by Adam Tooze
“We have a bunch of U.S. affiliates of some of the weakest European institutions that have faced very substantial dollar funding needs and have come to us and asked for substantial ongoing access to liquidity. When they have a substantial amount of . . . collateral with substantial market value relative to the needs, we have been comfortable meeting those needs [above all through the TAF program discussed above]. When their needs have substantially exceeded or might potentially exceed the market value of their eligible collateral, then we have talked to the home central bank. We have said that, in effect, if you want us to be able to meet those needs and they have collateral in your market that is substantial relative to those needs, then the better way for us to do this is for the home country central bank to meet their dollar liquidity needs against the collateral there . . . and we provide the dollar’s’ [sic] worth of guarantees from the central bank.”19
Having reached the limit of the dollars it could provide directly to Europe’s tottering banks, the Fed now lent to the ECB, the Bank of England, the National Bank of Switzerland and the central banks of Scandinavia. They then channeled the precious dollar liquidity to the European megabanks at one remove.20 The Fed and the central banks it was supporting agreed on an exchange rate. The European central bank needing the dollars deposited the required amount of local currency in an account in the name of the Fed. The Fed credited the European central bank with the equivalent amount in dollars. The two sides agreed to reverse the trade at a future date at the agreed exchange rate. The terms were spelled out with a minimum of fuss in a contract running to no more than seven pages.21 The Fed received an interest premium that ensured that the swap lines would be used only if market funding was not available. The European central banks passed that cost on to the banks that were the ultimate recipients of the dollars.
The initiative for the swap line program came from the Fed. In the aftermath of the disastrous Paribas announcement in August 2007, the Fed was seeing regular early-morning spikes in European dollar funding costs that were causing disruption when the US markets opened in the middle of the European trading day. Tellingly, the ECB’s initial reaction was skeptical. As one American journalist put it, the Fed’s proposal “ran up against a strong effort,” on the part of the ECB, “to pin the Great Panic on the United States.” The ECB’s reply to the Fed was blunt: “[I]t’s a dollar problem. It’s your problem.”22 As Bernanke was later to remark, the ECB “had some difficulty coming to the realization that Europe would be under a great deal of stress and was not going to be decoupled from the United States.”23 With regard to the swap lines, that attitude did not last much beyond 2007. The first agreements were reached with the ECB and the Swiss National Bank in December 2007.24 As the crisis became critical in September 2008, the swap facilities were rapidly expanded to a total capacity of $620 billion. On October 13, 2008, as the Europeans rolled out their guarantee programs and Paulson, Bernanke and Geithner persuaded America’s bankers to take their dose of TARP capital, even that cap was lifted. Four central banks—the ECB, the Bank of England, the Bank of Japan and the Swiss National Bank—were given unlimited access to dollars.
The swap lines helped to reassure markets. But they also threw a shadow of doubt over those central banks that had not been so favored. The shutdown in the money market was affecting the entire financial system. Where were major emerging market central banks to get their dollars from? For a nation like South Korea to have approached the IMF was out of the question given live memories of the Asian financial crisis of 1997–1998.25 So on October 29 the Fed’s favor was extended to four key emerging market central banks: Brazil, Korea, Mexico and Singapore.26 All told, fourteen central banks would be included in the program.27
The total amount outstanding on the network of dollar swap lines reached its peak in December 2008 at $580 billion. Briefly, the swaps touched 35 percent of the Fed’s balance sheet. But even these gigantic figures do not do justice to the scale of the program. The essence of the swap line was to provide easy access to short-term dollar funding. With the New York Fed and its counterparts across the world working on a hectic schedule, new dollar funding was flushed into the system on a daily basis. In a single week in late October 2008, as dollars previously sourced from American money markets hemorrhaged out of the global banking system, the Fed lent $850 billion through the swap lines. It was this circulation of funds that allowed the Bank of England, the ECB and the Swiss National Bank to meet huge demands for dollars without running down their exchange reserves to even more critical levels. But for the swap facilities, between September 2008 and May 2009, monthly demand for dollars at the auctions organized by the ECB would have wiped out its reserves several times over.
