Why is the Fed lending dollars unsecured to the ECB… again

By Warren Mosler

It remains my position that Congress should not allow the Fed to lend unsecured to foreign central banks without specific Congressional approval. But the Fed does currently have that authority and they are again using it to keep $ LIBOR from rising. And that lending must be in unlimited quantities to insure $ LIBOR is capped at the Fed’s target rate.

The Fed doesn’t want $ LIBOR to go up because many US domestic loans are indexed to $ LIBOR, including adjustable rate mortgages. That’s why I’ve been proposing the Fed not let its member banks index loans to $ LIBOR, but instead let them index to the fed funds rate, or some other rate controlled by the Fed. That would return direct control of US $ interest to the Fed, obviating the need to use unsecured (and unlimited) $US lending to foreign central banks.

By the way, when testifying to Congress the Fed Chairman states the lending is secured, with the Fed getting euro deposits as collateral. And he believes that. However, the euro are on deposit at the European Central Bank, who is also the borrower of the $ from the Fed. So if he ECB defaults on the $ loans, the only way the Fed could use those euro is by instructing the ECB to transfer them to another’s account so the Fed can buy the dollars it wants.

So what are the odds of the ECB even taking the call from the Fed if they just defaulted on it’s dollar loans from the Fed? And what can the Fed do if the ECB doesn’t make payment and won’t let the Fed use its euro at the ECB to buy dollars?

It’s like lending your dollars to someone in a far away land who uses his watch for collateral. But he gets to keep wearing the watch, and he’s out of your legal jurisdiction.

This article originally appeared at the Center of the Universe blog.

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