Alan Grayson amendment to restrict Federal Reserve on Foreign Currency Swaps

Update: This amendment passed by voice vote.

Frankly, I just don't understand foreign currency swaps. It's above my pay grade.

Yet, we have an amendment, by Rep. Alan Grayson and Ron Paul, to restrict the Federal Reserve on issuing foreign currency swaps.

The amendment restricts the Federal Reserve by requiring five Federal Reserve members of the board of Governors approve as well as the U.S. Treasury Secretary.

The Bank of International Settlements, Switzerland, has written a paper on the U.S. dollar shortage and the international policy response, from what happened by the fall of 2008. Below is a graph of the sudden increased foreign currency swaps issued by the Federal Reserve:

currency FX swaps fed
Src: Zero Hedge, click on image to enlarge

 

The global financial crisis has shown just how unstable banks’ sources of funding can become. Throughout the crisis, but particularly following the collapse of Lehman Brothers in September 2008, many banks faced severe difficulties securing short-term US dollar funding.
In response, central banks around the world adopted extraordinary policy measures, including international swap arrangements with the US Federal Reserve, to enable them to provide US dollars to commercial banks in their respective jurisdictions.

What happened? It seems banking is international and globally deregulated. Remember, "foreign" claims is in part, U.S. claims or dollar claims from the BIS paper terminology.

The origins of the US dollar shortage during the crisis are linked to the expansion since 2000 in banks’ international balance sheets. The outstanding stock of banks’ foreign claims grew from $10 trillion at the beginning of 2000 to $34 trillion by end-2007, a significant expansion even when scaled by global economic activity. The year-on-year growth in foreign claims approached 30% by mid-2007, up from around 10% in 2001. This acceleration took place during a period of financial innovation, which included the emergence of structured finance, the spread of “universal banking”, which combines commercial and investment banking and proprietary trading activities, and significant growth in the hedge fund industry to which banks offer prime brokerage and other services.

It seems banks invest in one currency but fund non-bank assets in another, mainly U.S. dollars.

It seems EU banks went long on the dollar as an investment and funded this gamble with their own domestic currency.

When the crisis hit, these European banks has all sorts of U.S. dollar dominated investments where the underlying assets...tanked. Then, Lehman Brothers failed and we had a international run on the banks. Seems European banks couldn't dump off their derivatives and needed more U.S. dollars to prop it all up.

So, by the Federal Reserve issuing foreign currency swaps allowed European banks to get a hold of the U.S. dollars they needed to prop up their worthless derivatives instead of dumping these structured finance debacles onto the open market and taking the loss.

Here is the major issue:

In providing US dollars on a global scale, the Federal Reserve effectively engaged in international lending of last resort. The swap network can be understood as a mechanism by which the Federal Reserve extends loans, collateralised by foreign currencies, to other central banks, which in turn make these funds available through US dollar auctions in their respective jurisdictions.

This made US dollar liquidity accessible to commercial banks around the world, including those that have no US subsidiaries or insufficient eligible collateral to borrow directly from the Federal Reserve System.

This in effect, kept the U.S. dollar value low.

A concluding remark by BIS:

The recent financial crisis has highlighted just how little is known about the structure of banks’ international balance sheets and their interconnectedness.

Get that? They, these experts on international finance, have no clue, no idea on the contagion of international finance and banking.

BIS also notes that thinking in terms of national boundaries for international finance is a huge mistake. One cannot determine the risks by these methods today. One must look at the overall balance sheets of the largest financial institutions.

This is true on a host of economic indicators inside the U.S. We are often without information on the effects of globalization, due to some illusion that the U.S. domestic economy is reasonably self-contained.

Zero Hedge wrote up an analysis on the same BIS paper:

What is notable from the above table is just how massive foreign banks' USD-funded positions are, especially when viewed from the perspective of various GDP numbers. The 6 countries that make up the core of the Eurozone all have foreign dollar denominated claims which are well over 100% of their respective GDPs! These countries took on an amount of Dollar exposure that would take on a country's entire GDP to fund and then some.

The fact that they have done so with the complicity of the Federal Reserve is staggering and a clarion call for a global risk regulator which is distinctly separate from the US Fed, which prompted this intractable risk taking in the first place.

