The Fed's Liquidity Swap And The Latest Media Hype

by: Walter Kurtz

Riding on the coattails of the recent court ruling on disclosure from the Fed, Bloomberg reporters are now focused on the Fed Liquidity Swap Facility (FLSF).

Bloomberg: As part of a currency-swap plan active from 2007 to 2010 and revived to fight the European debt crisis, the Fed lends dollars to other central banks, which auction them to local commercial banks. Lending peaked at $586 billion in December 2008. While the transactions with other central banks are all disclosed, the Fed doesn’t track where the dollars ultimately end up, and European officials don’t share borrowers’ identities outside the continent.

They are trying to make the case that the Fed is not aware of who the ultimate users are of what Bloomberg calls "loans". Not to defend the Fed, but the popularity of pounding on that institution for the sake of getting attention has become the latest pastime and represents the best of media hype. Most would expect Bloomberg to rise above that. Here are some facts that may help ease the minds of our zealous journalist friends:

1. FLSF outstanding currently is barely visible in comparison to what was in place in 2008 or even in 2010.

click to enlarge

Did our friends at Bloomberg just notice it?

2. FLSF is not a loan. It is in fact a currency swap. The Fed is in effect both lending dollars and borrowing euros at the same time. The impact of actual net financing provided is zero.

3. The swap is with the ECB, not the European banks. The credit risk of transacting with the ECB is similar to that of transacting with the Fed - nonexistent. That's because the ECB can always "print" enough euros to return the dollars, just as the Fed can always "print" enough dollars to return the euros.

4. If the Fed needed to do the swap to provide euros to US institutions, it would not be obligated to tell the ECB to whom it is providing the currency. The same holds true for the ECB. Just as a bank transacting with another bank is not obligated to disclose what the funds are used for, neither are the central banks.

5. Instead of focusing on this phantom FLSF risk, the reporters should look at the IMF exposure and the US administration's ability to provide additional funds without going to Congress. That's because the funding has already been approved:

The White House: ... It also expands the resources available to the International Monetary Fund (IMF) by allowing it to boost its lending ability. Many developing countries are experiencing severe economic decline and a massive withdrawal of capital, and the IMF needs to make sure it has the resources necessary to effectively respond to the current financial crisis

So congratulations go to Scott Lanman and Bradley Keoun of Bloomberg. They get our Sober Look Hype Award.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.