ECB and Fed Weigh Currency Swap

Along with continuing to pour funds into eurozone markets, the European Central Bank may allow the Fed to lend dollars to Continental banks

Amid fears that US mortgage market problems would prompt a worldwide credit crunch, the European Central Bank, ECB, is expected to continue pumping funds into the eurozone banking market today (13 August).

According to the Financial Times, the Frankfurt-based institution may also seek to arrange a currency swap with the US Federal Reserve -- a move allowing it to lend dollars to European banks struggling to meet short-term dollar funding needs.

"The attitude is don't show me anything east of a [New York] 212-area code'. If you lend to [those banks], it could be a career-ending experience", one banker said, the FT reports.

An ECB request for a currency swap -- reportedly due in the next few days -- is seen as a helpful way of dealing with the market turmoil and is likely to be welcomed by the US Federal Reserve.

A swap would be "a market calming measure and would be logical in the current situation", Chris Furness from economics consultancy 4Cast told the FT.

It would also be the first such arrangement between the world's two biggest central banks following the terrorist attacks in the US in 2001.

Conditions in the money markets have been extremely difficult since last Thursday (9 August), when French Bank BNP Paribas suspended three investment funds worth two billion euros, citing problems in the US sub-prime mortgage sector.

"The complete evaporation of liquidity in certain market segments of the US securitization market has made it impossible to value certain assets fairly regardless of their quality or credit rating", BNP Paribas said in the statement.

Sub-prime mortgages are loans made to borrowers who would not usually qualify for the normal market interest rates, often due to a poor credit history.

They are riskier both for the borrower and lender because of this combination of higher interest rates and weak credit history.

New market conditions have prompted banks to seek ways to limit their risks and they have begun charging significantly more for the money they lend to each other.

For their part, central banks worldwide have responded by injecting cash into the financial system.

The ECB poured €61.05 billion into the eurozone money market on Friday (10 August) "to assure orderly conditions in the euro money market".

The US Federal Reserve, the Bank of Japan and the Reserve Bank of Australia also injected cash into the system to ensure sufficient liquidity.

European stock markets were in positive territory across the board at the market opening Monday (13 August), in a tentative sign that swift Central Bank intervention has calmed investors' jitters.

And the ECB said Monday morning it will continue to "closely monitor" developments in the market, in another bid to soothe market concerns.