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Dudley Sees ‘Extraordinarily High’ Bar for Euro-Debt Buying

Federal Reserve Bank of New York President William C. Dudley
Federal Reserve Bank of New York President William C. Dudley. Photographer: Ramin Talaie/Bloomberg

Federal Reserve Bank of New York President William C. Dudley said he “cannot imagine” the U.S. central bank buying European sovereign debt to combat the crisis, though it has the legal authority to do so.

“The bar to doing that would be extraordinarily high,” Dudley, 58, said today at a hearing of a House Oversight and Government Reform subcommittee in Washington. “We have never gone out and bought large portions of sovereign debt in the history of the Fed that I’m aware of.”

Dudley defended the Fed’s currency-swap lines to foreign central banks under questioning from lawmakers, saying that the loans are “about helping ourselves.” Dudley also said he doesn’t anticipate the Fed will undertake additional steps to curb the impact of Europe’s crisis, though it is prepared to boost liquidity to U.S. banks if necessary.

“It’s really their problem to solve,” Dudley said. “The Federal Reserve is doing what we think is appropriate to support lending here in the United States.”

The Fed’s swap lines to foreign central banks surged by $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.

Flow of Credit

“This is about ensuring the flow of credit to U.S. households and businesses,” Dudley said. “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.”

Less than two hours after Dudley’s testimony ended, Fitch Ratings said it may cut the ratings of nations from Italy to Spain and Belgium as Europe’s debt crisis defies the “comprehensive solution” pledged by the region’s leaders.

U.S. stocks pared gains after the Fitch statement, while Treasuries extended their advance. The Standard & Poor’s 500 Index added 0.3 percent to 1,219.42 at 1:03 p.m. New York time, after rising as much as 1.3 percent. Yields on 10-year Treasury notes fell six basis points to 1.85 percent.

Countries that share the euro face “a critical problem of confidence” in the long-term sustainability of fiscal accounts for some nations and in the stability of their banking systems, Steven Kamin, the Fed’s Director of International Finance, said at the same hearing.

“It is incumbent upon European authorities to address all these issues, and indeed they have taken a number of steps on all three fronts,” Kamin said.

‘Very Alert’

The Fed and other regulatory agencies are “very alert” to the risks of short-term European bank debt held by U.S. money-market funds, which have “been substantially reducing their exposure” to the most vulnerable European economies, Kamin said. The Fed swap lines can work as a backstop against market-liquidity problems, helping European financial institutions get the dollar funding they need, he said.

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.

Identities of Borrowers

Representative Patrick McHenry, the North Carolina Republican who heads the subcommittee, said after the hearing that getting information on which European banks are obtaining loans through the Fed’s swap lines is a “big concern.” While the transactions with other central banks are all disclosed, the Fed doesn’t track where the dollars ultimately end up, and European officials don’t share borrowers’ identities outside the continent.

“I think it’s reasonable, if the Fed is extending the swap line to a central bank, that they actually have similar disclosures that our central bank requires from counterparties within our country,” McHenry said to reporters. “With less information, markets become less confident.”

Fed 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.”

‘Fiscal Capacity’

Dudley said Europe has the “fiscal capacity” to meet its challenge, which he said is “really a political one.” He said he doesn’t see the European Union dissolving.

“You really have to solve two problems,” Dudley said. Regulators need to “make sure the banks have enough capital,” and “you also have to get each country on a sustainable fiscal path so that people are comfortable that the sovereign debt they hold is going to be money good.”

The stress tests being undertaken by regulators in Europe are “a very important step” in bolstering confidence in the financial system, Dudley said. The Fed is also putting U.S. financial institutions through a “very severe stress test,” designed to ensure they can “withstand a very bad economic environment regardless of the source of the stress,” he said.

It will be easier for Spain and Italy to achieve fiscal-consolidation than for Greece, he said.

“As you go from the peripheral countries to the core, the debt challenges become much more manageable,” Dudley said. “They have to do substantially less than what Greece has had to do,” and “what Spain and Italy need to do is completely achievable.”

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