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This week, my
congressional committee will hold a hearing to examine how the Federal
Reserve bails out European banks, propping up spendthrift European
governments in the process. Unfortunately this bailout comes at the expense
of American citizens, in the form of higher prices and diminished savings
down the road.
A good analysis
of the Fed’s “swap” scheme first appeared in the Wall
Street Journal back in December, in an article by Gerald O’Driscoll
entitled, “The Federal Reserve’s Covert Bailout of Europe.”
Essentially, beginning late last year the Fed provided U.S. dollars to the
European Central Bank in exchange for Euros-- sometimes as much as $100
billion at a time. The ECB then funneled those dollars to European banks to
provide liquidity and prevent crises from bank insolvencies. Since the
currency swap was not technically a loan, the Fed did not have to embarrass
itself by openly showing foreign bank debt on its balance sheet. The ECB
meanwhile did not have to print new Euros and expose the true fragility of
big European banks.
The entire
purpose of this unholy arrangement was to obscure the truth: namely that the
Fed was bailing out Europe with U.S. dollars.
But why is it the
business of the Federal Reserve to bail out European banks that find
themselves short of dollars to pay their dollar-denominated contracts? After
all, those
contracts
often were hedges taken to protect banks against weakness of the Euro. Hedges
are supposed to reduce risk, but banks that miscalculate should suffer their
own losses accordingly. It’s not our business if the ECB chooses to
create moral hazards by providing liquidity to European banks, but why should
the Fed prop up Europe’s bad decisions!
The Fed has
promised to provide unlimited amounts of dollars to the ECB, should
circumstances require it. It boggles the mind. Of course when Fed officials
first entered into these swap agreements with the ECB last September, they
did so quietly. The American public only found out via websites of the ECB,
the Bank of England, or the Swiss Central Bank.
The Fed already
has pumped trillions of dollars into the economy since 2008, and US banks
currently hold $1.5 trillion of excess reserves. So why don't American banks
lend those excess trillions to European banks if they really need dollars? If
US banks could earn 1 or 2 percent on those loans, they might just be
interested. But they can't compete with the ½ percent interest rate
charged by the Fed to the ECB. That's one glaring example of the harm caused
by the Fed's ability to create money and loan it at below-market interest
rates.
The Fed argues
that these loans will be temporary, merely providing a little boost to get
Europe over the hump. But that's what they thought a few years ago when such
lines of credit to the ECB were set to expire, only to see the Fed
reauthorize them. What happens if the European financial system collapses?
Will the Fed be left holding a bunch of worthless Euros? Will the ECB simply
shrug and turn over the collateral it received from European banks, maybe in
the form of bonds from Ireland, Italy, or Greece? Have the 17 individual
central banks backing the ECB pledged their gold holdings as collateral?
The Fed has
placed a hundred-billion dollar bet on the future of the Euro, with the
strength of the dollar on the line. This is absolutely irresponsible, and
directly contrary to market discipline. Let private banks, European or
otherwise, take their own risks. Let foreign central banks inflate their own
currencies and suffer the consequences. In other words, it’s time to
apply market principles to banks and money.
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