November 30, 2011

Central Banks Take Joint Action to Ease Debt Crisis

WASHINGTON — The Federal Reserve moved Wednesday with other major central banks to buttress the global financial system by increasing the availability of dollars outside the United States, reflecting growing concern about the fallout of the European debt crisis.

Yves Herman/Reuters
Prime Minister Mario Monti of Italy, left, spoke with the president of the European Central Bank, Mario Draghi, at the start of a European Union finance ministers meeting in Brussels on Wednesday.

The banks announced that they would slash by roughly half the cost of an existing program under which banks in foreign countries can borrow dollars from their own central banks, which in turn get those dollars from the Fed. The banks also said that loans will be available until February 2013, extending a previous endpoint of August 2012.
“The purpose of these actions is to ease strains in financial markets and thereby mitigate the effects of such strains on the supply of credit to households and businesses and so help foster economic activity,” the banks said in a statement.
The participants in addition to the Fed were the Bank of England, the European Central Bank, the Bank of Japan, the Bank of Canada and the Swiss National Bank.
Stocks soared in response to the announcement, as some analysts hailed evidence that governments were showing greater determination to address the crisis. The Standard & Poor’s 500-stock index, a broad gauge of the American stock market, was up more than 3 percent in early trading. The DAX, which tracks Germany’s market, was up more than 4 percent late in the European trading day.
But other analysts were quick to note that the program does not address the root causes of the European crisis, falling far short of the steps that the E.C.B., in particular, is under pressure to take, like intervening in bond markets in support of Italy, Spain and other troubled countries. European banks are struggling to borrow the money they need to make loans and fund existing obligations.
The price of dollars has climbed to the highest level in three years, and the European Central Bank borrowed $552 million from the Fed last week to meet the rising demand. That brought the total value of the Fed’s outstanding currency loans to $2.4 billion, all to the E.C.B. except $100 million on loan to the Bank of Japan.
The shortage of dollars in Europe results partly from the pullback of American money market funds, which cut their investments in European banks by 42 percent between the end of May and the end of October, according to Fitch Ratings.

The retreat from France has been particularly severe, with funds cutting their exposure by 69 percent. It also reflects the broader collapse of funding for European banks, which have been extremely reluctant to lend to each other and are having trouble selling bonds to investors. As a result, banks took 265 billion euros in funding from the E.C.B. last week, the most since early 2009.
The Fed’s vice chair, Janet Yellen, underscored “the urgency of strengthened international policy cooperation” in a speech Tuesday in San Francisco in which she said that “the global economy is facing critical challenges.”
The Fed’s revised terms for its currency loans, effective next week, reduces to 0.5 percentage points an existing premium of one percentage point. Since the underlying price of the loans — the dollar overnight index swaps rate — stands at less than 0.1 percentage points, the move cuts the cost nearly in half.
The most recent loan to the E.C.B., which carried an interest rate of 1.08 percent, now would cost 0.58 percent.
The other central banks said they had also agreed to make similar loans of their own currencies as necessary, but they noted that the only extraordinary demand at present was for dollars.
The arrangements carry little risk for the Fed, which swaps the dollars for the currency of the borrowing country together with a commitment to reverse the transaction at the same exchange rate.
It is also modestly profitable, as the foreign central banks remit to the Fed the interest payments that they collect from borrowers.
The Fed operated a similar program with a broader range of central banks from December 2007 through February 2010, then allowed it to lapse because demand had dried up amid signs of improvement in the global economy.

But the Fed was quickly forced to reverse course, announcing the current program in May 2010. The Fed’s decision to reduce the cost of the dollar loans means that it is now providing money at a lower cost to European banks than to American banks.
The prevailing interest rate at the Fed’s discount window is 0.75 percent. The difference reflects the reality that European banks are in much more trouble.
“U.S. financial institutions currently do not face difficulty obtaining liquidity in short-term funding markets,” the Fed said in a statement accompanying the announcement. “However, were conditions to deteriorate, the Federal Reserve has a range of tools available to provide an effective liquidity backstop for such institutions.”
Jack Ewing contributed reporting.

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