It’s another one of those myths that gets repeated over and over because it has never been realistically challenged. Not in any public way. The Fed says its dollar swap lines, central bank liquidity swaps as they call them today, worked beautifully. They may not use that particular word to describe the results, but you are distinctly left with that impression as is intended.

Only until you do a little homework (and not all that much is necessary).

Mostly, the myth comes down to the raw numbers. Again, Federal Reserve Chairmen know their audience, people who are easily dazzled by larger balances regardless of any further details. In the case of the dollar swaps, talking about 2008 first, the amount quickly rose to an enormous $569 billion by the week of November 12, 2008.

Case closed. Massive flood.

Well, maybe not. First of all, there was that whole global panic while these things were being bid and sorted out. And then there were all the curious details that don’t really add up to the picture you’ve been led to believe about them; but do offer instead yet more confirmation as to why there had been a global panic despite this “flood.”

These guys (and gals) are just winging it as they go.

Case in point: Europe. You probably don’t know this but on September 30, 2008, just as the global fire-sales and liquidations were getting hot, the European Central Bank (ECB) claimed three separate lots from the Fed’s lines. From the Federal Reserve’s perspective, each of the three were one-day transactions. Over in Europe, the ECB was attempting to conduct fixed allotment, variable rate US$ auctions at different maturities.

That’s how the dollar swaps were initially conceived, to be an overseas extension of the TAF auctions (which were nothing more, really, than the Discount Window cloaked in anonymity to remove stigma). Thus, the dollar swaps and TAF were announced together first beginning in December 2007.

At a fixed allotment, that meant the ECB and other foreign central banks like it could only offer that many dollars. Given this cap, they then auctioned those limited dollars to banks operating in their own jurisdictions (which, as we know, were quite often the foreign subsidiaries of US banks while, at the same time, US subsidiaries of foreign banks were taking up all the dollars from TAF; probably the exact opposite as you would expect and were likely led to believe), which meant that banks had to compete for those limited funds.

Since they were capped, the interest rate had to be variable in order to figure out how to award them and to whom.

In the first stages of the dollar swap operations, December 2007 to September 2008, these were hugely overbid but the eventual stop out rate (the lowest interest rate that was accepted at these auctions) was never really far out of character with other pressured US$ money rates.

By September 30, 2008, however, things had certainly changed as Ben Bernanke was horrified to learn that, no, he hadn’t actually saved the world by his courageousness back in March with the “successful” rescue of Bear Stearns; he’d have to try again and try much harder. One avenue was expanding the dollar swaps such that these foreign central banks could offer even more dollars to their “local” institutions, but still capped.

Still fixed allotment therefore still variable rate. Of the three draws by the ECB on that day, the first for $30.7 billion paid the Fed (the ECB paid the interest it collected on its transactions to the US central bank for this “courtesy”) a paltry 0.50% interest rate. Why so low? Never explained, at least not to my knowledge.

The second, for $30 billion, still a 1-day tenor, paid the Fed a whopping 11%. Eleven percent. When the ECB had bid for $30 billion the day before, the Fed says it received just 3%.

And then the final September 30 draw from Europe, another 1-day this time for $24 billion which also fetched the same ridiculous 11% rate.

You might first notice how each of these three funding draws had taken place exactly at quarter-end before then appreciating just how bad, and how desperate, local European banks must’ve been trying to turn the quarter and bidding up into the double digits at the ECB, of all places, just to survive a little bit longer.

Stocks had been down somewhat in late September following Lehman/AIG, but it was on October 2 that they really began their tailspin. Subprime Ben then belatedly realized that his dollar swaps, like his TAF auctions, were about as useful as a screen door on a submarine.

By October 13, after stocks had surrendered about ~35%, and credit markets stopped functioning almost entirely (see: repo fails), the Fed finally changed up its swap parameters, from then on removing the caps and letting central banks bid for unlimited amounts at fixed rates. Not before, however, on October 8, during the depths of this global maelstrom, the ECB had drawn $130 billion in two 1-day operations (both on October 8) that paid the Fed a handsome 11.96%.

Generous payments to the US central bank like these demonstrate perfectly just how badly these people are at figuring out dynamic, evolving conditions in a dynamic, evolving global dollar marketplace.

And what do you think global eurodollar banks were themselves thinking about all this while it was happening? Thank God for Ben Bernanke? Not even remotely. Whatever changes (balance sheet shrinking) they had been contemplating since Bear Stearns were now moved way up in the order of priorities following only the top on that list which was survival.

These details matter in a way that shows the details don’t really matter. These things are all smoke and mirrors. The Federal Reserve is a very poor substitute for what a normally operating eurodollar system provides. It pretends it is a central bank but in reality it is a rigid, poorly-suited bureaucracy staffed by people who don’t really know their jobs (see: Dudley, Bill; IOER)

Banks took notice. Especially those in Europe.

