The Federal Reserve Bank of New York today released Central Bank Dollar Swap Lines and Overseas Dollar Funding Costs , the latest paper in the Bank’s Economic Policy Review series.
In the decade prior to the financial crisis, foreign banks’ exposure to U.S.-dollar-denominated assets rose dramatically. When the crisis hit in 2007, the banks’ access to dollar funding came under severe duress, with potentially dire consequences for global financial markets that could also spread to U.S. markets. The Federal Reserve responded in December 2007 by establishing temporary reciprocal currency swap lines, or facilities, with foreign central banks designed to ameliorate dollar funding stresses overseas. Drawing on rigorous analysis of the swaps, as well as insights of other economic studies and anecdotal accounts of market participants, this paper concludes that the lines were effective in reducing dollar funding costs abroad and stresses in the money markets. Furthermore, the facilities have been an integral part of the central bank toolbox for managing systemic liquidity disruptions as well as represent an important example of global policy cooperation.
In this paper, authors Linda S. Goldberg, Craig Kennedy and Jason Miu describe the events leading up to the introduction of the dollar swap lines, discuss changes to the facilities as funding conditions evolved and consider the facilities’ effects on market activity.
Goldberg, Kennedy and Miu observe that as pressures in the U.S. dollar funding markets built in late 2007 and continued through 2008, non-U.S. banks, particularly European institutions, faced difficulties accessing dollars through traditional sources, such as the foreign exchange swap market and other short-term interbank funding markets. The Federal Reserve and other central banks agreed upon the use of dollar swap lines to address these disruptions as well as the more broad-based dysfunction in the money markets.
As market conditions deteriorated, the Federal Reserve’s swap facilities expanded in terms of the number of central banks with swap agreements and the amount of dollars made available abroad. Participating central banks grew from an initial two to 14. Net dollars outstanding through the swaps climbed from $24 billion in 2007 to a peak of nearly $600 billion at year-end 2008. As conditions improved, amounts outstanding declined to less than $100 billion by mid-2009, to less than $35 billion by October, and to under $1 billion when the facilities expired on February 1, 2010. (Some of the lines were subsequently reintroduced in May 2010, when strains in short-term funding markets reemerged in Europe.)
Linda S. Goldberg is a vice president, Craig Kennedy an assistant economist and Jason Miu a senior trader/analyst at the Federal Reserve Bank of New York.