Home > Economics - General > The Bernanke put

The Bernanke put

August 18th, 2007

The US Federal Reserve has stepped in to bail out the financial sector, cutting its discount rate and, more importantly, encouraging banks to borrow directly from the Fed to finance mortgage lending. This action demonstrates that the famous “Greenspan put” has survived, and is now the Bernanke put.

A “put” in finance jargon is an option to sell an asset to to the issuer of the option at a “strike price”, typically selected to protect the holder of the put against disastrous loss. The put is exercised only when the market price falls below the strike price. Credit markets provide a range of put options for assets including equities, bonds and so on. From the viewpoint of financial market participants, the great thing about the Bernanke put is that it’s free. The masters of the financial universe can make bilions betting that things will go right. If things go wrong, the Fed is there to pick up the tab.

Of course, things have to go wrong in a bad enough way to threaten the stability of the financial system as a whole, and yesterday’s rescue shows what that means. The fact that a large proportion of subprime mortgages were going to go bad, with at least a million families losing their homes, 100 000 workers losing their jobs and so on was known months ago. The big news of the last few weeks is that the losses won’t be confined to this group, but extend to hedge funds, issuers of commercial paper and so on. Another group facing problems were homebuyers seeking mortgages too big to be covered by the quasi-official loan guarantee corporations, cutely called Fannie Mae and Freddie Mac. These ‘jumbo’ loans (over about $400 000) have become very hard to get and will now be effectively guaranteed by the Fed.

So, the Bernanke put is great for Goldman Sachs and JP Morgan and good for high-income homebuyers. But it won’t do any good for the low-income, poor-credit households who lined up for subprime loans. In fact, they represent the first line of defence for the financial system, made more effective by the Bankruptcy Reform Act of 2005, which has closed off this option for many.

It’s hard to criticise Bernanke for the choices he’s made, given the way the system works. On the other hand, it’s equally hard to see why we as a society are rewarding the financial sector so richly for an activity which involves little risk and big payoffs, whether decisions are good or bad.

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  1. conrad
    August 18th, 2007 at 18:45 | #1

    I don’t think its hard to criticize Bernanke at all — quite the opposite. Deliberately keeping inflated asset prices inflated and getting people to borrow more when they already have a negative savings rate just delays the inevitable — that one day people are going to start betting against some of the larger players and win. It also means that the US is going to continue to borrow vast sums of money from other countries that obviously have their interests close to their hearts, like Saudia Arabia and China.

  2. mugwump
    August 18th, 2007 at 21:21 | #2

    Umm, this post is off the mark.

    The credit markets were frozen across the board. Not just subprime mortgages – everything was seizing up.

    The Fed couldn’t care less about the hedge fund losses. This move was purely to get the credit markets operating again. Do you really think it is a good idea if companies can’t issue bonds?

    The Fed only accepts AAA paper as security, just now they’ll accept private AAA as well as govt AAA. The discount window represents a miniscule fraction of the Fed’s lending, so cutting the rate is largely a psychlogical ploy, which makes sense when you realize the credit crunch is also largely psychological in origin.

    Risk is being repriced. The Fed has said it needs to be repriced and they don’t want to stop that. The big private equity deals will disappear or at least slow right down. But hopefully now the healthy credit will start trading again. Nobody wants to see a global credit crunch of this nature – there is nothing fundamental underlying it.

    As for the poor subprime borrowers, give me a break. I live in one of those over-inflated US markets. Houses around here were bid up to twice their underlying value (in terms of rent) by people getting $600,000 – $1,000,000 no doc loans with teaser rates. Now those teaser rates are resetting, they’re defaulting and foreclosing. But hey, they sure had a party in the meantime.

    Housing prices are falling. First home buyers will be able to afford again. Normality is slowly returning.

    Most of the subprime borrowers that did not overextend will do just fine.

  3. August 18th, 2007 at 22:19 | #3

    Central banking creates moral hazard and exists to transfer risk away from lenders and towards the holders of cash and those that pay taxes. We should get rid of central banking.

  4. Ernestine Gross
    August 18th, 2007 at 22:29 | #4

    IMHO, references to ‘psychological factors’ indicate that something fundamental about monetary economies is not fuly understood.

  5. mugwump
    August 18th, 2007 at 22:50 | #5

    “We should get rid of central banking.”

    Replacing it with what?

