OK, here’s ‘the why’:
There are dollar-denominated assets held outside the US and the US banking system. Mortgage-backed securities, crap in SIV’s and other structure vehicles, etc. With me so far? Crappy paper, owned/held in banks overseas who don’t use the US dollar, but the instruments are valued in US dollars and issued here in the US.
There is no “global bank of last resort” to backstop this crap when it blows up on the balance sheet of a foreign bank. Let’s say some EU bank holds a bunch of crap US RMBS paper and now needs a lifeline as their asset package is downgraded and they have to cough up some more deposits or reserves to maintain their credit ratings, etc. Well, if the ECB tried to backstop this stuff, they first have to convert Euros to dollars (a moving target - perhaps moving a lot) and then backstop the problem.
So, the problem is “how do foreign central banks act as the ‘lender of last resort for $US assets without suffering a currency slip at the same time?”
The ‘solution’ is for the central banks to swap large chunks of each other’s currency. The ECB can then use $US to backstop assets in Euro banks held in dollars, and the Fed can use the Euros in the swap to do likewise for assets here held in Euros.
That’s the idea.
The implementation is clearly becoming a tad more tricky.
I like all this swap stuff. I feel like I’m at a swap meet looking at some guys old toaster and socket wrenches. I’ll ask him if I can swap my old couch for what he’s got