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Many people know that the Federal Reserve sets interest rates in order to loan money to other banks so they can keep cash flowing throughout the U.S. financial system. Mostly, this works great for everyone involved. But, sometimes, banks and thrifts need a little extra cash, mostly so they can meet the reserve requirement (the minimum amount of deposits banks need to be considered in good financial shape).
To meet the reserve, the Fed has what's known as the discount window, which allows banks to borrow money for a short period of time at a higher interest rate (called the discount rate) than the official Federal Funds rate.
It's called a window because it used to be an actual teller window, where banks would go to borrow from the federal government. Now, it's used more as a lender of last resort. In fact, banks prefer to borrow from one another than directly from the discount window, since the interest owed can be cheaper and going to the discount window tends to imply that the bank is in a spot of trouble.
The Fed, too, doesn't like banks borrowing this way, which is why the discount rate is always higher than the target rate. It also requires banks to collateralize the loans, meaning they have to turn over liquid assets, such as loans or CDs, to the Fed in order to get the money. As with any loan, the banks get the underlying collateral back when they pay off the balance.
Home / Markets / Industries / Government
Thursday, March 27, 2008
Fed Auctions $75B in Treasury Securities to Ease Credit Crunch
Associated Press
WASHINGTON --
Big investment houses took the Federal Reserve up on a first-of-it-kind offer Thursday to let them borrow Treasury securities and put up risky home-loan packages as collateral. It was the latest effort to ease a painful credit crisis.
The Federal Reserve auctioned $75 billion worth of Treasury securities. Bidders paid an interest rate of 0.330%. The Fed received bids of $86.1 billion worth of the securities. The identity of bidders is not released.
It was the first time the Fed conducted an auction of this kind. The next one will be held April 3.
The program, dubbed the Term Securities Lending Facility, was announced earlier this month by the Fed and is intended as a booster shot for financial institutions and for the troubled mortgage market. The Fed said it would make as much as $200 billion worth of Treasuries available through weekly auctions that started Thursday.
"It seems like the TSLF passed its first test," said T.J. Marta, a fixed-income strategist at RBC Capital Markets. "On the one hand I'm fairly positive about the auction. But on the other hand, we survived today. ... there is a whole lot more pain to come," in terms of more financial losses from the housing and credit debacles, he predicted.
Big Wall Street investment firms can borrow much-in-demand Treasury securities from the Fed and put up more risky investments, including certain shunned mortgage-backed securities as collateral for the 28-day loans.
The new program is designed to make investment houses more inclined to lend to each other. It also is aimed at providing relief to the distressed market for mortgage-linked securities. Questions about their value and dumping of these securities have driven up mortgage rates, aggravating the housing crisis. Since the Fed's announcement of this new program, rates on some mortgages have eased somewhat.
Federal Reserve Governor Randall Kroszner, in a speech Thursday, said curbing shady lending practices that contributed to the housing and credit debacles should help revive the badly shaken confidence of the public and investors.
"Effective consumer protection can help to restore confidence in the mortgage markets and help to preserve the flow of capital to consumers who wish to purchase a home," Kroszner said.
Under fire from Congress for being too lax in its oversight, the Fed has proposed a sweeping rule to protect homeowners from dubious lending practices. Subprime borrowers -- those with tarnished credit histories or low incomes -- have been hurt the most, although problems have spread to more credit-worthy borrowers.
The Fed has a proposal that would: restrict lenders from penalizing risky borrowers who pay loans off early; require lenders to make sure these borrowers set aside money to pay for taxes and insurance; and bar lenders from making loans without proof of a borrower's income.
It also would prohibit lenders from engaging in a pattern or practice of lending without considering a borrower's ability to repay a home loan from sources other than the home's value. The proposal would curtail misleading ads for many types of mortgages and bolster financial disclosures to borrowers.
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