  6. August 19th, 2007 at 07:05 | #6

    we should get rid of central banking, and replace it with barter: i’ll trade this gold bar for your virgin daughter, if you’ll throw in 2 cows and a milk-maid.

  7. swio
    August 19th, 2007 at 09:59 | #7

    I had forgotten about the 2005 bankruptcy act. I was following it reasonably closely at the time it passed. Its a truly horrible piece of legislation. Many of the people about to lose their homes are going to see that being kicked out of their home was only the first and easiest part of their new nightmare. The new laws means that its now very hard to declare bankruptcy and start over in the US today. Many of them will be forced onto adjusted repayment plans that they have no hope of ever completing. They’ll just have to keep paying money to their creditors, or whoever bought the debt, forever with no realistic prospect of ever paying the debt off.

  8. Ernestine Gross
    August 19th, 2007 at 10:58 | #8

    “The credit markets were frozen across the board. Not just subprime mortgages – everything was seizing up.”

    This is normal because all financial markets are interrelated and only ‘negligible’ (small) defaults at any point in time have no measurable impact on the financial system.

    The term ‘seizing up’ means to me that the financial market vanished (no longer exists). IMHO, this is an example of the empirical relevancy of abstract mathematical economic theory – theoretical models which aims to find sufficient conditions for the existince of a solution of the model. In my experience, practical men and women are not very interested in studying these models or, worse still, advancing knowledge in this area.

  9. jquiggin
    August 19th, 2007 at 11:16 | #9

    swio, one of the few saving graces of the situation is that many mortgages in the US are non-recourse. The lender gets the house but can’t pursue the borrower for any shortfall. Still, I imagine lots of people will find themselves in the position you describe, after running up other debts in the attempt to save their home.

    Responding to mugwump, of course subprime borrowers took a risk and are paying for it. But those being bailed out by the Fed got huge rewards for supposedly taking risk, and are now being protected because any real loss to them would ensure in your words that “the markets seize up” and that can’t be allowed to happen. I’m unsurprised to find that you think this is all hunky-dory.

  10. Ernestine Gross
    August 19th, 2007 at 13:03 | #10

    An individual sub-prime market borrower’s default would not rattle ‘the market’, although it might rattle the economic situation of the individual.

    An individual sub-prime market borrower, IMHO, may be savely assumed to not know the loan books of sub-prime market lenders (confidential commercial information?). However, for an individual to assess – however vaguely – his or her contribution to the event ‘freezing up of financial markets’ he or she would have to know what the club of lenders know. Hence, penalising only the individual borrowers is not a solution to the problem.

  11. gordon
    August 19th, 2007 at 17:06 | #11

    In a recent post at Economist’s View, Paul Krugman tried to refocus the debate on the homebuyers who can’t pay their mortgage debts. In that post, he suggested that a “bailout” would be “…for Fannie Mae or the Federal Reserve or someone to step in and buy mortgage-backed securities from troubled hedge funds…”

    Since we haven’t been told that any Govt. agency is actually buying these dubious securities, does that mean that no “bailout” has occurred?

  12. gordon
    August 19th, 2007 at 18:40 | #12

    Maybe I can at least partially answer my own question above. Apparently, the US Federal Reserve has begun to accept mortgage-backed securities as loan collateral at the “discount window”, and offer longer loans – see this Vox EU post.

    According to this post at B. DeLong’s site, the US financial community are taking the easing of “discount window” operations as a promise that the Federal funds rate will be lowered soon.

    So institutions holding dubious mortgage-backed securities can now borrow against them through the Federal Reserve, and can look forward to a lower interest rate in the future.

  13. August 19th, 2007 at 19:06 | #13

    “…it’s equally hard to see why we as a society are rewarding the financial sector so richly…”

    JQ, I can only suppose that you are blinded by your own preconceptions or you would see this as a fundamental part of a reductio ad absurdum. It should be shouting at you that there is no such entity as “we as a society”, as Maggie Thatcher once sought to point out, though she in her turn was misunderstood as asserting that there is no such thing as society. Nor may one properly conclude from the existence of society – the observable aggregation – that such an entity as “we as a society” ought to be brought into being to address the absence (improperly construed as a lack) of a directing intelligence for society; one may equally soundly conclude that “we” – meaning, whosoever finds it convenient to act at all – ought to engineer out any need as conclude that there is a mitigating excuse let alone a justification for such enveloping by social democracy.

  14. August 19th, 2007 at 20:24 | #14

    and replace it with barter: i’ll trade this gold bar for your virgin daughter, if you’ll throw in 2 cows and a milk-maid.

