Question of the Day: “Ever get the feeling someone isn’t telling you something that’s really important?”

Monday, March 17, 2008 

“I smell desperation in the wind.” 

Since September 17, 2007, the Federal Reserve has lowered the Federal Funds Rate – the rate at which the Fed allows banks to borrow from each other, overnight, to maintain their reserves – from 5.25% to 3.00%.  In percentage terms, they’ve lowered the rate by a whopping 43% in just 6 months.  Word on some newscasts is that they are about to lower it again, perhaps by another full point, in order to protect our banking system until it can recover from the widespread collapse of the subprime mortgage market.

And did I mention that the Fed also lowered its Discount Rate, the rate at which member banks borrow from the Government, to just 3.25%?  It’s almost as inexpensive for banks to borrow money from the Fed, as it is from each other.

In addition to lowering rates, the Fed has also put up $200 billion in Federal securities as equity which Wall Street firms can use to protect themselves, in the hopes of preventing any other major players from doing “a Bear Stearns.”

I smell desperation in the wind.

If a rapid 43% reduction in the cost of money America’s banks need to maintain their reserves doesn’t solve the problem, and the rate is already at only 3.00%, what exactly happens if the banking system doesn’t respond to further reductions?

What is it, precisely, that the Fed is worried about?  These changes in the rates are just minor adjustments to the cost of funds.  The Fed isn’t just tweaking an otherwise healthy economy – Greenspan-style – to smooth out downturns while avoiding inflation.  This is looking more and more like triage in a war zone.

Hello, Fed?  Chairman Bernanke?  What is it you’re not telling us?  Just how bad is it?  The thing about lowering rates is that eventually you run out of room.  Is the problem you’re trying to solve bigger than the power of the tools at your disposal?  And if it is, then what?


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