Borrowing at the Discount Window
The Fed allows banks to borrow “at the discount window” as a lender of last resort. Traditionally, the interest rate has been below the market rate, which seems wrong to me. The Fed only provides this service because there are banks which are truly solvent but can’t get short-term credit anywhere else. By definition, almost, these are banks which are willing to borrow at above the market rate. Thus, it would help to sort out who really needs the funds to charge above the market rate instead of below. Apparently the Fed only figured this out in 2003, a commentor at Marginal Revolution tells us:
Until 2003, the discount rate was always below the fed funds rates. After that point it has been 100 basis points above the fed funds rate (it is now 50 bps above fed funds). Despite the discount’s rate relation to fed funds (and despite seasonal blips), borrowing at the window has historically been less than $1 billion a week. Considering the trillions that banks borrow and lend from each other over night, $1 billion a week is like a twig on the banks of a mighty river. In terms of solving the liquidity problem, this is really kind of a joke.
Tyler Cowen’s post to which this is a comment quotes someone as saying:
Citigroup , Bank of America and other top banks took the rare step of borrowing $2 billion from the U.S. Federal Reserve on Wednesday, in a bid to reassure markets and remove the stigma associated with getting financing from the central bank….
Borrowing money directly from the Fed has historically been seen as a sign of weakness, but Bank of America, JPMorgan Chase & Co, and Wachovia Corp said they did it for the sake of the financial system. All four banks emphasized they have access to other, cheaper funds.
Professor Cowen himself says:
I don’t know if this will work, but it is a neat trick. Imagine that you, as a smart person, went around saying stupid things, in an attempt to limit discrimination against the stupid.
Why indeed would banker X say that he is borrowing at above-market rates because he thinks banker B would otherwise be too embarassed to borrow, preferring to let his, banker B’s, bank and career collapse? Maybe because that is so stupid that X knows nobody will believe him– it is mere “babbling”, to use the economic term. Or maybe X’s audience is made up entirely of stupid people, who would otherwise start a run on the banks.