US Fed reopens currency swap hotlines with Europe
A major European bank needed an emergency $500 million of ECB funding last week, after it proved unable to attract loans from the normal wholesale sources. And the Swiss National Bank turned to the Federal Reserve last week for $200 million of short-term funding. The move was also made on behalf of an unidentified bank. These can’t be explained away as ‘rumours’: the European banking system is already strained to near breaking point. One further exacerbation – via investor panic or bad ClubMed news – will be enough to cause the collapse of a major bank.
The weekend has arrived, and yet again serves as a breathing space during which somebody could come up with the way out of this chain-strapped sack, inside which the world economy is sinking. But they won’t, because that person isn’t running a government….just reading the signs and stacking away the sort of wealth that will never be counterfeit.
Earlier this week, another sign that it’s all over bar the jumping came with the US Fed’s quiet decision to reopen the ‘FX Swap’ lines with key central banks – notably those in Switzerland and the ECB in Frankfurt. Foreign Exchange instant swaps were developed after the grisly demise of Bear Sterns in 2008 – the idea being to get emergency funds instantaneously to any bank that looks wobbly. For if a wobble were to turn into a collapse, this time the effect would be beyond awful. But several US sources were categorical about US Fed chiefs having met with New York bank regulators to discuss the possibility of eurobanks siphoning funds out of their US businesses in order to prop up balance sheets….and that, partly as a result of this, the FX Swap facility was restored.
The financial media are, on the whole, nevertheless convinced that, as Reuters puts it, ‘…..strains are unlikely to escalate to the liquidity crisis seen during 2007 and 2008, however, because the ECB has put mechanisms in place to provide unlimited funds….’. The FT too peddled a similar line. Both papers’ euroviews seem to me redolent of unsinkable ships and unthinkable events: how on earth can the ECB provide unlimited funds to a banking major beset by stock devaluation, loss of lender confidence, and facing huge bad debts in Spain?
In fact, the general response I got from opinion leaders yesterday was that the Fed wouldn’t have done this purely to ward against a hypothetical collapse: indeed, one major bank asked for an instant €500 million 7-day loan from the ECB at one point this week.
But senior French banking officials rubbished the idea of instability yesterday, and blamed “wild rumours” for the frenzied selling. We’ve heard these denials so many times before – and highlighting French banks makes sense: they are particularly reliant on short-term wholesale funding, because most French consumers deposit savings with other institutions. And also because, as we’ve seen, their exposure to peripheral lending is massive. BNP Paribas, in particular, has over €53 billion of exposure to this sector – nearly eight times that of SocGen. Even worse, BNP has short term loan exposure of a massive €94 billion – well ahead of SocGen at €64 billion.
It thus seems highly likely, based on the train of events between the US and the EU from Tuesday to Friday, that at least one and possibly two European banks are causing enormous doubt among credit suppliers. Those and other institutions would be wiped out by anything from further bad news to signs of imminent collapse in Spain. And both Spain and Italy are in deep trouble.
We need to remind ourselves of the monies involved here. According to the Bureau of International Settlements, the total exposure worldwide to Portuguese, Irish, Greek, Italian and Spanish debt is over £2.2 trillion. As we’ve come to expect, most of it involves derivatives – and 70% of it is owed to external banks and sovereign credit firms.
But the real problem is Spain – and banks exposed to Spain. That country has already sold most of the family silver, and raided its social security budgets….yet still owes the rest of us more than £800 billion. The Spaniards mainly owe the money to Germany, France and the US in that order….but German banks are seen generally as being better equipped to withstand a hit than their French counterparts.
There was definitely a sense in Paris last weekend that President Sarkozy had thrown an epi when told details of an explosion in the size of French public finance debt. This was coupled with a degree of speculation that he was, perhaps for the first time, viewing that borrowing credibility in the light of a potential French banking institution failure.
Other sources have confirmed to The Slog that the FX swap lines would only have been reopened if at least one major institution were perceived to be in trouble. In turn, a senior US source was categorical in asserting that Fed chiefs have met with New York bank regulators to discuss the possibility of eurobanks siphoning funds out of their US businesses in order to prop up balance sheets….and that, partly as a result of this, the FX Swap facility was restored.
“There’ve been some crazy fluctuations in eurobank liquidity here of late,” the source affirmed, “everyone’s on edge about contagion – and the insurance liability”.
But as Crash 2’s initial impact draws ever nearer, the insurance liability on Wall St is beginning to look more and more like the least of several evils. It is clear that signs of stress are building. On Friday, dollar borrowing costs increased and crossed a new threshold, one very clear warning sign of strain in the global financial system. The three-month, dollar-denominated London interbank offered rate hit 0.303%, touching a level not seen since the Spring. The gauge, a measure of bank-borrowing costs calculated daily in London, has steadily increased in recent weeks from a low of 0.245% in mid-June.
Finally, sources were pointing a finger of doubt at Barclays this morning. Already facing legal action accused of having helped massage the Libor rate in 2008/9, the banking giant unveiled 3000 job losses earlier this month. It is also known to have a very high exposure to Italian debt, via subsidiaries in that country, which partly explains why in the last month its shares have fallen 28%.