Saturday, January 7, 2012

The Fed Is Financing the ECB's Support For European Banks

Perry Mehrling will probably be blogging on this soon, but I cannot resist getting this news out now. I saw him at Maurice Obstfeld's Ely lecture yesterday here at the AEA/ASSA meetings in Chicago. Obstfeld spoke on "Does the Current Account Still Matter?" Answer: It no longer determines overall balance of payments because of disconnect from ever larger capital flows, but does still matter in that a country with a current account deficit may be subject to a bop crisis, whereas a surplus country is not. But that is not what this post is about.

I asked Perry if the Fed was doing what it did for a period following the Sept. 2008 crisis, taking on ECB assets onto its balance sheet. The answer from him was yes, and this is a recent development, only a month old. He pulled it up on his android: as of Jan. 5 the Fed had acquired $99.8 billion in ECB assets, all within the past month. This is not small change.

I suspect what is going on is that the European banks are really struggling to adopt to the Basel III capital requirements in the continuing recessionary environment in Europe. Given the threat they face on sovereign debt, and the ECB wanting to limit its support for the sovereign debtors directly, it has been pumping money into the banks to keep them afloat. But this has become such a difficult enterprise, they have drawn on the old facility with the Fed that was renewed some time ago. Perry may disagree, but it looks to me that this is what lies behind this very striking and important recent development.


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