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.