Thursday, December 15, 2011

The Fed and the European Banking Crisis

Fed Chairman Bernanke held a meeting with Republican Senators yesterday.

The timing of this meeting makes absolute sense, as always:

  • the government is on the verge of yet another possible shutdown over a trivial dispute over a payroll tax that both parties profess to want to pass;
  • The federal debt burden continues to mount as no serious solutions to our budget deficits have been proposed;
  • And the approval rating of Congress hovers around 8%, meaning that probably their own families think they're incompetent.
So what better time to head over the Federal Reserve Building and do a heart-to-heart with the head of the one institution in Washington that is at least trying to help the country's weak economic growth.

But I digress.

After the meeting, a number of the Senators indicated that while Bernanke is "very concerned" about Europe, he has no intention of directing any sort of Fed intervention:

Senator Bob Corker, a Republican from Tennessee, said Bernanke made it “very clear” in closed-door comments today the central bank doesn’t intend to rescue European financial institutions. Lindsey Graham, a South Carolina Republican, said Bernanke told lawmakers that “he doesn’t have the intention or the authority” to bail out countries or banks. Both senators spoke to reporters after leaving the one-hour session at the Capitol in Washington.

Left unspoken was the fact that the Fed already has intervened.

Just a couple of weeks ago, the Fed opened the dollar interbank market to all European banks, lending dollars to all who needed funding at essentially 0% rates of interest. Without the Fed, the dollar-starved European banks would have been on the verge of collapse.

And this is the real problem in this whole euro mess: No one really knows how vulnerable the banks really are.

New York Times columnist Jesse Eisinger wrote a piece last October about the banks.

In the column, he noted that by most conventional measures the banks and brokers seem to be in much better shape than they were during the financial crisis of 2008.

However, financial stocks keep falling, as investors have very little faith in both the numbers and the managements of our largest financial institutions:

Yet, the moment one examines almost any detail of the global financial system, faith falters once again. Take the uncertainty about the derivatives markets. Morgan Stanley has a face value of $56 trillion in derivatives. That’s really nothing. JPMorgan Chase has more — amounting to the G.D.P. of large countries — a face value of $79 trillion in derivatives. If something goes wrong with just one-tenth of 1 percent of those trades, it’s kablooie.

Now those are gross numbers. Many people would dismiss those totals as ridiculous and misleading. Anyone who brings them up is merely displaying ignorance. The banks’ derivatives portfolios are full of off-setting trades that net out at a smaller number.

Derivatives can be dismissed as a popular bugaboo, but they really are just a symbol of the larger problem. A litany of daily stories reveals all kinds of reasons that banks don’t trust each other. To take just one news item, almost at random: Bloomberg News reported the other day that a Danish bank was refusing French sovereign debt as collateral.

Nobody really knows how much exposure the American banks have to the European financial and political crisis, with the Treasury Department minimizing the issue while other outlets raise the specter of catastrophic problems.

So Bernanke and the Senators can agree that Europe should fix their own problems, but the truth is elusive, and we're really all in this together.