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How Ben Bernanke Saved Europe’s Banks

The story of an unprecedented effort by the U.S. central bank to serve as the lender of last resort to the world.

May 12, 2013

The story of an unprecedented effort by the U.S. central bank to serve as the lender of last resort to the world.

The most commonly told story of the 2008 financial crisis goes something like this: There was a lot of bad lending for U.S. housing. Big U.S. financial institutions took losses they couldn’t handle.
U.S. officials engaged in a series of bailouts, or in the case of Lehman, a non-bailout. These eventually, and at great cost, contained the damage.

But it was not before the sense of panic spread across the world, making almost every country on earth part of the collateral damage.

However, in researching my new book on the efforts of the world’s leading central bankers to combat the crisis and the aftermath, a different narrative emerged.

You can’t understand the crisis, I found, unless you understand how a huge portion of the Federal Reserve’s work during this period—and off and on since then—was about propping up banks in Europe and across the globe.

To a degree that few people understood at the time, banks in continental Europe had bought vast sums of the very shaky mortgage securities that were rapidly losing value as U.S. homeowners defaulted in numbers that had once seemed unimaginable.

Their exposure to U.S. assets was a whopping $10 trillion. Those were the dollar assets on their books. They had a similar amount of dollar liabilities, particularly as short-term debt owned by U.S. money market mutual funds.

In 2007 and particularly 2008, as the value of those dollar-denominated securities plummeted and their normal sources of dollar funding dried up.
The European banks were in a pickle.

They desperately needed dollars, but their usual sources of liquidity — interbank lending markets, and in extreme circumstances the European Central Bank (or the Swiss National Bank, depending on their provenance) — were in no position to provide them.

Into the breach stepped the one entity on earth with bottomless capacity to create dollars: the Federal Reserve.

If you read the press coverage when the Fed first introduced the “Term Auction Facility” in December 2007, you would have read vague talk of how the Fed was trying to inject money into the banking system.

There was no real hint of what was really going on.

Of the $40 billion the Fed lent out as part of the Facility, only trivial amounts were to household name U.S. banks like Citibank ($10 million) and Wachovia ($25 million).

The real money was going to the New York-based arms of European banks that most Americans could neither recognize, or in many cases, pronounce: $2 billion each to Germany’s WestLB, Dresdner, DZ Bank and Landesbank Baden-Württemberg, and Dexia, headquartered in Belgium and France.

As a Fed official told me years later, “The [Facility] laundered the crisis. It made it look like we were solving a U.S. problem, when the real problem was the exposure of European banks to the dollar.”

Ironically, at the ECB, the great fear was that if anyone understood the scope of the European banks’ need for dollars, it could spark an even deeper crisis.

Jean-Claude Trichet, the ECB president, portrayed their cooperation as a step they took almost as a favor to help the Fed in its efforts to unfreeze American lending markets.

His argument isn’t without validity—after all, the European banks, as major buyers of American mortgage securities, were ultimately providing the funds for home loans across the United States.

Internally, ECB officials referred to their own dollar lending as “Euro-TAF,” essentially a complement to the Americans’ programs.

In the aftermath of the Lehman Brothers bankruptcy in September 2008, those early experiments in pumping money from the Federal Reserve into the European banks became one of the most important, but least-understood, portions off the Fed’s crisis response.

At a time the U.S. media and political class was focused on the bailouts of AIG and the banking rescue of which Fed chair Ben Bernanke was a leading advocate, officials of the global central banks were quietly and behind-the-scenes hammering out how they could funnel money between them to solidify the global banking system.

The conference calls were usually early in the morning New York time. That was the only point in the day at which neither the Americans, European, or Japanese would have to participate in the middle of the night.

The central bankers would turn again to the swap lines, with a particular eagerness to get, as then New York Fed President Tim Geithner often put it, the “theater right.”

A German bank would be more inclined to lend dollars to a Swiss bank — if it could be confident the Swiss bank would have access to dollars no matter what when it came time to repay, after all.

“Making it known we were getting the fire engines rolling was almost as important as what the fire engines would do once they arrived at the scene.”

Along with the December 2007 program, there had been a $24 billion program of international swap lines between the Fed and other central banks like the ECB and Swiss National Bank.

That was expanded to $180 billion, then expanded further to include the likes of Australia, Denmark, Norway and Sweden.

It worked like this: The Fed would swap dollars for euros (or Swiss franc, or Swedish krona) of comparable value. The ECB and the other banks would lend the dollars out to their banks — and the transaction would unwind after a set period.

With bank lending freezing up across the globe, and the dollar the most widely used currency in all sorts of international commerce, the Fed soon faced entreaties to expand the swap lines beyond the central banks of the advanced western nations.

The Fed was willing to help, but only for those central banks that represented significant economies or financial centers. That way there was a solid case to be made that the swap lines were returning benefits to the U.S. economy.

Brazil, Mexico, South Korea, and Singapore passed that test; Peru did not.

At the peak of the lending, some $580 billion of U.S. taxpayer dollars from the Fed were swapped with international central banks.

No one involved had incentive to cast this publicly as what it was: An unprecedented effort by the U.S. central bank to serve as the lender of last resort to the world.

But it was a critical, if little understood, piece in the wall of money global central banks erected to contain the damage of the 2008 crisis.

It was only the beginning of the story: In further coordinated efforts, the central bankers re-instituted the swap lines in May 2010, as part of a strategy to contain the Eurozone crisis that began (and remains most intense in) Greece.

When the European crisis was at its darkest phase, in the fall of 2011, the Fed, ECB and other leading central banks eased the terms of the swap lines further as part of a concerted strategy to contain the panic.

Swap lines have been the unsung hero of managing the mega-crisis of the last six years.

They are the tool the central bankers have used again and again to keep the world financial system together in a show of global coordination like few the world has seen.

“In a way,” as a European central banker told me, “we [Europe] became the thirteenth Federal Reserve district.”

Editor’s note: This article is adapted from The Alchemists: Three Central Bankers and a World on Fire (Penguin Press) by Neil Irwin. Published by arrangement with the author. Copyright © 2013 by Neil Irwin.


Few knew at the time that European banks had bought vast sums of U.S. mortgage securities.

Swap lines have been the unsung hero of managing the mega-crisis of the last six years.

They are the tool central bankers used repeatedly to keep the world financial system together.

"In a way," as a European central banker told me, "we became the thirteenth Federal Reserve district."