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Dudley Doesn’t Foresee More Fed Action to Limit Harm from European Crisis

Federal Reserve Bank of New York President William C. Dudley said the Fed isn’t planning to undertake additional steps to curtail the impact of Europe’s crisis, while standing by to boost liquidity if necessary.

“At this time, although I do not anticipate further efforts by the Federal Reserve to address the potential spillover effects of Europe on the United States, we will continue to monitor the situation closely,” Dudley, 58, said in prepared testimony. He is scheduled to appear at 9:30 a.m. at a hearing in Washington of a House Oversight and Government Reform subcommittee, which posted the remarks on its website.

The Fed “has a range of tools available to provide an effective liquidity backstop” for U.S. financial institutions if the crisis escalates, Dudley said. U.S. banks don’t currently “face difficulty obtaining liquidity in short-term funding markets,” he said.

Chairman Ben S. Bernanke signaled this week he’s concerned that Europe’s sovereign debt crisis will damage a 2 1/2-year expansion in the U.S. and that the central bank is prepared to provide easing if needed. The Federal Open Market Committee said after meeting in Washington on Dec. 13 that “strains in global financial markets continue to pose significant downside risks to the economic outlook,” and that there is an “apparent slowing in global growth.”

Swap-Use Surge

The Fed’s swap lines to foreign central banks surged $52 billion to $54.3 billion this week after the Fed and five other central banks lowered borrowing costs by a half-percentage point in a coordinated action. The Fed lends dollars through the swaps to other central banks, which auction them to local commercial banks and give the Fed foreign currency as collateral.

“By reducing the cost of dollar funding via the swap lines last month, we reduced the pressure on banks in Europe to abruptly liquidate their U.S. dollar assets,” Dudley said. “Thus, this step will help to insulate U.S. markets from the pressures in Europe and support the availability of credit to U.S. households and businesses.”

Dudley’s remarks echo those made by Bernanke to Republican senators on Dec. 14. Bernanke said the Fed plans no additional aid to European banks amid the region’s crisis, according to senators Bob Corker of Tennessee and Lindsey Graham of South Carolina, who attended the meeting.

While the Fed may not be able to lend directly to banks outside the U.S., it can provide loans to their U.S. branches through the discount window. The Fed’s currency-swap lines also provide indirect dollar funding to overseas banks through the European Central Bank and other central banks who assume the credit risk.

‘Severely Impaired’

“It is in the U.S. national interest to make sure that non-U.S. banks that are judged to be sound by their central bank are able to access the U.S. dollar funding they need in order to be able to continue to finance their U.S. dollar assets,” Dudley said. “If the access to dollar funding were severely impaired, this could necessitate the abrupt, forced sales of dollar assets by these banks, which could seriously disrupt U.S. markets and adversely affect U.S. businesses, consumers, and jobs.”

Lending through the swap lines peaked at $586 billion in December 2008. The swaps are separate from Fed emergency loans to banks and other businesses that peaked at $1.2 trillion the same month, including about $538 billion that European financial companies borrowed directly, according to a Bloomberg News examination of available data.

Pressure on Banks

A worsening crisis in Europe risks damaging overseas demand for U.S. goods and services, putting pressure on the U.S. banking system and causing financial-market conditions to deteriorate, Dudley said.

“I am hopeful that Europe can effectively address its current fiscal challenges,” Dudley said. “Although the U.S. economy is currently expanding at a moderate pace, we face significant downside risks, mostly relating to the sovereign debt crisis in Europe.”

Steven Kamin, director of the Fed’s Division of International Finance, said in prepared testimony for the same hearing that Europe’s financial stress is “undoubtedly spilling over” to the U.S. by curbing exports, lowering business and consumer confidence and adding to pressures on U.S. financial markets and institutions.

Kamin also defended the swap lines as necessary to help non-U.S. financial companies who “have heavy borrowing needs in our currency.” The half percentage-point cut in borrowing costs last month was needed to contain growing market strains that “if left unchecked, could impair the supply of credit to households and businesses in the United States and impede our economic recovery,” Kamin said.

Foreign central banks assume the credit risk on the dollar loans from the Fed, whose “interactions with them over the years have provided a track record that justifies a high degree of trust and cooperation,” Kamin said. Fees on the swap lines have added about $6 billion to the Fed’s earnings over the past five years, increasing returns to taxpayers, he said.

To contact the reporter on this story: Caroline Salas Gage in New York at csalas1@bloomberg.net

To contact the editor responsible for this story: Chris Wellisz at cwellisz@bloomberg.net

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