In a smoothly operating credit market, banks lend to each other on a daily basis. But now, Europe’s debt crisis has escalated to the point where the region’s banks are so jittery, they’re reluctant to lend to each other. The evidence of this is seen in the cost European banks pay to borrow dollars on the open market. Those costs skyrocketed this month to their highest levels since October 2008, sparking fears that a Lehman-like credit crunch is brewing in the region. This time around, the Fed nearly cut in half the rate foreign central banks pay to borrow U.S. dollars. The move was coordinated with the European Central Bank and the central banks of England, Japan, Switzerland, and Canada.
While the Fed never said the plan was meant to target European banks, it’s certainly implied. Since the Fed set up this facility in September, the ECB has been its largest borrower. Currently, the ECB holds $2.2 billion in outstanding loans from the Fed. In exchange for those loans, the ECB is paying the Fed a 1.08% rate. But, starting on December 5 and lasting through February 1, 2013, the Fed has slashed that rate to around 0.58%. In effect, the ECB will soon be getting an even cheaper rate on U.S. dollars than American banks do (they pay a 0.75% rate at the Fed’s discount window).
According to the Fed, this is going to allow them to mitigate some of the risk and ease strains on the markets. What is good for main street isn’t always what is best for Wall Street. But looking a little deeper into this setup, you can see that the Fed is creating an even greater artificial demand for dollars by making them seem more attractive to foreign debt holders.
Maybe this will defer the collapse of American’s inflated lifestyles by kicking the can down the road?!
“The greatest shortcoming of the human race is our inability to understand the exponential function.” Dr. Albert A. Bartlett