By November 2008, these foreign central banks who had by then drawn that whopping $569 billion began to ween their banks off this “largesse”, the aggregate balance falling significantly (a $94 billion drop) through the middle of November and remaining lower until right around mid-December. Especially the ECB. Apparently, European officials were becoming more comfortable with the post-October dollar climate.

After all, stocks had recovered quite a bit to early November (the S&P 500 had risen from an October low of around 845 to over 1,000). Only to then tank again to a new low later in the month coinciding with renewed dollar funding pressures which would push outstanding dollar swap balances to a new high by mid-December (and Bernanke into his final panicky move into ZIRP and QE).



I fail to understand how anyone can view this as a successful program – just up to this point in history. Forget about what came next, which for Europe was the final humiliation when banks by January 2009 were being nationalized and rumored to be nationalized left and right. The dollar shortage wouldn’t release its grip until mercifully in March 2009, many months later and by then the dollar swap line balance significantly lower again.

The only way you can claim these things accomplished anything is to try to make a counterfactual, just as Bernanke’s narrative shifted, too, how at least it wasn’t worse. These, along with the others like super-TAF and TARP, supposedly kept it to this level of damage.

Except, it did get a whole lot worse only starting in December 2008 and would remain that way, in the real economy, all the way to June 2009 (for the labor market, the bottom wouldn’t be reached until early 2010). The great in the Great “Recession” came about after the “flood” of swaps!

The reason why? Because despite Bernanke’s super-friendly narrative about how all the “jobs” he “saved”, the banking system as well as Corporate America were actively altering their very basic routines after sitting horrified watching this man and his minions bungle one thing after another. Massive layoffs and ultra-high liquidity preferences would follow, worldwide, because in the real economy it was pure survival mode from then on to the real end.

And these people have the nerve to call this very period, the worst panic since the thirties up to that point, one of “adequate reserves.” The reserves were adequate and nothing else. Certainly nothing that mattered.

There are a couple of important points to takeaway from the unexplored details of this sordid little tale. First, weening doesn’t necessarily mean much. I write this because, surprise, surprise, after writing last Friday how swap lines were still at full volume (for GFC2) first Europe’s central bank along with England’s and now Japan’s are finally beginning the weening process.



The second takeaway is a transition I’ve written about for years; which is really more of the point I’m making here. As discussed above, Europe had clearly been the epicenter of GFC1 and it really wasn’t close. We can tell this in any number of ways, including the use of the Fed’s swaps (and, in particular, those ridiculously high rates only European banks were bidding during the worst days).

Since 2008, one thing Europe’s banks have learned especially with another global dollar problem emerging by May 2010 was to get out of the dollar business as much as possible – which, confirmed by TIC, they certainly have.

Offsetting their departure only somewhat, Japan’s banks have picked up part of that slack turning the eurodollar into more of an Asian dollar. In the end it may seem like the same sort of thing, global dollar shortages and all, but this is an important distinction in that it proposes a different set of factors which might be impacting Japanese as opposed to European banks at any given time; therefore a different sort of center of gravity setting the conditions for all the rest.

China, to put it bluntly.

You’ll see the nature of this more Asian dollar system in the more recent GFC2 swap details.



Unlike 2008, the Bank of Japan rather than the ECB has been, by far, the Fed’s biggest swap counterparty. And it has been Europe, not Japan, which is leading the declines in recent days (the data above is daily up to yesterday).

Central bankers, at least, are growing more confident about the situation – particularly as it might look to those in Europe. There is no denying there has been a lull in the most visible aspects of this global dollar problem. Right now, especially taking share prices into account, it really doesn’t look too bad.

And that may be true, but in a very limited sense. It may not look disturbing on the surface, but underneath still hidden in the shadows there’s behavioral changes taking account of what happened in March. It may not show up straight away, nothing ever goes in a straight line, but that much is still the same GFC1 to GFC2.

How do we know? Markets. UST’s, yield curve, eurodollar futures, global yields, inflation expectations, even LIBOR still at a premium (and fed funds, where EFF has ticked up by 4 bps just since June began).

The swap levels only tell us what central bankers are thinking, those counterparties to them on the other side from the Fed who are the absolute lowest threshold to clear. Last week, they weren’t so sure about conditions despite the Fed’s claim to have flooded the world – which was my whole point. If Jay Powell hadn’t even convinced his overseas cronies, they still clinging to the same swap balances, then the entire conversation stops right there.

Now that his cronies are dipping their toes into normalcy, the conversation only begins to move, like November 2008, into the next layer (corroboration). This week, starting last Thursday, actually, those central bankers have shown they’ve become a little more confident in Japan, more optimistic in Europe, in at least the fact that outwardly the world seems to be calm and stable.

Is it, though? Has this been confirmed by anything else? More to the point, how would they know? Especially given Asia, and especially by how we know, in the end, the swaps aren’t what they really seem.



Print Friendly, PDF & Email