The Fed De-Eases Bank Lending Terms

Yesterday, February 18, the Federal Reserve Board announced several changes to the extraordinary liquidity measures it instituted to help alleviate the recent financial crisis. Just last week, Tom Moeller described here how extensive those liquidity provisions have been for just one part of the program, the Term Auction Facility. Even as that effort winds down – it will be concluded altogether with a final auction on March 8, yesterday’s announced said – the Fed Board is also pulling back or diminishing some of its other emergency operations. In particular, the old “discount window”, which is now also called “primary credit”, sees its rate raised from 50 basis points (0.50%) to 75 basis points (0.75%). · As the Fed’s statement explains, this move increases the spread of the primary credit, or discount, rate to 50 basis points over the high end of the FOMC’s target for the federal funds rate, as shown in the chart. The chart also shows the altered treatment of the discount window beginning in 2003. Previously, the discount rate hovered just below coincident fed funds rates, but it was changed in January that year to a penalty rate, pegged at some spread over the funds rate. Generally this has been 1 percentage point, 100 basis points. Part of the emergency liquidity boost beginning in August 2007 was making these funds cheaper for borrowing banks by cutting the spread, first to 50 basis points, and then in March 2008, to 25 basis points, where it has been until today, when the hike to 50 took effect.

The second graph shows the amount of this primary credit. This is similar to, but not exactly the same as the old “adjustment credit” in the pre-2003 procedures. The idea then was that banks avoided the discount window like the plague, so there was rarely any use of it at all. You can see the spike over the 9/11 period, which was, up to mid-2008, by far the record amount of borrowing. The philosophy was changing though; the rate was made higher than other sources of funds, but banks theoretically wouldn’t be stigmatized by availing themselves of it. In the easy-money period of those mid-2000s, hardly any ever needed to anyway. All this changed in 2007 and 2008. The Fed Board cut the spread with the express intention of helping banks get money. At the peak in late October and early November 2008, banks were borrowing more than $100 billion in this one facility alone. More recently, this has shrunk markedly, to “just” $14.3 billion in the Fed’s statement week ended this past Wednesday.

Some wonder if this action by the Fed is a “tightening”, even though their statement argues that it is not. It certainly is the first action involving a rate. But they have already reined in their “quantitative” easing substantially, and this newest can thus be seen as part of a progression toward non-emergency conditions. They further indicated that the maturity of the primary credit borrowing, which has been as long as 90 days, will be shortened to the more typical overnight on March 18. So there are several steps here, and in one sense, they are reactive, not pro-active. They seem to be a response to smoother money market conditions rather that an attempt to disrupt the markets and alter the underlying demand conditions. So technically, this would not be a “tightening”. But it is a “de-easing”, which must, by definition, come first.

The Fed’s statement is here . The rates and borrowing amounts are contained in Haver’s DAILY and WEEKLY databases, with monthly averages in USECON.