Brian Sack, the Federal Reserve Bank of New York’s markets group chief, said the central bank’s decision in May to restart swap lines with counterparts in Europe, Canada and Japan was a “preemptive” move to help bolster market confidence.
“From the perspective of the Federal Reserve, the liquidity swap arrangements are safe,” Sack said during a speech to the New York Association for Business Economics today. He described the Fed as taking a “limited and supportive role” in stemming the European debt crisis, saying “the successful resolution of these problems ultimately rests on European policy actions.”
By restarting its emergency currency-swap tool, the Fed agreed to provide as many dollars as needed to the foreign central banks to help keep Europe’s sovereign-debt crisis from spreading to more markets. The Fed’s action last month came as European policy makers unveiled an unprecedented loan package worth almost $1 trillion to stop a crisis that threatened to shatter confidence in the euro.
“The swaps were essentially put in place in a preemptive manner, under the view that their presence would provide a backstop for dollar funding markets and help to bolster market confidence,” said Sack, a former Fed economist and section head who returned to the central bank system last year.
No Credit Risk
“We should all view these programs as having no credit risk,” he said in response to audience questions after his speech. The Fed has had “extensive discussions” with the staff of the European Central Bank, and “I have full confidence that they understand markets and that they have the capacity to make the correct policy decisions,” Sack said.
Along with the Fed’s Term Asset-Backed Securities Loan Facility designed to spur consumer and business borrowing, the swap lines “suggest that liquidity programs can be quite effective at restoring market functioning and facilitating the flow of credit to households and businesses,” Sack said in the speech.
The programs provided credit in stressed markets and at a penalty rate that “yields several benefits,” he said. In addition, there may be benefits for central bankers in extending credit to nonbank financial firms during turmoil, Sack said.
Fed officials are trying to balance efforts to keep the economic recovery going with plans to unwind the record expansion of the central bank’s balance sheet and shut emergency-lending programs. Sack, 39, is helping devise the programs to withdraw funds from the banking system and tighten credit to prepare for when policy makers decide to do so.
“There’s a very active discussion about policy strategy” at the Federal Open Market Committee’s meetings, Sack said after his speech.
“We’re thinking about getting the tools ready” for an exit, he said, while reiterating policy makers’ pledge to keep rates low for an “extended period.” The Fed has made “considerable progress” on building tools to drain bank reserves through programs such as reverse repurchase agreements and term deposit facilities, he said.
Fed Chairman Ben S. Bernanke and his colleagues on the FOMC plan to eventually sell the central bank’s holdings of mortgage-backed securities and cut the balance sheet to less than $1 trillion, its size before the financial crisis. The committee will next meet in Washington on June 22-23.
The Fed’s assets were little changed at $2.34 trillion in the week ended June 2 after reaching a record level of $2.35 trillion on May 19. The Fed had $6.64 billion of swaps outstanding as of June 2, compared with a record $583.1 billion in December 2008, at the height of the financial crisis.
The Fed started TALF last year to revive issuance and jumpstart lending after sales dried up amid the credit seizure. The program is designed to spur consumer and business borrowing and closed in March for assets except new commercial mortgage- backed securities, for which the program will remain open through June.
The New York Fed is the central bank’s main liaison with financial markets.