WASHINGTON - The Federal Reserve's dollar swap lines with the European Central Bank have achieved their goal of encouraging an "orderly" deleveraging of European banks loans in the United States, New York Federal Reserve Bank President William Dudley said Tuesday.

Dudley, in testimony to a subcommittee of the House Financial Services Committee, also said the Fed's dollar swap lines "at the margin" are likely enhance the credibility of the dollar as a world reserve currency, though he stressed this was not their chief goal.

In the United States, both households and banks have made "considerable progress" in deleveraging and banks are much better prepared to withstand shocks to the system, he said and also cited some deleveraging on the mortgage front, including principle forgiveness.

"You're actually seeing the debt burden become less overwhelming," Dudley said in response to a question, though it is "too soon to say the deleveraging process is over."

The Fed's dollar swap lines and the ECB's three-year LTROs "have helped create some time" for European governments to get their fiscal house in order, "but for this to work out well, countries still have to take some steps."

Given the potential spillover effects, Dudley said it is in "our self interest" to engage in dollar swap lines with the ECB in order to "prevent any damaging effects on the U.S. economy," rather than just aid Europe.

The swap lines "have had their desired effect because they've given a source of backstop funding to European banks," he said, adding the swap lines helped slow the pace of European deleveraging in the United States, which had been moving at a "pretty feverish pitch" last year.

"From what I can tell ... the deleveraging in European banks is continuing, but it's happening in a more orderly way," Dudley said, though there was only "soft evidence" of this.

Dudley added that, while not the chief goal, dollar swap lines likely "makes people more comfortable to use the dollar" and thereby enhances the role of the dollar in global currency markets.

"At the margin it probably enhances the dollar as a reserve currency," Dudley said.

Dollar swaps with other central banks also made sense to prevent possible funding stresses spreading from Europe to other parts of the world. He said there are "some draws on those swap lines from these other central banks."

Dudley again stressed the Fed was well secured and that dollar swaps remained "extraordinarily safe" for the United States, having netted a total profit of $4 billion for U.S. taxpayers. He expects that as investors regain confidence in the Eurozone's sustainability, the "swap programs will wind down automatically" as happened in the past.

Asked whether the Fed would consider investing directly in foreign sovereign debt, Dudley said the bar "is extraordinarily high for the Fed to go out and buy (foreign) sovereign debt," outside of its small foreign exchange reserve portfolio.

Market News International is a real-time global news service for fixed-income and foreign exchange market professionals. See www.marketnews.com.

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