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Walsh sees need for swaps rules, but warns against overlooking the benefits of derivatives to the industry.
January 24 -
Market participants must monitor as much exposure information as they can, not only on their own counterparties but on everyone in the market.
September 29
WASHINGTON — Federal Reserve officials told a congressional panel Tuesday that U.S. banks and consumers are benefiting from the Fed's agreements with other central banks to swap dollars for Euros and other foreign currencies.
"Our principal aim is to protect U.S. banks, businesses, and consumers from adverse economic trends abroad," William Dudley, president of the Federal Reserve Bank of New York, told the House subcommittee on domestic monetary policy. "I am pleased that the swaps seem to be working."
His largely upbeat remarks drew a skeptical response from Republicans on the panel, especially its chairman, Texas Rep. Ron Paul, who questioned the sustainability of the Fed's commitment to other central banks.
"Very soon, we're going to have to admit that you can't solve the problem of debt with more debt," Paul said. "What is the limit to us making these promises that we will always be there?"
For most of the last five years, the Fed has had swap lines with the European Central Bank and the central banks of Japan, Canada, England, and Switzerland, allowing those institutions to swap their own currencies for dollars, which they can in turn lend out to private financial institutions.
By easing liquidity strains in the European financial system, Fed officials argue that the currency swaps have lowered the chance that the continent's debt crisis will spread across the Atlantic to U.S. banks.
On Tuesday, Dudley reiterated what the Fed has been saying for months about the exposure of U.S. financial institutions to Europe: that U.S. institutions have become considerably stronger in the last few years, and they have little net exposure to Greece and other countries at the center of the European crisis, but they are considerably more exposed to core European countries like Germany and France and the continent's banking system.
"U.S. money market mutual funds, in particular, have significant European holdings," Dudley said in written testimony. "This means that if the crisis were to broaden further and intensify, it would put pressure on the capital and liquidity buffers of U.S. banks and other financial institutions."
Also testifying Tuesday was Steven Kamin, director of the Fed's division of international finance. He noted that the Fed has built-in protections against fluctuations in interest rates, and said that the swaps last for no longer than three months, which provides an additional safeguard.
"Notably, the Fed has not lost a penny on these swap lines since they were established in 2007," Kamin said.
But Rep. Blake Luetkemeyer, R-Mo., was among the Republicans who voiced reservations about the currency swaps, expressing doubt about the strength of Europe's economy.
"This whole thing is held together by confidence," he said to Dudley. "Isn't it?"
Luetkemeyer also questioned a decision announced by the Fed on Nov. 30 to lower the interest rate it charges foreign central banks from 1.1% to 0.6% in an effort to encourage more European banks to participate in dollar borrowing.
Luetkemeyer said that lending dollars to European banks at low interest rates makes it easier for them to compete with U.S. banks.
"I don't think we need to be doing that, do you?" he asked the Fed witnesses.
Dudley responded that if European banks were forced to liquidate their U.S. assets quickly, which could happen if their access to dollar funding went dry, it would hurt American financial institutions and the broader U.S. economy.
