Fed Cuts Discount Rate To 5.75%!

[This post is written and copyrighted by FIRE Finance (http://firefinance.blogspot.com).]

Today in a press release the Federal Reserves have issued the following:

"To promote the restoration of orderly conditions in financial markets, the Federal Reserve Board approved temporary changes to its primary credit discount window facility. The Board approved a 50 basis point reduction in the primary credit rate to 5-3/4 percent, to narrow the spread between the primary credit rate and the Federal Open Market Committee's target federal funds rate to 50 basis points. The Board is also announcing a change to the Reserve Banks' usual practices to allow the provision of term financing for as long as 30 days, renewable by the borrower. These changes will remain in place until the Federal Reserve determines that market liquidity has improved materially. These changes are designed to provide depositories with greater assurance about the cost and availability of funding. The Federal Reserve will continue to accept a broad range of collateral for discount window loans, including home mortgages and related assets. Existing collateral margins will be maintained. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of New York and San Francisco."

The discount rate is the interest rate charged to commercial banks and other depository institutions on loans they receive from regional Federal Reserve lending facilities. It differs from the key federal funds rate, which is the rate at which private institutions lend to other depository institutions overnight [1].

After this release the US stocks rocketed high: the Dow Jones Industrial Average jumped 196.31 points (1.53 percent) to 13,042.09 and the technology biased Nasdaq added 45.06 points (1.84 percent) at 2,496.13. The Standard & Poor's 500 rose 28.38 points (2.01 percent) to 1,439.65 [2].

This move by the Feds shall release money to the commercial banks in an effort to bail out the credit crunch in the financial system. But will it affect the consumer and commercial interest rates?

David Greenlaw, an economist for Morgan Stanley said:

"It's conceivable that the Fed's actions today could go a long way toward restoring liquidity to the markets."

Carl Weinberg, chief economist for High Frequency Economics wrote:

"Markets should not be calmed by this tactic. This move is not going to provide any relief to the overall economy. We can only speculate about this, but the decision to move the primary discount rate rather than the fed funds rate may indicate that the Fed anticipates some institutional failure as soon as today, probably not a bank, but rather an institution that has substantial bank liabilities that may not be able to clear."

In recent months, investor worries have been accelerated as many mortgage firms have gone out of business and the number of foreclosures are on the rise. Fears about the deflation of the housing and credit bubbles have led investors to sell off financial and other stocks that has swept billions out of the world market in the last few weeks. Let us keep our fingers crossed and hope that the situation improves in time. Hopefully there might be a cut in the federal funds rate to ease us out of the current financial crisis.

Reference(s):

1. Rex Nutting & Mike Maynard, MarketWatch: "Fed cuts discount rate to 5.75%, Central bank's move aimed at easing credit crunch"
2. Agence France-Presse: "US stocks rocket higher after Fed cuts discount rate"

Image Source(s): iStockPhoto

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