Sunday, August 05, 2007

Na Na Na Na/Na Na Na Na/Cramer's World

by Ken Houghton

Just a brief note on this post from Barry Ritholtz and the folks at The Big Picture (h/t Dr. Black):

It took less than an hour—on a Saturday morning—for dblwyo to point out the obvious: the Fed's Discount Window is always open. But the Discount window has changed since the days when it was a discount loan of Last Resort:
The rule replaces adjustment credit, which currently is extended at a below-market rate, with a new type of discount window credit called primary credit that will be broadly similar to credit programs offered by many other major central banks. Primary credit will be available for very short terms as a backup source of liquidity to depository institutions that are in generally sound financial condition in the judgment of the lending Federal Reserve Bank. The Board expects that most depository institutions will qualify for primary credit.

Reserve Banks will extend primary credit at a rate above the federal funds rate, which should eliminate the incentive for institutions to borrow for the purpose of exploiting the positive spread of money market rates over the discount rate. The Board anticipates that the primary credit rate will be set initially at 100 basis points above the FOMC's target federal funds rate.

which means the current Discount Rate is 6.25.

In the old days (pre 9 Jan 2003), the Discount Rate was a legitimate discount (generally, iirc, about 3% below FedFunds). The alleged "incentive for institutions to borrow for the purpose of exploiting the positive spread" was more than mitigated by two things: (1) everyone knew you were doing it and (2) you had to explain to the Federal Reserve why you were doing it.

I interviewed once at a major money center bank that had, a year or so previously, been generally discussed as being on the brink of collapse. They had used the discount window six times in their worst year. So I view the talk of that "incentive" with a large barrel of salt.

What is real is that the "discount window" is now a Lender of Last Resort, with all the stigma and all of the information of the old Discount Window, and a higher interest rate.

So—as Jim Cramer should know—going to the Discount Window won't improve a financial institution's short-term cash flow problems; it will exacerbate them, both directly and indirectly. It's one of the improvements of the Federal Reserve made during the Bush Administration.

Jimmy Cayne, a major Bush supporter, undoubtedly knows that. That Jim Cramer didn't is sad.

Go read the whole thing at The Big Picture; check out the videos, listen to the remix. And mark Friday as the day that financial journalism—even in the context of Cramer's normal hyperbole—reached the level usually reserved for political reporters.

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