Running Low: Eurosystem Foreign Exchange Reserves and Foreign Currency Provided to Commercial Banks
US dollars provided to commercial banks by the ECB ($ billions)
Swiss francs provided at auctions reported by the ECB ($ billions equivalent)
Eurosystem foreign exchange reserves ($ billions)
End of
Sep ’08
150.7
0
210.3
Oct ’08
271.2
17.4
210.2
Nov ’08
244.0
19.2
204.2
Dec ’08
265.7
25.8
202.0
Jan ’09
187.3
27.8
191.1
Feb ’09
144.5
32.5
186.4
Mar ’09
165.7
33.1
189.2
Apr ’09
130.1
33.0
187.9
May ’09
99.7
35.4
191.9
Jun ’09
59.9
29.9
192.5
Jul ’09
48.3
18.6
197.9
Aug ’09
46.1
15.4
197.8
Sep ’09
43.7
10.1
195.0
Source: William A. Allen and Richhild Moessner, “Central Bank Co-operation and International Liquidity in the Financial Crisis of 2008–9,” BIS Working Paper 310 (May 2010), table 12.2.
The absence of a euro-dollar or a sterling-dollar currency crisis was one of the remarkable features of 2008. It was no accident. It was the swap lines that did the trick. What the Fed had done for money markets, the central banks now did for the global provision of dollar bank funding. They absorbed the currenc
y mismatch of the European bank balance sheets directly onto their own accounts. Compensating public action ensured that private imbalances did not spill over into a general crisis.
The scale of the compensating credit flow was staggering. By September 2011 total lending (and repayment) under the terms of the swap facility came to $10 trillion at varying lengths of maturity. Standardized to a twenty-eight-day term, the sum was equivalent to $4.45 trillion in one-month loans. On either measure, by far the largest beneficiary of the swap lines was the ECB. Every cent of this staggering flow of funds was repaid in full. Indeed, the Fed made profits of c. $4 billion on its swap lending in 2008–2009. But this sober accounting understates the drama of this innovation. Responding to the crisis in an improvised fashion, the Fed had reaffirmed the role of the dollar as the world’s reserve currency and established America’s central bank as the indispensable central node in the dollar network. Given the even vaster volume of daily transactions in global financial markets, it is not the sheer size of the effort that mattered. The Fed’s programs were decisive because they assured the key players in the global system—both central banks and large multinational banks—that if private funding were to become unexpectedly difficult, there was one actor in the system that would cover marginal imbalances with an unlimited supply of dollar liquidity. That precisely was the role of the global lender of last resort.
The Fed as Global Lender of Last Resort: Central Bank Liquidity Swap Lines, December 2007 to August 2010 (in $ billions)
Raw swap amount
Standardized to 28-day swap
ECB
8,011
2,527
Bank of Japan
387
727
Bank of England
919
311
Swiss National Bank
466
244
Sveriges Riksbank
67
202
Bank of Korea
41
124
Reserve Bank of Australia
53
122
Danmarks Nationalbank
73
95
Norges Bank
30
68
Bank of Mexico
10
30
Total
10,057
4,450
Source: Federal Reserve.
IV
Prior to the crisis, the transatlantic offshore dollar system had lacked a manifest center of leadership. Indeed, it had developed “offshore” so as to avoid national regulation and control. After 2008 it was openly organized around the Fed and its liquidity provision. “In a way,” one European central banker remarked, “we became the thirteenth Federal Reserve district.”28 But if that was the case, the American public was not informed about the extension of their country’s monetary territory. Not the least remarkable thing about the Fed’s crisis response was its politics, or rather the lack of explicit political legitimation. The emergency liquidity provision to the international economy by the Fed between 2007 and 2009 was shrouded in as much obscurity as possible. In July 2009, when Bernanke was challenged by campaigning Democratic congressman Alan Grayson of Florida to explain “who got” the swap line money, the chairman of the Fed could reply “I don’t know.”29 The ultimate destination of the trillions of dollars that had flushed back and forth between the central banks of the global system was not under direct American oversight. There was little doubt, of course, that the Swiss National Bank channeled the dollars it received from the Fed to its ailing giants, UBS and Credit Suisse.30 But from the point of view of the Fed, it was far better that the swap be done with a central bank than with the fragile banks themselves.