    That suggests a decided lack of imagination. The idea that virgin daughters should be bought and sold also suggests a desire to characterise any solution other than big government as somehow depraved. Perhaps predictable but somewhat sad.

    Replacing it with what?

    In Australias case we could quite easily replace it with a currency board and target a reference point for value such as gold, the euro or the US dollar. In the case of the USA the list of options would be slightly shorter. The world survived before government run central banks were created. In Australias case we had no central bank until 1910 and no national currency until then either. And yet we did just fine with the private sector alternatives (or rather we did no worse).

    Denmark and Estonia essentially fix their exchange rate to the EURO so they could very readily dispense with their central banks and replace them with currency boards.

  15. Ernestine Gross
    August 19th, 2007 at 21:31 | #15

    Re Terje’s post:

    Denmark has a ‘central bank’. It is called ‘Nationalbank’.


  16. mugwump
    August 19th, 2007 at 22:05 | #16

    gordon, the Fed still only accepts AAA. The subprime junk is not AAA. In fact, this problem all started when some cleverly packaged subprime junk with an overinflated rating was “priced to market”, meaning it was sold on the open market and fetched far less than it should have as high-quality debt.

    quiggin, by dropping the discount window rate and accepting private AAA the Fed is enabling the banks to raise cash to meet redemptions without having to sell their good debt on the open market below its true value. It is not a bailout of the bad debt, but it stops banks being unnecessarily forced into bankruptcy through selling their good assets at below value.

    The discount window repayment period has also been extended to 30 days. If the problem doesn’t rectify itself in that time, those banks are still going under. The subprime debt is being marked to market regardless. No-one is getting bailed out for the subprime mess. But the Fed is doing its best to ensure widespread panic doesn’t lead to an artificial recession.

    As for me being “hunky dory” about executives making out big while driving their companies into the ground: as an investor, I am as incensed by it as the next persion. It is patently absurd that people like Angelo Mozilo (CEO of Countrywide) can collect 500 Million from exercising options and then just walk away. But it is fundamentally a problem with compensation structure.

    I have no problem with Mozilo making 500M per se, if he adds 100 times that in long-term value to his company. That’s win/win. Since most employees are also invested in the company through 401K or options, it’s a win for them too.

    The problem with the way CEOs are currently compensated is they make 500M by adding 100 times that in short-term value to the company, because they get to exercise all their options exercise before they leave. That encourages them to do whatever it takes to boost the short-term share price, without taking the long-term view.

    The easiest way to fix this would be to grant a small fraction of options with a vesting window during the CEO’s tenure, but have the vast majority vest in the decade after their departure. That will encourage them to build lasting value, and, if the next CEO is lousy, it will also encourage them to lobby the board along with the rest of us mug shareholders.

    Why doesn’t this already happen? I am not sure, but I suspect it has something to do with being the first board to break ranks. In a competition for the top talent; those boards offering lucrative option packages with short-term vesting will win. Some of these boards need to take a risk: hire an unproven up-and-comer with longer vesting schedules and see how it pans out.

  17. gordon
    August 19th, 2007 at 22:24 | #17

    P.M.Lawrence, I have no difficulty in understanding Prof. Quiggin’s reference to “we as a society”. I have considerable difficulty in understanding your objection, particularly the final sentence.

    It seems to me that the option to use mortgage-based securities as collateral for loans from the Federal Reserve, loans which apparently can be extended ad lib., is the next best thing to selling such securities outright to the Federal Reserve or other US Govt. agency. That was Krugman’s definintion of a bailout (see my first comment above). I would like to know what the phrase “existing collateral margins will be maintained”, used in the FRB press release, precisely means, but other things being equal, it seems we do indeed have a bailout.

    This is a good post, with informative links. Thanks, Prof. Quiggin.

  18. August 19th, 2007 at 22:32 | #18

    Re Terje’s post:

    Denmark has a ‘central bank’.

    Ernestine – I did not say otherwise.

  19. Ernestine Gross
    August 19th, 2007 at 23:24 | #19

    Terje, you are right. You said Denmark could dispense of its central bank. Apologies.

  20. observa
    August 19th, 2007 at 23:45 | #20

    “It’s hard to criticise Bernanke for the choices he’s made, given the way the system works. On the other hand, it’s equally hard to see why we as a society are rewarding the financial sector so richly for an activity which involves little risk and big payoffs, whether decisions are good or bad.”

