Letter to the Editor Regarding Central Bank Liquidity Swaps
January 5, 2012

Published in the Letters to the Editors section of the Wall Street Journal on January 5, 2012

To the Editor,

In response to Gerald O'Driscoll Jr.'s "The Federal Reserve's Covert Bailout of Europe" (op-ed, Dec. 28): I would like to clarify the purpose of the dollar-swap program recently undertaken by the Federal Reserve, which is to help insulate U.S. markets from the pressures in Europe and support the availability of credit to U.S. households and businesses..

The intention is to ensure that financial institutions headquartered outside of the U.S. that are deemed credit-worthy by their central banks have the dollars they need to fund their U.S. dollar assets and activities.

These institutions play an important role in providing credit and other financial services in the U.S., providing a total of approximately $900 billion in overall financing within the U.S., and making extensive use of dollars in their financing activities. If their access to dollar funding was severely impaired, it could necessitate the abrupt forced sale of dollar assets, which could seriously disrupt U.S. markets and raise the costs for borrowing and lending in the U.S.

At a time when it is already difficult for American families and firms to get the credit they need, we have a strong interest in making sure that these banks can continue to be active in the U.S. dollar market.

The swaps further this interest while fully protecting the U.S. taxpayer. The Federal Reserve temporarily provides a central bank with dollars in exchange for its currency at a fixed exchange rate and receives a fee. That central bank in turn lends those dollars to private institutions on a collateralized basis and assumes any credit risk.

These measures are meant to create a credible backstop to, but not supplant, private markets. Banks with surplus dollars are more likely to lend to banks in need of dollars if they know that the borrowing bank will be able to obtain the dollars it needs to repay the loan, if necessary, from its central bank.

The swaps, which have been used as a policy tool dating back to 1962, are fully disclosed to the public and their usage updated weekly on the Federal Reserve's website. Their current use is consistent with the Federal Reserve's mandated responsibility to provide liquidity to the financial system in times of stress in order to shield the U.S. economy, to the extent possible, from the severe effects of financial instability, regardless of its source.

William C. Dudley
President of the Federal Reserve Bank of New York
New York

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