On this point, I can agree. It's clear we need a better understanding on global systemic risk. Look at the experts. They don't even have a clear idea what's really going on!

Here was the upper bound risk at one point:

If we assume that these banks’ liabilities to money market funds (roughly $1 trillion, Baba et al (2009)) are also short-term liabilities, then the estimate of their US dollar funding gap in mid-2007 would be $2.0–2.2 trillion. Were all liabilities to non-banks treated as short-term funding, the upper-bound estimate would be $6.5 trillion.

This is runaway risk with no international regulatory system in place.

Now Zero Hedge claims the Federal Reserve bailed out the world. In a way, that's very true.

But what if the opposite happened and the Federal Reserve did not step in and be the lender of last resort?

How would that have affected the U.S. economy? While what the Federal Reserve did stinks and the fact we have global runaway risk with no oversight really stinks and even worse, the world has no clue on how this all interacts smells to high heaven....

Do we know the real effects if the Federal Reserve did nothing?

Currently Zero Hedge is promoting the Grayson amendment. In Alan Grayson Seeks To Moderate Fed-Mandated Currency Swaps Which Bail Out Foreign Central Banks Shorting The Dollar:

We ignore the ethics of bailing out those who have done nothing but piggyback on the dollar carry trade, and in doing so, have decimated the purchasing power of America's working class, which is precisely what Ben Bernanke did.

I hear ya there. But Zero Hedge also notes if the amendment passes:

Watch for the dollar carry trade to implode immediately, as foreign CB's will know they can not rely on the Fed to pump them full of dollars when the margin calls come crashing in and there are no more dollars to be bought in the free market. As the BIS estimated: the total amount of potential dollar funding shortfall could be as high as $6 trillion. Take the Fed out of the equation, and you get just one word: panic.

Now this is of grave concern. What really happens if this dollar carry trade has immediate implosion?

Here is Rep. Alan Grayson introducing his amendment:

 

So, while I certainly applaud limiting foreign bank bail outs and U.S. taxpayer funds going overseas, a currency swap isn't just handing over cash. We do get foreign currency in exchange. It's quite clear the Federal Reserve put U.S. taxpayer money, through foreign exchange rates and potential losses, at risk, but what was the risk if the Federal Reserve had not become the lender of last resort?

Here is Rep. Grayson' trying to get to the bottom of these foreign currency swaps.

 

Our site names implies we are fire breathing Populists, very much interested in the United States being economically strong and especially fighting for working America, but frankly, I just do not understand the ramifications enough to know what kind of effect Grayson's amendment will have on the U.S. economy to know if it's a good idea or not.

I suppose if it's a good idea, then the members of the board of governors and the U.S. Treasury Secretary would approve...but on the other hand, do we really trust Geithner with anything at this point, never mind the board of Governors of the Federal Reserve?

More importantly, we have an amendment which might greatly affect global currency markets and us, the peanut gallery, the little guy, really don't have any idea on what kind of effect the Grayson amendment would have. It seems the only blog on the case, performing due diligence, is Zero Hedge.

See this post on the U.S. dollar being the mother of all carry trades.

Meta: 

Comments

Weak but Something at least

Most of the fed bank district heads are on the same page so finding 5 to vote for this won't be a problem its not even a majority and Geithner might as well be still back at the Fed.

This is part of the tens of trillions in monopoly money the Fed has created and kept off the books.

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Fantastic write up Robert!

Kudos, this is your best effort since I have been following the site. This should go viral!

It appears that we are finally getting somewhere in the vicinity of the real nitty gritty of what is and has been going on. I applaud Grayson's persistence, regardless of the repercussions for the US and global economy.

For me, it is already a fait accomplis...we the sheeple are royally screwed. There is no "soft landing" out of this crisis for those of us at the bottom of the pyramid. The only real "danger" I can see in pursuing the Grayson amendment is that the totality of the fraud itself may be exposed! The old saying goes "the bigger they are, the harder they fall". So, the downside fear is much greater for the TPTB, the bondholders, the hedge funders, and the many other types of capitalist greed bastards, as compared to we, the great unwashed proles.