    Well it depends on how you view the system working. Suppose Central banks allow money creation over a number of years to the point where such cheap money causes serious malinvestments (particularly in long term investments like housing), and/or increased demand for imports(China?),and they finally get concerned about inflationary consequences and raise interest rates to curb their profligate credit expansion and then the inevitable collapse occurs and then they immediately panic and throw the money they effectively created over the years from the balcony to ameliorate the collapse and so noone should really blame these overpaid, pompous gits masquerading as economic experts and bankers. That’s just the way the financial system always works and it’s noone’s fault. Bwahahahahaha!

  21. mugwump
    August 20th, 2007 at 03:32 | #21

    It’s easy to pick on the Fed, but I don’t see how this is a bailout.

    Even if a bank uses subprime as collateral at the discount window, the still have to take the subprime back in 30 days (and repay the loan). So the only way the Fed (and hence the taxpayer) will end up holding bad loans is if the bank goes bankrupt in that 30 days, which is very unlikely.

    What the policy does do is give banks confidence that they can get cash from the Fed quickly if they need it. Lack of such confidence is exactly what is causing the current squeeze: “keep your cash because there may be a run”.

    I reiterate: the bad subprime debt has already been repriced. The hedge funds holding large chunks of that debt are losing tons of money. Rich people are losing more money than most. The Fed is simply trying to prevent the lack of confidence spreading to healthy credit sectors.

  22. August 20th, 2007 at 10:15 | #22

    Gordon, I too understand Prof. Quiggin’s reference to “we as a societyâ€?, just as I would understand “five sided triangle”. It means a geometrical shape with three angles and five straight edges. Test either combination of features out and you will find that they are inconsistent – you will get a reductio ad absurdum. If you do not see that, then you cannot have checked these things out. For instance, there is no “we” operating as a single aggregate called society – that is precisely how pattrens of reward can get evolved, ones that are nurtured by groups that overlap with the rewarded groups but do not operate or self identify as “we as a societyâ€?.

    Thus “we as a society� does not exist. Q.E.D.

    As for the final sentence, it is naturally going to be hard for people with a certain mindset to wrap their heads around it – it doesn’t fit their thinking. These are the people who, if they ever do manage to wrap their heads around the idea that “we as a societyâ€? is non-existent, will then say, “Aha! We need to make that start working”. They will say, “You, you, and you – stop that and do this! ‘We’ are more important, and what you are doing clashes with ‘us'”. They literally will not understand that there need not be a conflict to be resolved in “our” favour – they will be unable to wrap their heads around the idea of staying separate enough that conflicts of interest have their grounds cut out from under them, rather than merely plumping in favour of some abstract collective “us” every time (which means that each one of us is always bound to lose out).

  23. gordon
    August 20th, 2007 at 10:23 | #23

    Mugwump, the Fed. Reserve press release says: “he 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” (my underlining).

    I take this to mean that a holder of subprime mortgage backed securities can borrow against them for 30 days, then another 30 days, then another 30 days… Very close to an outright sale, except for the interest payable, now reduced to 5.75%. But 5.75% isn’t high compared with the discount that an outright buyer would certainly demand.

    I’m not so sure that “…the Fed still only accepts AAA. The subprime junk is not AAA…” One of the problems in the current situation seems to be that the rating agencies have been generous with their AAA rating – see this item from The Independent about the European Commission starting an inquiry into rating practices.

    Got to agree with you about CEO compensation. Also agree with Observa about money printing.

  24. August 20th, 2007 at 11:09 | #24

    What the policy does do is give banks confidence that they can get cash from the Fed quickly if they need it. Lack of such confidence is exactly what is causing the current squeeze: “keep your cash because there may be a run�.


    This is a big part of the problem. If banks knew that they could not necessarily get cash in a hurry from a complicit government printing press they may be substantially more conservative in their business affairs and the dodgy operators would be weeded out over time. What you seem to be in favour of is moral hazard.

    When gold was the centre piece of the financial system in the pre-fiat days all operators new that their were physical constraints placed on their activities. Nobody was going to be able to magically make more gold in a crisis and so there was substantial more incentive to lend carefully. Of course our governments sold out monetary policy to the interests of bankers long ago. Although sinse then other special interest groups have also had a turn at messing up our lives.

    The nationalisation of money remains perhaps one of the most insidious government interventions into economic affairs.


