Difference between interest rate cuts and FED loans?
This may be a dumb question, but what is the difference between the FED lowering interest rates and the FED loaning huge amounts of cash to banks and investment firms?
"By lending directly to banks, the Fed can provide capital that banks need to lend to consumers and businesses without fueling higher prices in industries that don't, said Bill O'Grady, chief investment strategist at Wachovia Securities."
I don't understand this statement - if it was true, why would the FED lower interest rates at all?
The interest rate is the one the Fed charges banks to borrow from it. If the Fed wants more money in the system, they lower the interest rate so that banks will borrow more money from them which the banks will in turn loan out to someone else at a higher rate than the Fed is charging. They cannot force banks to borrow- only encourage them to do so by lowering the rate. In the wake of the subprime loan crisis, lending by banks basically dried up meaning no money circulating so since they (the Fed) wanted to get them to start lending again, they made it easier for them to borrow from the Fed since they (banks) were not lending to each other or their customers. Once the banks do start lending again, the Fed should raise their rates back up to prevent too much money from being available and causing inflation- there are already too many other factors pushing inflation up now and we do not need to add the money supply to that mix.
Last edited by Zippyjuan; 05-03-2008 at 11:27 AM.
On the positive side, so far it doesn't look like the rate cuts have caused a lot of new lending. Lowering the rates really only inflates the money supply if it causes new loan origination, but obviously, the consumers are strapped and lending costs have risen in the face of the lower rates.
What is doing damage right now are all of the new loan facilities where the Fed is bypassing the standard Fed funds markets (which require good collateral to be provided by the banks). The Fed pumping money into the system for questionable collateral could be very hurtful if that paper proves worthless.