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

Fed Discount Window Cut

The Federal Reserve has taken significant action in the last few weeks due to the credit crunch. And now they've made an unexpected move by cutting the discount window rate – which is great news. I'll get to that in a minute, but first let's look at recent events and understand what they mean.

Market movement:
To date, over 120 mortgage companies have closed their doors due to reduced liquidity.
The result: Borrowers who want to take out non−conforming loans have fewer, more expensive options.
Many media outlets have incorrectly added fuel to the fire by stating that mortgage lending has stopped altogether and that borrowers can't get a loan without a 20% down−payment.
This is not true.
Conforming interest rates and loan programs, those backed by Fannie Mae and Freddie Mac, have not been significantly impacted by recent events. Even better, interest rates have come down from recent highs.
While this is good news, the market is experiencing unprecedented volatility and changes could come at any time. Borrowers need to act swiftly and decisively in today's climate.

What did the Fed do?
Now back to the discount rate. This is the interest rate charged to commercial banks and other depository institutions on the loans they receive from their regional Federal Reserve Bank's lending facility. The Fed's decision to cut this rate provides stability in the financial markets and this can be good for all of us. How exactly does this provide stability? Here's an example: Imagine you just wrecked your car and it requires $5,000 worth of repairs. You have a short−term need for cash to pay your mechanic. Even though you know you will eventually be
reimbursed by your insurance company, you still need the cash now. So do you sell off stocks to get the cash, or tap into an equity line of credit? Most likely, you draw from that line of credit rather than liquidating a long−term investment. This is what the banks are facing in today's liquidity crisis. And Bernanke's move helps them avoid long−term damage by
supplying access to short−term cash. It's important to note that the discount rate is different than the Fed Funds Rate, which directly impacts interest rates that you pay for Home Equity Lines of Credit, credit cards, and automobile loans. Most importantly, the discount window rate cut does not directly impact mortgage rates.

What should you do now?
Information, knowledge, and expertise are the building blocks of sound financial decision making. If you are considering financing or are in the process of financing a home, you should tap into the resources of a skilled mortgage professional. I strongly encourage you to contact me as soon as possible. I would welcome the chance to help you navigate these choppy waters.