The Fed’s Swap Loans and Libor – OIS Spread

For about two years—from August 2007 to September 2009—fluctuations in the spread between dollar Libor and the overnight index swap (OIS) served as a valuable quantitative indicator of financial stress in the interbank loan market. It also served as a measure of the impact of various government interventions. The paper “A Black Swan in the Money Market” by John Williams and me focused on the unprecedented jump in that spread in August 2007 and showed that the Fed’s Term Auction Facility (TAF) was not effective in reducing the spread. As shown in the chart, the dollar Libor-OIS spread rose further during the panic in September-October 2008. It then returned to near pre-crisis levels in September 2009 and stayed there until the new crisis in Europe erupted when it started to increase again, attracting the attention of financial analysts and the financial press.

Note, however, that the recent increase—visible in the right part of the chart—is very small compared with the jumps in 2007 and 2008. Nevertheless, as part of the European rescue package, the Fed agreed to provide dollar swap loans to the ECB and other central banks so that they could provide dollar loans in the interbank market. Have these swap loans affected the spreads?

As shown in the second chart, which focuses on the Libor – OIS spread during March – May 2010, it is hard to find any effect, not even an announcement effect. On the Friday (May 7) before the announcement of the European rescue package the spread was 18 basis points.

It increased on the Monday (May 10) after the announcement and then continued to increase in the two weeks since then, reaching 32 basis points on May 24. However, the size of the loans has thus far been remarkably small and has declined sharply since the start of rescue package. According to the Fed’s H.4.1 release of today, the amount of swap loans provided was $9.205 billion on Wednesday May 12, remained the same on $9.205 on Wednesday May 19, but fell to only $1.242 billion ($1.032 to the ECB and $210 to the BOJ) on Wednesday May 26. I have argued since the start of the crisis that the Fed should provide daily (not just weekly) balance sheet data so people outside the Fed can evaluate the impacts of its programs on the markets, but this is all we have. It is not clear why the loans have declined so rapidly.

Perhaps criticism about participating in the European bailout led the Fed to discourage the use of the swap loans under the program at a time when the Fed is trying to prevent the Congress from reducing its independence. Or perhaps the interest rate (1.24 percent) was simply too high.

About John B. Taylor 117 Articles

Affiliation: Stanford University

John B. Taylor is the Mary and Robert Raymond Professor of Economics at Stanford University and the Bowen H. and Janice Arthur McCoy Senior Fellow at the Hoover Institution. He formerly served as the director of the Stanford Institute for Economic Policy Research, where he is now a senior fellow, and he was founding director of Stanford's Introductory Economics Center.

Taylor’s academic fields of expertise are macroeconomics, monetary economics, and international economics. He is known for his research on the foundations of modern monetary theory and policy, which has been applied by central banks and financial market analysts around the world. He has an active interest in public policy. Taylor is currently a member of the California Governor's Council of Economic Advisors, where he also previously served from 1996 to 1998. In the past, he served as senior economist on the President's Council of Economic Advisers from 1976 to 1977, as a member of the President's Council of Economic Advisers from 1989 to 1991. He was also a member of the Congressional Budget Office's Panel of Economic Advisers from 1995 to 2001.

For four years from 2001 to 2005, Taylor served as Under Secretary of Treasury for International Affairs where he was responsible for U.S. policies in international finance, which includes currency markets, trade in financial services, foreign investment, international debt and development, and oversight of the International Monetary Fund and the World Bank. He was also responsible for coordinating financial policy with the G-7 countries, was chair of the working party on international macroeconomics at the OECD, and was a member of the Board of the Overseas Private Investment Corporation. His book Global Financial Warriors: The Untold Story of International Finance in the Post-9/11 World chronicles his years as head of the international division at Treasury.

Taylor was awarded the Alexander Hamilton Award for his overall leadership in international finance at the U.S. Treasury. He was also awarded the Treasury Distinguished Service Award for designing and implementing the currency reforms in Iraq, and the Medal of the Republic of Uruguay for his work in resolving the 2002 financial crisis. In 2005, he was awarded the George P. Shultz Distinguished Public Service Award. Taylor has also won many teaching awards; he was awarded the Hoagland Prize for excellence in undergraduate teaching and the Rhodes Prize for his high teaching ratings in Stanford's introductory economics course. He also received a Guggenheim Fellowship for his research, and he is a fellow of the American Academy of Arts and Sciences and the Econometric Society; he formerly served as vice president of the American Economic Association.

Before joining the Stanford faculty in 1984, Taylor held positions as professor of economics at Princeton University and Columbia University. Taylor received a B.A. in economics summa cum laude from Princeton University in 1968 and a Ph.D. in economics from Stanford University in 1973.

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