As Neil Irwin describes it, “[T]he scale of lending to foreign banks . . . was a closely guarded secret even by standards of the always secretive Fed. . . . During the panic, this information was so closely held—and had it been known publically, so potentially explosive—that only two people at each of the dozen reserve banks were allowed access to it.”31 The Fed used every legal means at its disposal to prevent detailed information about its support programs to both domestic and foreign banks from leaking to the general public. The vociferous libertarian and gold standard advocate Congressman Ron Paul ran a vigorous campaign for Fed transparency, which Bernanke did his best to ward off. Only in June 2009 did the Fed begin publishing regular reports on the uptake of swap lines. The fuller records of the Fed’s emergency programs, on which this chapter is based, were not opened to the public until December 2010 and March 2011. They were produced as a result of the Dodd-Frank legislation of 2010 and a Freedom of Information suit brought by the Bloomberg news organization and contested by the Fed and the New York Clearing House Association, a banking lobby group, all the way to the Supreme Court.32 In defense of its secrecy, the Fed argued that revealing the information demanded by Bloomberg would jeopardize its efforts to calm financial markets, because full disclosure would reveal which banks were most in need of its liquidity assistance. The courts ruled in favor of Bloomberg and the Fed grudgingly complied. The forced disclosure offered an unprecedented glimpse into the operations of the world’s key central bank at a moment of maximum stress. The data are a quantified ultrasound of the convulsions of the Atlantic financial system. No such records are available for either the ECB or the Bank of England. Beyond the generalities of “systemic stress and stability,” they reveal the significance of individual banks, the extent of the pressure that they were under and the scale of the relief the Fed provided.
Backing the Banks: Fed Liquidity Facilities and Their Users
Source: Federal Reserve and my own calculations.
At the top of the Fed’s list were Citigroup and Bank of America and the two highly stressed US investment banks, Merrill Lynch and Morgan Stanley, with their respective London operations. Then came a comprehensive list of the big European and American players in the global dollar banking business. Of the liquidity on one-month or three-month terms that the Fed provided to big banks, European banks took the majority. European banks and the London operations of the major US investment banks accounted for 23 percent even of the overnight primary dealer credit facility. When this support is added to the gigantic swap line facilities provided for the European central banks, the conclusion is inescapable. What the Fed was struggling to contain in 2008 were not two separate American and European crises but one gigantic storm in the dollar-based North Atlantic financial system.
These data are explosive not only in revealing what was required by the Fed to keep a globalized financial system on the rails. They are remarkable also for the light that they shed on the politics of the bailouts in Europe. In Europe, the bullish CEOs of Deutsche Bank and Barclays claimed exceptional status because they avoided taking aid from their national governments. What the Fed data reveal is the hollowness of those boasts. The banks might have avoided state-sponsored recapitalization, but every major bank in the entire world was taking liquidity assistance on a grand scale from its local central bank, and either directly or indirectly by way of the swap lines from the Fed. Using the Fed’s reco
rds we can track the liquidity support provided to a bank like Barclays on a daily basis, revealing a first hump of Fed borrowing during the Bear Stearns crisis and a second in the aftermath of Lehman.
The anatomy of the Fed’s hidden liquidity support measures also casts in a rather different light the widespread discussion in 2008 about the future of the dollar system. Not surprisingly, in 2008 the United States faced a global chorus of criticism. Advocates of reform argued that at the root of global financial instability was the overreliance on the dollar as a reserve currency. This conferred on America an exorbitant privilege, which it exploited irresponsibly, running up deficits and borrowing abroad. In 2009 the head of China’s central bank and a special commission of the United Nations would advance proposals for a new global currency system.33 The Russians liked the idea, and so too did the West Europeans.34 In September, Peer Steinbrück told journalists, “When we look back 10 years from now, we will see 2008 as a fundamental rupture. I am not saying the dollar will lose its reserve currency status, but it will become relative.”35 Two months later, President Sarkozy declared ahead of the G20 summit, “I am leaving tomorrow for Washington to explain that the dollar—which after the Second World War under Bretton Woods was the only currency in the world—can no longer claim to be the only currency in the world. What was true in 1945 cannot be true today.”36