Posted on Wed, Nov. 30, 2011
last updated: November 30, 2011 05:52:59 PM
WASHINGTON — A surprise coordinated move Wednesday by the Federal Reserve and five other central banks to keep credit flowing amid the worsening debt crisis in Europe sparked a huge rally on Wall Street, but experts doubted the momentum would hold.
The central banks announced before the opening of U.S. markets that theyd lower the pricing for arrangements where one central bank swaps its national currency for dollars. The move, which shaves half a percentage point off the borrowing costs, affects central banks, which in turn lend money to private banks. It should make it easier for private banks, especially European ones, to make loans in dollars or to hold securities denominated in U.S. dollars.
The Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank and the Swiss National Bank all joined the Fed in Wednesday mornings surprise action.
Still, the move doesnt remedy what ails Europe. But it is a combined show of strength designed to reassure markets that the Fed and its allies are on the job. Reassure it did, with blue chips on the Dow Jones Industrial Average soaring all day and closing up 490.05 points, or 4.2 percent, at 12,045.68. Similarly, the S&P 500 gained 51.77 points to 1246.96, and the NASDAQ leaped 104.83 points to close at 2620.34.
A Fed statement explained that the action was designed to support financial stability and to promote the extension of credit to U.S. households and businesses.
It added that U.S. financial institutions currently do not face difficulty obtaining liquidity in short-term funding markets. However, were conditions to deteriorate, the Federal Reserve has a range of tools available to provide an effective liquidity backstop for such institutions if the European crisis spreads.
A liquidity backstop is a fancy way of saying that banks and corporations continue to have access to credit amid tightening lending conditions in Europe.
The move ensures that companies in developed economies continue to have access to U.S. dollars, even as their own currencies such as the European Unions euro come under stress. Thats important, since most major U.S. corporations either manufacture in or sell to European countries. Its another step to ensure Europes problems dont land here.
The Feds interest-rate setting arm — the Federal Open Market Committee — held a video conference Monday to discuss the move and voted in favor of it by 9-1, said Fed spokesman David Skidmore. The sole dissenting vote was Jeffrey Lacker, president of the Federal Reserve Bank of Richmond, Va.
I dissented on the vote because I opposed the temporary swap arrangements to support Federal Reserve lending in foreign currencies. Such lending amounts to fiscal policy, which I believe is the responsibility of the U.S. Treasury, Lacker said in a statement late Wednesday.
Independent analysts welcomed the surprise move but warned it isnt a panacea.
Economists for forecaster RDQ Economics in New York said in a note to investors that the actions obviously do not address the underlying cause of the rise in funding costs, particularly for European banks.
RDQ likened the actions to giving aspirin to a patient with a fever, lowering the fever but not addressing its cause. It added that economists continue to believe that expanded bond purchases by the ECB (European Central Bank) will be required to temporarily stabilize eurozone debt markets.
Borrowing costs for European governments are soaring, and even the healthiest economy, Germany, has seen flagging interest for its government bonds, as investors fear Europes debt crisis may grow worse. The European Central Bank is under pressure to purchase more government bonds to drive down the price investors are demanding in exchange for holding what they view as increasingly risky debt.
Former St. Louis Fed President William Poole was among the critics of the central banks action. Poole, who retired in March 2008, told McClatchy that markets may come to regret Wednesdays effusive cheer. That's because tapping the lower lines of credit and the expanded ability of countries to swap their currencies is a sign of stress.
If central banks put these operations into place, thats going to be a signal to the market that the environment has gotten a lot worse, said Poole, a self-described libertarian. Why do the central banks want to open themselves up to a situation that their actions intending to calm things may exacerbate strains in the market?
Poole also questioned the reference by the Fed and the European Central Bank to easing strains on consumers and firms.
The problem is not credit to households and businesses, but credit to governments that may turn out to be impaired, he said.
Wednesdays moves buy some calm ahead of a nervous next week in Europe. The European Central Bank meets on Dec.8 and the European heads of state meet the next day.
Note that the problems in Europe continue to be an issue of solvency and have only recently morphed into a funding problem, Michael Hanson, an economist with Bank of America Merrill Lynch, wrote in a research note. Actions taken today help ease the funding problem, but the issue of solvency remains unaddressed.
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