–Fed FX Swaps ‘Prudent Effort’ to Minimize Risk of EU Market Turmoil

By Heather Scott

WASHINGTON (MNI) – Countries with high debt and deficit levels,
including the United States, must work quickly to put in place
“credible” programs that will improve their fiscal situation, Federal
Reserve Gov. Daniel Tarullo said Thursday.

Tarullo said the Fed’s recently-restarted currency swap program was
a “prudent effort” to reduce the risk of financial market turmoil in
Europe which could spillover into the U.S. market, and was not designed
to insulate banks and investors from losses.

In testimony prepared for the afternoon hearing of the House
Financial Services Subcommittee on International Monetary Policy and
Trade and the Subcommittee on Domestic Monetary Policy and Technology,
Tarullo discussed the Fed role in the European response to the Greek
crisis.

“With unemployment remaining quite high, and with continued need
for balance sheet repair by many businesses, financial institutions, and
households, it is particularly important that the United States not
sustain a significant external shock,” he said.

So, the decision “to reinstate foreign exchange swap arrangements
was designed not to insulate banks and investors from losses they may
incur, but as a prudent effort to help minimize the risk of financial
turmoil in Europe, with the consequences that would ensue for the global
financial system, including the United States. In the worst case, such
turmoil could lead to a replay of the freezing up of financial markets
that we witnessed in 2008.”

He said while the crisis has shown the U.S. financial firms are
tightly interconnected with those in Europe, there are “good reasons to
believe that these institutions can withstand some fallout from European
financial difficulties.”

But “the swoon in global financial markets earlier this month”
shows that a retrenchment by banks and financial institutions, though
unlikely, is not out of the question, the Fed official said.

Tarullo said the “key near-term priority” for Europe is to prevent
liquidity from drying up, but “uncertainties are still clouding
financial markets” due to the market’s need for clarification about over
the recently announced support measures.

But he cautioned that even if European authorities are successful,
and the measures are fully implemented, including support for sovereign
debt markets, this “will not solve the sovereign debt problems; it will
only provide time to make necessary policy adjustments.”

“Lasting beneficial effects will require credible action to bring
fiscal deficits under control,” Tarullo said.

He added this warning to the legislators: “The United States is in
a very different position from that of the European countries whose debt
instruments have been under such pressure. But their experience is
another reminder, if one were needed, that every country with sustained
budget deficits and rising debt — including the United States — needs
to act in a timely manner to put in place a credible program for
sustainable fiscal policies.”

** Market News International Washington Bureau: 202-371-2121 **

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