How The Federal Reserve Bailed Out The Worldhttp://www.zerohedge.com/article/how-federal-reserve-bailed-out-world">Zero Hedge
When the financial system almost imploded in the fall of 2008, one of the primary responses by the Federal Reserve was the issuance of an unprecedented amount of FX liquidity lines in the form of swaps to foreign Central Banks. The number went from practically zero to a peak of $582 billion on December 10, 2008. The number of swaps outstanding was almost directly correlated with the value of the dollar (much more on that shortly). A graphic representation of this can be seen below:
The topic of skyrocketing liquidity swaps was in fact the headline feature of one of the numerous grillings of the Chairman by the inimitable Alan Grayson as can be seen in the following video:
http://www.youtube.com/watch?v=n0NYBTkE1yQAnd while Bernanke was not very interested in getting caught up in providing actual explanations, the Bank of International Settlements just released a major paper titled "The US dollar shortage in global banking and the international policy response" which goes on to demonstrate just how it happened that Fed chief Ben Bernanke in essence bailed out the entire developed world, which was facing an unprecedented dollar shortage crisis due to the sudden implosion of FX swap lines and other mechanisms which until that point were critical in maintaining the dollar funding shortfall for virtually every foreign Central Bank.
The BIS provides the following big picture perspective:
The funding difficulties which arose during the crisis are directly linked to the remarkable expansion in banks’ global balance sheets over the past decade. Reflecting in part the rapid pace of financial innovation, banks’ (particularly European banks’) foreign positions have surged since 2000, even when scaled by measures of underlying economic activity. As banks’ balance sheets grew, so did their appetite for foreign currency assets, notably US dollar-denominated claims on non-bank entities. These assets include retail and corporate lending, loans to hedge funds, and holdings of structured finance products based on US mortgages and other underlying assets. During the build-up, the low perceived risk (high ratings) of these instruments appeared to offer attractive return opportunities; during the crisis they became the main source of mark to market losses.
How exactly did this improper perception of funding risk manifest itself?
The accumulation of US dollar assets saddled banks with significant funding requirements, which they scrambled to meet during the crisis, particularly in the weeks following the Lehman bankruptcy. To better understand these financing needs, we break down banks’ assets and liabilities by currency to examine cross-currency funding, or the extent to which banks fund in one currency and invest in another. We find that, since 2000, the Japanese and the major European banking systems took on increasingly large net (assets minus liabilities) on-balance sheet positions in foreign currencies, particularly in US dollars. While the associated currency exposures were presumably hedged off-balance sheet, the build-up of net foreign currency positions exposed these banks to foreign currency funding risk, or the risk that their funding positions (FX swaps) could not be rolled over.
Once again, the specter of everyone (and in this case it really means everyone) doing the same trade: sound familiar? This is eerily similar to what happened to basis traders in late 2008 (nothing pretty) when the balance of the trade was so skewed to one side, that there was nobody willing or able to take the opposing side, leading to massive wipe outs for everyone who participated. It is also comparable to the situation prevalent in equity markets currently.
What is now unquestionable, and what will be made clear shortly, is that the dollar trade is precisely what the basis trade, or any other trade, would have ended up being for any and every Central Bank that had a funding mismatch in dollars after the Lehman bankruptcy (all of them),
had the Federal Reserve not stepped in and become the lender of last resort to the entire world.http://www.zerohedge.com/article/how-federal-reserve-bailed-out-world">More...