fed Bailout of Europe Must Be Stopped!)

Now, beltarian insider Gerald O'Driscoll (former vice president at the Federal Reserve Bank of Dallas and later at Citigroup and now a senior fellow at the Cato Institute) warns, in WSJ, that the bailout that Ron Paul warned about has started, when one examines the latest Fed reports.

O'Drsicoll writes:

This Byzantine financial arrangement could hardly be better designed to confuse observers, and it has largely succeeded on this side of the Atlantic, where press coverage has been light.

Perhaps MSM is spending time on what Dr. Paul didn't write 20 plus years ago versus what he is actually writing now.

Here's O'Driscoll warning about what Dr. Paul spotted:

America's central bank, the Federal Reserve, is engaged in a bailout of European banks. Surprisingly, its operation is largely unnoticed here. [Except for Ron Paul-rw]

The Fed is using what is termed a "temporary U.S. dollar liquidity swap arrangement" with the European Central Bank (ECB). There are similar arrangements with the central banks of Canada, England, Switzerland and Japan. Simply put, the Fed trades or "swaps" dollars for euros. The Fed is compensated by payment of an interest rate (currently 50 basis points, or one-half of 1%) above the overnight index swap rate. The ECB, which guarantees to return the dollars at an exchange rate fixed at the time the original swap is made, then lends the dollars to European banks of its choosing.

Why are the Fed and the ECB doing this? The Fed could, after all, lend directly to U.S. branches of foreign banks. It did a great deal of lending to foreign banks under various special credit facilities in the aftermath of Lehman's collapse in the fall of 2008. Or, the ECB could lend euros to banks and they could purchase dollars in foreign-exchange markets. The world is, after all, awash in dollars.

The two central banks are engaging in this roundabout procedure because each needs a fig leaf. The Fed was embarrassed by the revelations of its prior largess with foreign banks. It does not want the debt of foreign banks on its books. A currency swap with the ECB is not technically a loan.

O'Driscoll then goes on to detail a bit of bailout history and report on how the bailout is cranking up again:

The Fed had more than $600 billion of currency swaps on its books in the fall of 2008. Those draws were largely paid down by January 2010. As recently as a few weeks ago, the amount under the swap renewal agreement announced last summer was $2.4 billion. For the week ending Dec. 14, however, the amount jumped to $54 billion. For the week ending Dec. 21, the total went up by a little more than $8 billion. The aforementioned $33 billion three-month loan was not picked up because it was only booked by the ECB on Dec. 22, falling outside the Fed's reporting week. Notably, the Bank of Japan drew almost $5 billion in the most recent week. Could a bailout of Japanese banks be afoot? (All data come from the Federal Reserve Board H.4.1. release, the New York Fed's Swap Operations report, and the ECB website.)

Aside from the obvious inflationary consequences of printing more dollars via swaps (even though they start off in Europe those dollars could easily hit these shores) O'Driscoll lists a number of other problems with the swaps, including the fact that they are illegal:

First, the Fed has no authority for a bailout of Europe. My source for that judgment? Fed Chairman Ben Bernanke met with Republican senators on Dec. 14 to brief them on the European situation. After the meeting, Sen. Lindsey Graham told reporters that Mr. Bernanke himself said the Fed did not have "the intention or the authority" to bail out Europe. The week Mr. Bernanke promised no bailout, however, the size of the swap lines to the ECB ballooned by around $52 billion.

Second, these Federal Reserve swap arrangements foster the moral hazards and distortions that government credit allocation entails. Allowing the ECB to do the initial credit allocation—to favored banks and then, some hope, through further lending to spendthrift EU governments—does not make the problem better.

Third, the nontransparency of the swap arrangements is troublesome in a democracy. To his credit, Mr. Bernanke has promised more openness and better communication of the Fed's monetary policy goals. The swap arrangements are at odds with his promise. It is time for the Fed chairman to provide an honest accounting to Congress of what is going on.

The Fake Bailout Continues (Federal Reserve division)

The Federal Reserve currency swaps have collapsed.

In the last week, the Fed conducted only $1 billion in swaps (this was with the ECB). The Fed is now also reporting that the initial $9.2 billion swap conducted on 5-19 has matured and was not rolled over.

Bottom line: There is near zero Fed participation in the "bailout" and on Tuesday we will see if the data indicates any strong bailout activity from the ECB, but, at this point, it appears that the central bank bailout operations consist  pretty much of smoke and mirrors press releases.

Bulletin: Fed Conducted No Currency Swaps in the Last Week

The Federal Reserve has annonced that it did not conduct any currency swaps for the week ending 5-19-10.

Outstanding currency swap balances remain at $9.2 billion as the result of a swap conducted with the ECB the prior week.

How Big is the Fed's Currency Swap Facility Likely to Get?

No one knows. Not even the Fed. But if past is prologue, it could be huge.

According to the Federal Reserve's own calculations, the  Fed during the first part of the current crisis, at peak, had nearly $600 billion in currency swap facilities outstanding.

If the Fed comes anywhere near this number this time around, it will be hugely inflationary, as I seriously doubt banks will simply put these funds on deposit as excess reserves (as they did in phase 1 of the crisis). If the Fed attempts to sterilize the swap facilities, it will mean huge drains of money from other parts of the economy and roller coaster distortions in the markets.

The Federal Reserve Describes Currency Swaps

Now that the Federal Reserve has decided to take part in the PIIGS bailout via currency swaps, it will be valuable to understand just how currency swaps work.

The Fed also used currency swaps in the first part of the current crisis and the Federal Reserve economists Michael J. Fleming and Nicholas J. Klagge have written a primer on the swaps and how they functioned.

That primer is now in the EPJ Vault, here.

Fed Set to Go Nuke to Help Bailout Europe

The Federal Reserve has announced that it will re-establish the temporary U.S. dollar liquidity swap facilities with the Bank of Canada, the Bank of England, the European Central Bank (ECB), and the Swiss National Bank that it first implemented in the early part of the financial crisis.

Further details on these arrangements will be available shortly. It appears, though, that for all practical purposes, the Fed has agreed to bailout the world. Essentially, foreign central banks will print up any amount of money they want  in their currency and the Fed will print up an equal amount of dollars that they will then loan to the foreign central banks (against the foreign banks newly printed money)who will then  loan the funds to the banksters  who will  use as collateral the securities of the PIIGs, to gain the dollars.

Needless to say this is complete and utter madness. It is potentially extremely inflationary on a global scale.What's more, outside of banksters, no one in America will benefit from this move.  Every one in America could suffer from the potential inflationary consequences.

The size of these swaps must be watched very closely.  It does not appear that these funds will be stored as excess reserves. This means they will be out in the system. Every $100 billion added to the system in this manner (unless somehow sterilized by money drains elsewhere) will mean an immediate increase of 1.16% in M2 money supply. But this $100 billion would be high powered money. This means the  final impact would be a multiple of the initial Fed money creation.

Given that the U.S. financial situation is delicate, and the Fed is likely to be called on to bailout the Treasury Department within a short-time, for the U.S. to be a major player in the bailout of Europe is sheer madness. It's the taller drunk holding up the shorter, eventually they will both collapse.

Bottom line: The Federal Reserve bank is on the edge of pushing the financial nuclear button, and print money in reckless abandon. Even if this were done for Americans it would be a terrible policy, but to do this for foreigners, where there would be little benefit for Americans reflects the extraordinary madness of the elite bankers.

The full Fed statement is in the EPJ vault, here.