Five of the largest central banks in the world - the European Central Bank, the Federal Reserve, Swiss National Bank, Bank of England and Bank of Japan - will offer non-capped, three-month dollar loans to help leverage European banks under pressure from the debt crisis.
These fixed-rate dollar loans are for an unlimited amount as long as the central bank demanding the money has collateral.
Brown Brothers Harriman Currency Strategist Mark McCormick told Businessweek that although the new measures may prevent a short-term panic, it will not solve the root problem, which is debt.
Many banks are struggling to receive loans due to the fear of potentially massive losses from their holdings of unsavory government bonds. According to McCormick, although stress indicators are the worst they have been in over three years, the banking industry is still healthier than it was prior to the failure of the Lehman Brothers.
European ministers are finalizing a second Greek bailout to alleviate default worries while demonstrating unity and determination to worried investors.
European nations are also hoping for an improved rescue fund, which aims to allow investors to purchase government bonds on the open market. Changes to the rescue fund will require a parliamentary vote from member states - a process that is expected to take weeks.
Until then, the dollar loans are considered a viable short-term fix. On September 15, anticipation of the dollar loans meeting sent stocks soaring: The euro reached a high of $1.393 before closing at $1.385, while shares in BNP Paribas and Societe Generale, who have been targeted as risky due to Greece's debt problem, spiked 13.4% and 5.4% respectively.
The current swap arrangement began last year to replace a swap facility that began in 2007 to help with the global financial crisis. It allows the Federal Reserve to provide dollars to the ECB, who distributes the dollars to commercial banks.
The Federal Reserve then receives euros in return, plus interest. The ECB is expected to repay the dollars when the swaps mature.
Peter Tchir, who heads the hedge fund TF Market Advisors, is concerned that if the market discovers the banks who borrowed dollars, those banks' shares will plummet, causing the banks to risk failure. Even if no bank names are given, speculation can damage banks who did not benefit from the loans.
In contrast, Christine Lagarde, managing director of the International Monetary Fund, told CNBC that she believes this new project is “exactly what is needed” to demonstrate a determined response to do what it takes to preserve stability.
Treasury Bonds React
On September 15, the support given by the Federal Reserve in helping to ease Europe's debt crisis caused stocks to rise.
Because stock and bond prices tend to have an inverse relationship, bond prices dropped. The benchmark 10-year T-bond fell to $1.21 for every $100 invested. The 10-year Treasury note, which has a negative relationship with bond prices, rose from 1.99% to 2.08%. The 30-year Treasury bond reported a yield of 3.36%, up roughly 0.09% from the day prior.
Since then, the slump in global stock prices has led to an increased investment in Treasury bonds. As a result, the 30-year T-bond yield dropped to 3.19% on September 19. The 10-year benchmark bond has dropped to an index value of 1.94%.
Key Statistics – EU27 Deficit (source: Eurostat; reported on September 9, 2011)
- In the second quarter of 2011, the EU27 external balance in services experienced a trade surplus of nearly €23 billion ($31 billion), roughly €3.3 billion ($4.5 billion) more than in the second quarter of 2010.
- This year's second quarter saw losses in the EU27 external trade balance in goods by €37.4 billion ($50.9 billion), compared with the year-earlier period's roughly €30 billion ($40 billion) deficit.
- In Q2, a deficit in the EU27 external current account was recorded at roughly €43 billion, overshadowing last year's Q2 deficit by over €10 billion ($13.6 billion).