Rapid Growth of the Swap Program: September 15, 2008-October 28, 2008

The day after Lehman Brothers filed for bankruptcy, the FOMC held an emergency meeting. Chairman Bernanke opened the meeting with a request. He wanted the Committee to grant the Fed’s Foreign Currency Subcommittee (FCS) the temporary authority to authorize swap lines with foreign central banks as needed, without preset limits.[1] This way, the Fed could respond to changing conditions immediately, without needing to call an FOMC meeting for approval. Although central bank swaps were already an incredibly effective ILLR mechanism, Bernanke wanted to move them as close as possible to Bagehot’s ideal of automatic and unlimited lending. Before his request went to a vote, Dudley briefed those in attendance on what had transpired in the hours since the Lehman shoe had dropped. Money market funds, he explained, were hemorrhaging money and suffering from a serious liquidity problem as panicked investors withdrew their investments.[2] Breaking the buck, he explained, was a very real risk as "the capital resources of ... the [money market funds are] often quite modest, so their ability to top up the money funds and keep them whole is quite limited.”[3] The bloodletting from the money markets meant that the commercial paper market, already dealing with a lack of liquidity, had entered a deep freeze. Dudley went on to explain that stresses in the market were greatest in Europe. The lack of liquidity across the Atlantic raised the prospect of a European bank default and was "having a feedback effect on people’s willingness to do business with one another in the broader market.”[4]

After Dudley’s briefing of the committee on the market’s dramatic turn for the worst over the past 24 hours, discussion turned back to approving Bernanke’s request for transferring swap authorization authority to the FCS. Making the case for the chairman’s request for authority to authorize credit without limit, Dudley warned that any "notions of capacity” could be tested by markets. It was better, he felt, to "provide a backstop for the entire market.” He then added, "If the program is open ended, the rollover risk problem goes away. If I lend you more dollars today, I don’t have to worry about getting those dollars back because I always know that the facility is there.”[5] In other words, the only way that money markets and banks both at home and abroad would continue to lend to each other, thereby preventing the collapse ofthe US and global financial systems, was if some ILLR was willing to provide dollars without limit. The only actor capable of doing this was the Fed. Ultimately, the committee unanimously approved Bernanke’s request to give complete swap authorization authority to the FCS through January 30, 2009.[6] Over the course of the next 40 days, the swap program grew from two participating foreign central banks to 10 and from an aggregate total of $67 billion to unlimited in size.[7]

  • [1] The FCS consisted of the chairman of the Federal Reserve (Bernanke), the vicechairman of the FOMC (Geithner), and the vice chairman of the Board of Governors(Donald Kohn).
  • [2] Specifically, Dudley pointed to the Reserve Fund, which, as discussed above, ultimately did "break the buck” after Lehman’s collapse triggered investors to withdraw theirsavings in a race for the exits. Governor Rosengren also warned about another money market fund, backed by State Street Global Advisors—a massive asset management firm inBoston, Massachusetts—which paid out $20 billion to terrified investors on September 15,that on its own did not "have sufficient capital to make people whole” (FOMC 2008f, p. 7).
  • [3] FOMC 2008f, pp. 3-5.
  • [4] Ibid., pp. 4, 10.
  • [5] Ibid., pp. 11, 17.
  • [6] Ibid., p. 18.
  • [7] Most of the conversations related to the expansion of the swap program during thisperiod took place among the FCS and, consequently, there are no publicly available recordsto review. However, at one meeting after the FOMC granted swap authorization authorityto the FCS, Dudley remarked, "All of the foreign central banks that have obtained dollarswap lines in response to dollar funding pressures in their home markets have decided, withsome encouragement on our part, to seek an increase in the size of these swap line authorizations” (FOMC 2008g, p. 4; emphasis added). Thus, it appears that just as the Fed initiatedswap discussions with the ECB and SNB in August 2007, it also initiated talks to increasethe size of the lines.
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