Liquidity Problems

I don’t really care most of the time about banks, they are the vice of vipers in my opinion, but recent events are casting a deadly shadow on the economy as a whole. The sub-prime market collapse and the lending institutions reeling from it are beginning to affect the economy in ways that some only fear.

On Friday, April 17th, the Federal Reserve cut the discount rate from 6.25% to 5.75%. The discount rate is the rate that Banks can borrow from the Federal Reserve. Not was the rate reduced, but the term of the loan was increased to 30 days. It was salve on the wounded economy so that banks could be assured that they could avoid liquidity problems.

The Economist talks about the discount rate and several nuggets of good information were provided.

In normal circumstances a bank would be loth to use the discount facility as, by doing so, it reveals that it cannot find funding at a reasonable price from peers—a hint of possible insolvency.

Further on:

The discount facility bypasses the money markets and allows a far wider range of depository institutions to borrow cash directly from the Fed, with a broader range of assets as collateral. Reducing the penalty rate does not alter the overall stance of monetary policy. And the changes are temporary. The Fed says they will remain in place until it judges that market liquidity has “improved materially”.

I guess we are just waiting for how long for things to improve materially….and how much worse things will get before they do improve materially.