The U.S. Federal Reserve Bank rides to the Rescue

Posted on December 2, 2011



Do you remember a few years back when the major European banks were required to go through a financial examination to determine their fiscal stability? It was designated as the “European Bank Stress Test” and 91 of the foremost banks passed with flying colors. Initially, the market response was one of relief and reassurance. However, it was later disclosed that the banks were allowed to remove from their portfolio their considerable exposure to their holdings of sovereign debt. So much for restoring lost confidence. To ease public concern, it was then decided the following year to have the banks re-take the test, but this time including their true risks to debt issued by countries like Greece, Ireland, Portugal, Spain, and Italy. Again, surprisingly, a majority of the banks did well. All was right with the world. But, in a short time, it was revealed that while the banks included their exposures to sovereign debt, as long as they were receiving interest on these bonds, they were not required to mark to market their accurate exposure to these investments. So, it was decided to re-test the re-test.

 

In the meantime, European banks have stopped lending and borrowing from each other. International financial institutions have for the most part cut back or cut off credit lines creating a substantial loss of liquidity to these banks and their customers. The IMF has limited funds and the ECB, at this moment, refuses to be the lender of last resort. There are strong disagreements among the EU governments on how to resolve this monetary trainwreck. German Chancellor Angela Merkel refuses to support an expanded European Central Bank role in solving the debt crisis. The distress of rising interest rate costs for banks is so immense that European Union leaders are considering proposing that bank debt issued prior to 2013 be exempt, compelling private investors to take losses, with the intent of keeping lender’s funding costs from increasing. But, for the moment, availabilty of much needed resources remains quite limited.

 

So the US Federal Reserve Bank rides to the rescue.

 

For the past two weeks, European banks have basically been closed out of the dollar borrowing market, or if they can borrow, they only have access to funds a week at a time. With the lack of liquidity intensifying, the US Fed, along with several other central banks provided entry to capital funding. The intended objective is to ease the strains in the financial markets, offer lower dollar interest rates and try to halt a toxic credit crunch in Europe. While this may bring a short reprieve, it is just another band aid. As per Chancellor Merkel said, “it is fighting debt with more debt.”

 

The ongoing differences and battle of constantly changing proposals on how to work through this eurozone debt and banking disaster between EU leaders and the ECB creates volatility and instability in the world’s currency markets.  This uncertainty and explosiveness of the euro vs. the US dollar and other trading partners just compounds their predicament in creating a secure and comfortable investment environment.

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