Friday, August 17, 2007

Bernanke Bails Out the Street; Fed Lowers Discount Rate to 5.75%

From the FOMC:

Financial market conditions have deteriorated, and tighter credit conditions and increased uncertainty have the potential to restrain economic growth going forward. In these circumstances, although recent data suggest that the economy has continued to expand at a moderate pace, the Federal Open Market Committee judges that the downside risks to growth have increased appreciably. The Committee is monitoring the situation and is prepared to act as needed to mitigate the adverse effects on the economy arising from the disruptions in financial markets.

First -- let's get some terminology down. The Discount Rate is, "The interest rate that an eligible depository institution is charged to borrow short-term funds directly from a Federal Reserve Bank." This is usually considered a bad move because it signals the borrower may be in trouble. Essentially, the discount rate is the rate of last resort.

This type of borrowing from the Fed is fairly limited. Institutions will often seek other means of meeting short-term liquidity needs. The Federal funds discount rate is one of two interest rates the Fed sets, the other being the overnight lending rate, or the Fed funds rate.

In other other words, this is as much a symbolic gesture as a practical one.

But the damage has been done. Bernanke has continued the the "Greenspan put" tradition. When financial markets screw-up and make a ton of bad loans, the Federal Reserve will bail them out.

As Bloomberg said:

Today's move also shows how Bernanke, like his predecessor, is prepared to temporarily abandon Fed growth forecasts and inflation objectives to offset the risk of a credit crunch. Former Chairman Alan Greenspan was known for his tendency to give financial market conditions a primary role in policy, and he came to the rescue on several occasions when turmoil struck.

`Greenspan Put'

Until now, Bernanke had shown every intention of shunning the so-called Greenspan put. He wanted more emphasis on the forecasts of the institution and policy less dependent on the whims of whoever occupies the chairman's suite.