Colin Barr

Following the money in banking, economics, and Washington

Fed throws euro banks a lifeline

December 21, 2010: 4:19 PM ET

For an outfit whose policies supposedly are plunging the world into unspeakable conflict, the Federal Reserve is doing an awful lot to avoid another meltdown.

The Fed said Tuesday it would extend the dollar swap lines it provides to central banks in Europe, Japan and Canada in a bid to avoid a cash crunch like the ones seen to such devastating effect in 2008.

Your dollars, our problem?

The swap lines, under which the Fed provides foreign central bankers with essentially unlimited stocks of dollars in exchange for the equivalent amount of the counterpart's currency, are intended to help head off a banking crisis like the one that appears to be developing in the European Union.

The European Central Bank said Tuesday that money market conditions are deteriorating, raising fears that rising government bond yields and undercapitalized banks will start feeding off one another in a sort of euro doom loop. 

Investors have spent recent months backing away from the debt issued by weaker countries such as Spain and Portugal amid questions about their finances and the strength of their banks, which have been impaired by steep declines in property prices.

The financial temblors of the past two months have made it clear that, for all the talk at the beginning of 2010 about the Fed and other government bodies executing their supposed exit strategies and leaving financial markets to their own devices, we are still probably years away from a world in which your taxpayer dollars won't be propping up the misguided ambitions of bankers everywhere.

And if that sounds less than ideal, try coming up with an alternative. Anyone remember Lehman Brothers?

The eight-month extension of the swap lines, to August 2011, "highlights the fact that, in a structurally fragile and interrelated global financial system, the running risk of unforeseen shocks elevates central banks' 'lender of last resort' function to a systemically indispensable role," wrote Tullett Prebon economist Lena Komileva.

Naturally, its decision to provide dollars overseas to keep foreign banks from seizing up won't make the Fed any more popular at home, where it is under fire for high-volume bailout lending during the crisis of 2008, nor overseas, where its expansive QE2 program is seen as beggaring already poor-feeling neighbors.

Winning this unpopularity contest won't sit well with Ben Bernanke & Co. at a time when political pressure is only building. But then, discomfort with its prominence is nothing new at the Fed.

"The Federal Reserve is not comfortable with its role as the world's central bank," longtime former Fed official Ted Truman wrote when Bernanke took over for Alan Greenspan in 2006. But he added that Fed officials "know, finally, that they ignore the international implications of their polices and developments in the rest of the world at a peril to their overall objectives."

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About This Author
Colin Barr
Colin Barr
Senior Writer, Fortune

Colin Barr has covered finance for Fortune.com since November 2007. Previously he was a writer and editor for TheStreet.com, winning a 2006 Society of American Business Editors and Writers award for "The Five Dumbest Things on Wall Street," and for Dow Jones Newswires. He is a 1991 graduate of Penn State and lives in Port Washington, N.Y., with his wife Meena Bose and their two kids.

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