A Fistful Of Euros

This week, my congressional committee will hold a hearing to examine how the Federal Reserve bails out European banks, propping up spendthrift European governments in the process. Unfortunately, this bailout comes at the expense of American citizens, in the form of higher prices and diminished savings down the road.

A good analysis of the Fed's "swap" scheme first appeared in the Wall Street Journal back in December, in an article by Gerald O'Driscoll entitled, "The Federal Reserve's Covert Bailout of Europe." Essentially, beginning late last year the Fed provided US dollars to the European Central Bank in exchange for Euros − sometimes as much as $100 billion at a time. The ECB then funneled those dollars to European banks to provide liquidity and prevent crises from bank insolvencies. Since the currency swap was not technically a loan, the Fed did not have to embarrass itself by openly showing foreign bank debt on its balance sheet. The ECB meanwhile did not have to print new euros and expose the true fragility of big European banks.

The entire purpose of this unholy arrangement was to obscure the truth: namely that the Fed was bailing out Europe with US dollars.

But why is it the business of the Federal Reserve to bail out European banks that find themselves short of dollars to pay their dollar-denominated contracts? After all, those contracts often were hedges taken to protect banks against weakness of the euro. Hedges are supposed to reduce risk, but banks that miscalculate should suffer their own losses accordingly. It's not our business if the ECB chooses to create moral hazards by providing liquidity to European banks, but why should the Fed prop up Europe's bad decisions!

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