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Fed Lowers Bank Rate, Shifts View On Economy
Kevin Gleason trades contracts for the S& P 500 at the Chicago Mercantile Exchange. On Wall Street, stocks finished higher after the Federal Reserve cut a key rate, which helped to calm financial markets after a week of turbulence.
(By Tim Boyle -- Bloomberg News)
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The "discount window," operated by the Federal Reserve Bank of New York, is where banks needing cash can go to borrow from the central bank, simply by putting up collateral such as loans that are considered to have a low risk of default. The practice was designed to prevent U.S. financial institutions from experiencing a run on the bank.
Normally the loans are overnight; with its action yesterday, the Fed made them available for a renewable 30-day span. And it noted that home mortgages are acceptable as collateral at the discount window.
There are two basic problems transpiring in the markets. Many investors are so fearful of further losses that they are unwilling to buy mortgages or corporate debt at any price, so those markets have frozen up. And market participants of all stripes are moving money from risky assets into cash, leading to a shortage of money in the economy.
The Fed action attempts to deal with both problems. Banks can use their portfolios of mortgage-backed securities as collateral to borrow money at the now-reduced rate, freeing up more cash.
Not since 1980 has the Fed moved the discount rate but not the more widely followed federal funds rate, according to Standard & Poor's. Cutting the federal funds rate might ease the losses faced by lenders that wrote bad mortgages or companies that took on too much debt. By cutting the discount rate, the central bank is trying to manage the tricky task of keeping the financial system humming without bailing out people who simply made bad bets.
"The message to the markets in this is that to the degree some of this has been irrational, we will prevent the markets from harming themselves through their own irrationality," said Neal Soss, Credit Suisse's chief economist Neal Soss said.
In practice, there has been a stigma attached to using the discount window, and banks have rarely used it. Now, the Fed is effectively encouraging banks to do so.
"They've opened the door , and rather than have the door just ajar, now it is wide open," said Richard A. Yamarone, director of economic research of Argus Research in New York. "That doesn't mean anyone is going to show up."
The Dow ended the day up 1.8 percent, or 233.30 points, at 13,079.08. The technology-heavy Nasdaq composite index was up 2.2 percent, or 53.96, to 2505.03. The broader Standard & Poor's 500-stock index rose 2.5 percent, or 34.67, to 1445.94.
