Discount Window – What’s the Hype all about? Lehman Bro’s

As for as the discount window, the Fed has lowered the discount rate through a series of rate cuts to 2.25% from the 6.25% rate that was effective in August, 2007. This is the interest rate that banks pay when they borrow money directly from the Fed. The problem with this, however, is that most banks do not like to borrow from the Fed’s discount window because it can be construed as a sign of weakness.

How so?

Imagine that you are in an action movie playing the part of the hero who is being mistaken for a criminal.

You are on the run from the police who don’t really know that you are on their side in the first place. After a few days on the run, you start getting hungry. You find a grocery store, find some food and proceed to the check-out line. You are faced with two choices:

• Pay cash for the food
• Use a credit card

If you use the credit card, you know that the authorities will be monitoring all the activity on that card. This will tip them off to your location and "BAM" – you are caught! On the other hand, if you pay cash for the food, you can remain anonymous and continue with whatever it is you are doing to prove your innocence and give the movie a happy ending.

The banking industry is like an action movie, and the banks that need funds are like the heroes of the movie. The banks on the sidelines are like the authorities. If you are a bank that needs funds, and you go directly to the Fed and borrow from their discount window, this would tip off all the other banks that you could be experiencing financial difficulty. This in turn causes them to be more cautious when dealing with you and could potentially result in driving down your stock price because the stock market may interpret this as a sign of financial weakness.

That is why the discount rate is often referred to as symbolic, as most banks don’t like to borrow from the Fed’s discount window if they can avoid it. If a bank finds other sources of funding outside of the Fed’s discount window, they can borrow anonymously and avoid tipping off all the other banks to the fact that they are in need of short term funds.

Mortgage Planner William Doom