Events are forcing me, willy-nilly, to post on the ongoing euro crisis. A consortium of five central banks has taken action to shore up the euro:
Five central banks including the European Central Bank, the Bank of England and Switzerland’s central bank said they would provide three-month dollar loans to banks from October, which will cover the year-end period. The display of firepower was intended to prevent an escalation of financial market tensions and signal that authorities are prepared to take action to boost market confidence.
Within minutes of the announcement, European banking shares led a strong rebound in equity markets. BNP Paribas, one of the French banks that had suffered most on rumours of funding problems, rose as much as 22 per cent before closing up 13 per cent. Société Générale, another embattled French bank, finished up 5 per cent while Italy’s Intesa Sanpaolo and UniCredit gained 10 and 7 per cent respectively.
“Central banks are more than ever an anchor of stability and confidence,†said Jean-Claude Trichet, ECB president. The globally co-ordinated effort to provide US dollar liquidity was “a clear illustration of our very close co-operation at the global level and of the unity of purposeâ€, he said.
“This is good news as the stress in funding markets was starting to become self-reinforcing,†said Huw van Steenis, banking analyst at Morgan Stanley.
A number of gauges of stress in funding markets for European banks fell off from their highest levels since the 2008-09 financial crisis. The euro, which had fallen sharply against the dollar in recent weeks, rose 0.9 per cent to $1.386. US, German and UK government bond yields all moved away from multi-decade lows.
The move by the central banks, in conjunction with the US Federal Reserve, followed escalating difficulties, especially at continental European banks, in obtaining dollar funding as US investors took fright at the eurozone debt crisis. The Bank of Japan, which had already offered three-month dollar liquidity, also said it would be making additional offers to cover the year-end period.
I have a number of problems with this, the most significant of which is that the Federal Reserve is not empowered to act as it sees fit. It must act within the constraints of its empowering legislation and my reading of that legislation suggests that this action is only licit insofar as it promotes the health of U. S. banks, controls inflation, and reduces unemployment.
I think it only does any of those things quite indirectly and since, at the very best, this move only kicks the can down the road for another couple of months, it should be coupled with actions targeted at insulating U. S. banks from the effects of the collapse of vulnerable European banks, the default of Greece, or the collapse of the euro itself. Are these steps being taken?
Honestly, I think what’s going on in Europe is the foreseeable outcome of Germany’s “beggar they neighbor” mercantilist strategy (which has been receiving so much praise in the U. S. press lately). For this policy to continue German banks had to buy up euro-periphery sovereign debt and a lot of that debt was clearly bad.
Foreign policy is not the province of the Federal Reserve. It belongs exclusively to the federal government, particularly the executive branch with the advice and consent of the Senate.
Isn’t the appropriate U. S. policy under the circumstances either a) to encourage German taxpayers to shore up their own banks, b) to encourage a graceful breakup of the Eurozone, c) to protect the U. S. from collateral damage produced by the incipient explosion, d) some combination of the above? Why should we care about German banks more than the Germans do?
Within minutes of the announcement, European banking shares led a strong rebound in equity markets.
This is the part that amazed me. Basically, the central banks in question have declared this a crisis of world-wide importance, and the markets freakin’ cheered. It’s perverse. I guess it really is a BTFD world.
As for the Fed over-reaching its powers – isn’t that what every part of the US government does these days?
I guess you can make the case that a collapse of the German banks would lead to the economic collapse of the EU, and a potential Depression. We may have economic self-interest in preventing that. However, I would rather call the Germans out on this. Let them bear the major responsibility. It is more than enough that we already pay for the defense of Europe.
Steve
I’m sure we do. It’s also beyond our ability to control and I don’t think that enabling the Germans in their folly is a productive use of scarce assets, even for the Fed whose assets are a lot less scarce than for practically anybody else.
My main point here is about mitigating downside risk. This is a case in which we should be doing our best to walk and chew gum at the same time. We should be encouraging the Europeans to take the necessary corrective steps while reducing our risks in case they don’t. I think the Fed action actually increases our risks by putting more of our skin in the game.
My main point here is about mitigating downside risk.
Given that after the Lehman Crisis the policy response was to increase the size of the biggest banks and double down (at least) on the risk, I don’t think you should hold your breathe.
Hasn’t this ship already sailed? I’d have to look it up, but didn’t a lot of the TARP and other bailout money go to foreign banks?
Andy, I think there’s a distinction between “we’ve established some bad precedents” and “the ship has already sailed”. Simply that we’ve allowed an error to have been made in the past does not compel us to make the same error in perpetuity for consistency’s sake.
c) to protect the U. S. from collateral damage produced by the incipient explosion
“It’s the Credit Default Swaps, stupid”
The problem was/is the CDS’s. US banks are on the hook for Euro banks’ “paper”. These CDS’s may be 1st, 2nd, 3rd, … nth order derivatives, and they are affecting the US banks’ balance sheets either directly or indirectly. The assets used as collateral are nowhere near their “book value”, and when these assets are marked-to-market, the insolvency will be revealed. Until these assets are marked down or mature, this is not going away.
This is not an endorsement of what the Fed is doing. The Fed has been doing what it wants for a long time now, and it is not going to stop anytime soon.
“For the Snark was a Boojum, you see.”
Encouraging the Germans to do what they don’t want to do isn’t a policy. For a set of words to be a policy, there must be some teeth to it. Unfortunately, if we bite the Germans, we — as well as they — will bleed.
The only way this makes sense is if our objective is to be the last country standing — which we would be because the dollar is a far more important reserve currency than the euro. If we wanted to engage in self-immolation (a depression), we could implement a policy that would destroy the euro in short order, e.g., by raising interest rates. But it would be very unpleasant.
I don’t think that’s true, Marc. What’s the U. S. interest? I would say that it’s a free, peaceful, and prosperous Europe. To that end Germans need to consume more and, particularly, need to import more from the countries of the euro-periphery. Does the Fed propping up insolvent German banks promote that? I don’t see it.