  25. gordon
    August 20th, 2007 at 11:46 | #25

    Still over my head, P.M. Lawrence. But I’m beginning to get the idea that I shouldn’t let you stand behind me – you might have an onset of individualism so extreme that you hit me over the head in order to steal my wristwatch.

  26. August 20th, 2007 at 14:15 | #26

    If PML suffered from extreme respect for the individual why would he steal your wristwatch.

  27. August 20th, 2007 at 14:24 | #27

    As you know Terje, I do not agree with you on the use of gold as currency, but the rest is (IMHO) right. The belief that the Fed will ride in on a white charger is a great source of moral hazard.

  28. August 20th, 2007 at 14:29 | #28

    You are more likely to have the government detain you for failing to pay taxes than a libertarian hit you over the head for your watch.

  29. gordon
    August 20th, 2007 at 14:52 | #29

    I pay my taxes, P.M. Lawrence. Do libertarians pay theirs? Or do they justify tax avoidance with a ton of philosophical hokey?

  30. August 20th, 2007 at 15:05 | #30

    I cannot speak for PML, but I pay mine. That is, I pay them as far as I can understand them. The ITAA is an impossible mess – it could be that I am under- or over-paying them and not know it due to the sheer impossibility of understanding the Act.

  31. August 20th, 2007 at 19:45 | #31

    As you know Terje, I do not agree with you on the use of gold as currency, but the rest is (IMHO) right. The belief that the Fed will ride in on a white charger is a great source of moral hazard.

    Andrew, do you see a cure to this moral hazard or do you think we should live with this problem because the alternatives are worse?

  32. observa
    August 20th, 2007 at 20:42 | #32

    “It’s easy to pick on the Fed, but I don’t see how this is a bailout.”

    Mugwump, you are half right in the sense that the Fed had little choice when faced with this particular crisis, but that’s the bone of contention. If they didn’t facilitate/allow credit expansion (virtually printing money), then it would not continue to manufacture these crises. Think of it this way. You cannot envisage the dollar in your pocket today buying the same or more in say ten years time than it does now. Why is that? The answer is, there is no reason whatsover that cannot be the case and furthermore if it were the case always, then lenders would be much more circumspect about who they lent their precious asset to. Get the picture?

  33. Ernestine Gross
    August 20th, 2007 at 23:22 | #33

    P.M.Lawrence, where is the proof that “we as a society” does not exist, using the same methodology you would use to prove that a “five sided triangle” does not exist? Until such time I don’t understand a word you are saying.

    Have a look at the proof of existence of a solution to a theoretical model of a competitive private ownership economy which uses the notion of ‘a social system’ (rather than excess demand functions). I should think that the term ‘we as a society’ is a reasonable verbal expression in this context but one which excludes your hypotheses, stated as if they were facts, about other people’s objectives.

  34. conrad
    August 21st, 2007 at 07:21 | #34

    I don’t know what you are talking about either PML. There’s huge evidence that human’s are adapted to live in groups, and that comes from multiple domains. In addition, if large groups of people are able to live together, co-operate, and act alturistically, what should people call them? Also, if by rewards, you mean short term rewards that can be calculated (whether monetary or otherwise), you almost certainly wrong. That idea died in the 80s once people started investigating it rather than just assuming people wander around trying to maximize some benefit for themself function (which then leads to complex systems). Some of the reason people act in groups/altrusitically is sure to be thanks to our evolution as social creatures.

  35. August 21st, 2007 at 12:54 | #35


    PML has already stated that society exists. You seem to be barking up the wrong tree. What PML said was that “we as a society” does not make sense in the context that it was used. It does somewhat presumes that society can be both the whole and a subset of the whole at the same time.

    The inference in the original article that people in the financial sector are not part of society is clearly flawed. It is also a form of prejudice along the lines of “why should we as a society tolerate blacks and jews”. Tomorrow “we as a society” will be opposed to economists or immigrants or any other subsection of society that the speaker prefers to pick on. But of society can meaningfully be a reference to something that excludes bits of society.

    I’m not meaning to pick on JQ and I think the hair splitting is a little tedious and probably contains it’s own set of contradictions. I am sure that I use words just as flippantly all the time in the name of expediency. And clearly my grammar stinks much of the time.