The truth must be told. Only then can those of us who care about the general welfare of the human race begin to implement a sustainable future.

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De Fazio stirs the pot.

Read this late post at NC. Grayson may be contagious and more of the Dems are finally growing a pair.

Read the comments too. For instance, here's what Jesse had to say:

Firing Timmy and Larry? A consummation devoutly to be wished. Although I shudder to think what foul beasts might be scraped up to serve in their place.

Obama is hopeless. The US is in thrall to a group of financial interests that control it from top to bottom. How this will be resolved, God only knows.

For Pete's sake, we need more honest dialogue from our elected officials.

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classic DeFazio

But note! While Ed is calling it the Progressives, DeFazio has a new gang, the Populists! I think that's great because no offense to anyone who believes they are a Progressive, that title has been co-opted by more than one special interest agenda that doesn't make a whole lot of sense economically.

Anyway, DeFazio is probably my favorite House Rep. He doesn't lay down. Since he's now head of the Populist caucus, I guess we should be on the look out more on what they are up to.

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DEFAZIO'S THE ONE

Yup! DeFazio is THE REAL DEAL...no doubt about that.

His record speaks for itself -- not one who claims one thing but votes completely differently!

I do disagree somewhat that the Fed was bailing out the world. What appears more likely is that they were working to continue the USD as the reserve currency of the planet.

Let's see how much longer that works out. And foreign currency swaps are normally for currency arbitrage -- same reasoning.

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Liquidity Swaps

Currency swaps get confusing, I know, especially when countries holding debt in one currency need to manipulate their own. But after reading this paper from the BIS, what I come away with is an elegant explanation of one chain reaction event in a well-executed coup to set off a global crisis, which attempts to lend academic objectivity to the notion of a U.S. dollar shortage as the pivotal event which evoked a pivotal response by the Federal Reserve.

http://letthemfail.us/archives/2366

To answer your question, what if the Fed had NOT engaged in these liquidity swaps?

Perhaps the necessary response to place this entire pyramid of unregulated risk insurance, leveraged to more than 14 times the entire world's GDP, through a Glass Steagall type bankruptcy procedure to separate the chaff from the wheat.

Better that, than to further bankrupt the already bankrupt US government, as Bernanke did. Grayson's intent is good, but irrelevant. Neither the dollar, nor the country, could ever survive the next counter-party run on dollar denominated derivative risk.

Arguably, we won't (that is didn't) survive this one.

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Hi Will Martindale

I've seen you comment many times on EP, so can I recommend creating an account? You an track your comments and bypass the CAPTCHA that way.

Also, can you format your links?

Finally, I just read your post and frankly I know this is a very tough question to answer, so I don't blame anyone for not having an answer...

but the question is what would have happened at that time if the Fed did not issue those foreign currency swaps?

The reason I'm asking is the international finance world is really borderless and they are assuredly using the U.S. dollar as a reserve currency as well. So, I'm wondering what the ramifications were at the time.

Believe me, I am just not into at all bailing out foreign banks or destroying the U.S. dollar, I'm just wondering, because we're an international reserve currency what kind of global financial ramifications would that have had if it wasn't done, right at that moment?

Simple as they had to write down some losses or would it have implied some sudden value dollar spike to the point it killed our exports and real economy?

I think I understand the BIS paper and amendment well enough actually.

I'm really pointing to international interactions, or contagion, which experts in international finance, global banking admit they have no clue on.

Come join us for more complete discussion and posting. This crap is hard!

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committee or house?

I watched the hearings and it passed in committee. But I thought in terms of the full house it has to now go to the floor, more debate, amendments.

I don't know what is completely in it...I watched the hearings and saw both of Ron Paul/Alan Grayson's amendments passed....quickly! by voice vote but in terms of giving the Fed more super regulatory power, what's going on with the fact all of these regulatory agencies as are, failed, the huge, drive a truck through it derivatives loophole and so on, I don't know the status at the moment.

This is pretty cool on the audit the Fed...finally something both sides can agree on! I'm also shocked they decided to do it.

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what would happen?

Foreign banks would start offering better and better deals for dollars, and that would drive interest rates in the United States through the roof. It would severely damage our economy and a lot of jobs would be lost.

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