Swap Lines for Four Emerging Markets: October 29, 2008
Although the FOMC had granted full authority to the FCS to authorize swap agreements with foreign central banks as needed, Bernanke still brought such proposals before the full committee for a vote on several occa- sions. One such occasion came on October 29, when the FCS wanted to include four EMEs in the swap program. Historically, the Fed had only opened swap lines with other advanced industrial economies—Mexico, being the one notable exception. Before taking such an unprecedented step, Bernanke wanted the FOMC’s blessing. In the days after Lehman’s demise, the global financial system had not healed itself. A major, historic money market fund, the Reserve Fund, broke the buck. The result was a "wholesale flight out of prime institutional money market funds” and even further tightening in the commercial paper market. During a conference call earlier that month, Bernanke painted the grim picture: "It’s more than obvious that we have an extraordinary situation. It is not a single market ... . Virtually all the markets—particularly the credit markets—are not functioning ... . It’s creating enormous risks for the global economy.”
Within the context of this global economic tailspin, a number of EMEs approached the Fed, interested in establishing swap lines with the US
ILLR. Among the countries that had asked for help, the FCS felt that four were deserving: Brazil, Mexico, Singapore, and South Korea. The FCS had proposed that the lines be $30 billion in size and come with additional "safeguards” that were not included as part of the agreements with the industrialized countries. In particular, even after authorization of the lines, the FCS would cap individual drawings at $5 billion and would not permit drawings without the approval of the FCS. Thus, the Fed could ensure that the credits were being used "in a manner consistent with the purposes of the swap agreement.” A Fed economist, Nathan Sheets, explained that these four EMEs were appropriate candidates for three reasons. First, they were all large economies with "significant financial mass”; thus, "a further intensification of stresses in one or more of these countries could trigger unwelcome spillovers for both the US economy and the international economy more generally.” Second, these countries had all pursued "prudent” economic policies in recent years. Third, the FCS felt that the swap lines would help diffuse financial pressures facing these countries. Later, the members were also informed that the dollar had strengthened considerably against the currencies of major trading partners and that "effective exchange values of the currencies of Brazil, Mexico, and Korea were particularly hard hit.”
The proposal raised some concerns among the committee. Charles Plosser, the president of the Reserve Bank of Philadelphia, wondered why these countries should not go to the IMF for assistance, adding "I just don’t know where this ends.” The exchange that followed once again highlights the inadequacy of the Fund as an ILLR during the crisis:
chairman bernanke. President Plosser, a couple of things. The IMF has very limited resources. They’re not remotely able to meet the needs of—
mr. plosser. We don’t know what the needs are yet, do we? chairman bernanke. Well, the resources are very limited ... mr. sheets. Just to put some numbers on IMF lending capacity— total IMF lending capacity is about $250 billion. To get even that high they have to call in some special arrangements that they have with a variety of countries. The maximum capacity is $250 billion. So the $120 billion that we’re proposing today would be essentially half of what the IMF could do. In that sense I really see what we’re proposing as our taking off the IMF’s hands some of the largest potential liquidity needs, which then allows them to focus on a whole range of additional countries.82
Another concern expressed was that there was a risk these countries would not pay the Fed back in full. However, Sheets pointed out that because each of these countries held substantial dollar-denominated assets in reserve at the New York Fed, this was not a concern. In the event an EME defaulted on a swap, Sheets explained, "We can take other assets on the books ... to extinguish those liabilities.” Geithner echoed this point, saying that the Fed could "take assets from their accounts to cover any loss,” adding that the swaps were "a mechanism to help them transform the composition oftheir dollar reserves in a waythat might be more effective in responding to lender- of-1 ast-resort needs in dollars, rather than having to sell Treasuries ... in a period of panic or distress to meet that cash need.” Another member suggested that rather than accepting local currency as collateral, the Fed should require US Treasury bonds. In other words, the EMEs should have to put up their dollar reserves in order to get access to dollar swaps. However, several members spoke up saying that such a condition would "stigmatize” and "insult” these countries.83
Finally, some committee members were also worried that approving these swaps would open Pandora’s Box by sending a signal that Fed swaps were available for all EMEs. When asked if other EMEs had asked for help, Sheets replied in the affirmative and listed the countries (which have been redacted from FOMC transcripts). Bernanke interjected: "But we have not encouraged that.” Sheets quipped, "We have done everything we possibly can to discourage it ... . We’re not advertising.”84 In the end, the FOMC again unanimously moved to authorize the four EME swap lines. However, the committee did not agree to authorize the FCS to increase or authorize additional EME lines, preferring to set the bar for additional countries high and require full FOMC approval. In the end, the committee did not add new countries to the swap program or increase any existing swaps in size. The committee renewed all lines two more times in 2009 before it allowed the lines to expire in February 2010.
-  In each case, the FOMC voted unanimously to increase the size of the program.
-  FOMC 2008g, p. 30.
-  FOMC 2008h, p. 12.
-  Later, Sheets referred to these four EMEs as being "systemically important” (FOMC2008i, p. 33).
-  FOMC 2008i, p. 10. Bernanke also added that both the Treasury and State Departmentshad been consulted and each agreed that if EMEs were going to be included, this was theproper group.
-  FOMC 2008i, p. 52.