What is the feed doing with the overseas banks?

The Federal Reserve on Thursday nearly quadrupled the dollars it provides to foreign central banks as part of a coordinated effort to inject liquidity into the global financial system.

What follows are questions and answers about what the Fed did and why.

Q. How much money is involved?

A. The Fed increased temporary currency agreements, or “swap lines,” that it already has in place with the European Central Bank to $110 billion and with the Swiss National Bank to $27 billion.

It also set up new swap lines of $60 billion with the Bank of Japan, $40 billion with the Bank of England, and $10 billion with the Bank of Canada.

All told, the Fed increased the amount of dollars available under the agreements by $180 billion to $247 billion.

Foreign officials already have said how they plan to use the money: the ECB will provide up to $40 billion in overnight loans to European banks, while the Bank of England said it will inject $40 billion into the system.

Q. What exactly is a “swap line”?

A. They enable the Fed to provide dollars to overseas central banks in exchange for an equal amount of that country’s currency. The arrangements are temporary and set to expire Jan. 30.

Overseas banks use the dollars to lend to their own commercial banks, many of which, like U.S. banks, are in dire need of short-term dollar loans.

Q. Why are the central banks and the Fed throwing so much money around?

A. The central banks are providing the short-term loans because the commercial banks are reluctant to lend to each other due to the ongoing credit crisis. In essence, banks worldwide are now borrowing from their central banks rather than from each other, said Adam Posen, deputy director of the Peterson Institute for International Economics in Washington, D.C.

In the wake of the collapse of Lehman Brothers Holdings Inc. and the U.S. government’s takeover of American International Group Inc., major banks in the U.S., Europe and Asia have scrambled to conserve their capital and are reluctant to provide the overnight loans to each other that are the lifeblood of the financial system.

Banks use overnight loans to clear transactions and maintain the level of reserves they’re required to have by regulators.

Q. What is the Fed doing in the United States?

A. The Fed also is providing huge, short-term loans to U.S. banks to address the liquidity crisis. The New York Federal Reserve Bank provided $100 billion in overnight loans Thursday and $5 billion in 14-day loans. The Fed regularly makes short term loans but rarely on such a large scale.

Q. Will all of this work?

A. Economists generally believe that these measures are helping the banking system muddle through the current crunch.

“While the credit lines have not reversed the financial crisis they have probably prevented it from being worse,” Wachovia senior economist Mark Vitner wrote in a research note.

But the temporary loans are only stopgap in nature and don’t necessarily encourage banks to resume lending to each other. The Fed could come under increasing pressure to cut the short-term rate it controls in order to loosen credit markets. The Fed decided against taking that step on Tuesday, in part because it is worried that lower rates could worsen inflation.


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