  36. gordon
    August 21st, 2007 at 14:30 | #36

    People interested in how the “Bernanke Put” works out in practice will obviously be interested in the value of loans at the Federal Reserve’s discount window over the next few months. Working back from a clue in the text of this post at Econbrowser, it seems that the value shown against the heading “Loans to depository institutions ” in the Fed. Reserve’s publication “Factors Affecting Reserve Balances” (available here) is the number to watch.

  37. mugwump
    August 21st, 2007 at 21:11 | #37

    gordon, I would restrict the “Put” to the value of defaulting loans at the discount window. That’s the amount subsidized by the taxpayer. Performing loans cost us nothing.

    Even more accurate would be the risk-adjusted value of the defaulting loans, since the taxpayer is receiving around 1%-1.5% more interest for our largesse, compared with the “risk free” rate of the equivalent (28 day) Treasury Bill (in other words, if the default rate is less than 1%-1.5%, we’re still ahead.)

  38. Ernestine Gross
    August 22nd, 2007 at 08:53 | #38

    “Performing loans cost us nothing”.

    Any comments regarding the existence of ‘us’ versus ‘them’?

  39. gordon
    August 22nd, 2007 at 09:57 | #39

    Mugwump, do you know what the phrase “existing collateral margins will be maintained” in this Federal Reserve press release precisely means? I would love to know.

    As far as the cost to the taxpayer is concerned, it seems to me that the Federal Reserve is offering to lend against securities that the private sector isn’t prepared to accept as collateral. I take your point about the importance of watching the value of defaults, but if these discount window loans are rolled over again and again over a period of several months, when exactly do we call “default”?

  40. gordon
    August 22nd, 2007 at 10:09 | #40

    There is certainly a school of thought in the US that the Federal Reserve’s offer at the discount window is more symbolic than anything else, and that the real impact will come when (not if; when) the Federal Funds rate is cut. I suppose for that school the recent recovery in stock prices reflects the anticipation of that cut. Watching the value of loans at the discount window should test that theory; if it doesn’t rise much, they are probably right.

  41. mugwump
    August 22nd, 2007 at 11:05 | #41

    Mugwump, do you know what the phrase “existing collateral margins will be maintained� in this Federal Reserve press release precisely means?

    I do now.

    if these discount window loans are rolled over again and again over a period of several months, when exactly do we call “default�?

    Fed rules prohibit using defaulting loans as collateral. The rules are spelled out in great detail on that site. I think taxpayer funds are pretty safe.

    As for ‘us’ versus ‘them’. ‘Us’ is the taxpayer. So there is no ‘them’ (if you know otherwise, can I have the number of your tax advisor?)

  42. gordon
    August 22nd, 2007 at 13:27 | #42

    Thanks, Mugwump. It seems we have between 10% and 20% less of a bailout than I thought. But you could still say that we have between 80% and 90% of a bailout (before adjusting for discount window interest)! Is the glass 80% full or 20% empty?

    As far as defaulting loans are concerned, I have been assuming all along that unsaleable collateral (eg. CDOs) presented at the Federal Reserve’s discount window haven’t matured yet (assuming they have maturity dates), so the problem of default by the issuer doesn’t arise. Maybe that is why we have been talking past each other on the default issue. I am saying that it will be hard to define default by the borrower (the bank) because if the borrower can’t redeem the CDOs he can just renew the loan for another 30 days.

  43. gordon
    August 23rd, 2007 at 12:56 | #43

    I should have said: “…default by the borrower (the bank’s client)..”

  44. gordon
    August 24th, 2007 at 12:52 | #44

    It seemed to me when the Federal Reserve put out this press release that it would be interesting to watch the value of loans through the discount window over the succeeding weeks, not only to see whether there was a rush to the window but also to test the theory that the Federal Reserve’s discount window action was mainly symbolic, ie. that it really amounted only to a promise to lower the Federal Funds rate. If there were no sudden interest in the discount window, I reasoned that the “symbolic” school of thought was right.

    The Federal Reserve publication “Factors Affecting Reserve Balances of Depository Institutions” for the week ending 22/8/07 has now come out. At the end of the week preceding the press release, Loans to Depository Institutions stood at a daily average of $271m. In the week ending 22/8/07, the figure was $1,541m., an increase of 468%. The Federal Reserve is now lending an average of $1.5b. daily to banks using the discount window.

    Though this looks like an enormous amount, I find I’m still not really sure whether it is a lot or a little in comparison to the scale of the difficulties in securities markets. And should I now dismiss the “symbolic” theory on the ground that the discount window operations are really where the bailout action is?

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