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The Federal Reserve Board this week made a dramatic departure from long-standing policy, opening its low-cost lending window to an institution outside the commercial bank membership of the Federal Reserve System.
In providing short-term lending to Bear Stearns Cos. and announcing it would make its so-called discount window available to 19 other investment banks, the Fed startled Wall Street and Washington lawmakers. Until now, the discount window has been limited to federally insured depository institutions. The move prepares the Fed to prevent implosions at other investment banks that could result from Wall Street's heavy investment in mortgage-backed securities. The impact may be as much emotional as practical -- by providing assurance of liquidity, the Fed may be able to stem panic from spreading to other firms. The new program differs from traditional discount window lending to insured banks, which have access to overnight and term funding for up to 90 days. The eligible investment banks, by contrast, have access only to an overnight facility. The facility can be renewed, however, every 24 hours for up to 120 business days. Primary dealers will be subject to a frequency-based fee after they exceed 30 days of use within the first 120 business days of the program. Like many specifics of the program, the size of the frequency-based fee must still be communicated to primary dealers in advance. There are 20 primary dealers now registered with the Federal Reserve Bank of New York, which administers the discount window. Primary dealers are banks and securities brokerages that trade in U.S. government securities with the Federal Reserve System. Besides Bear Stearns and Morgan Stanley, they include Banc of America Securities LLC, Cantor Fitzgerald, Citigroup Global Markets Inc., Countrywide Securities Corp., Credit Suisse Securities (USA) LLC, Goldman, Sachs & Co., Lehman Brothers Inc., Merrill Lynch Government Securities Inc. and UBS Securities LLC. The rate paid on a loan will be the same as the discount rate to Fed-member commercial banks, known formally as the primary credit rate. The New York Fed now charges 25 basis points above the target federal funds rate, the interest rate at which commercial bank balances are loaned to other depository institutions. The discount rate is usually higher than the federal funds rate, which is set by the Fed's open market sales of Treasury bills and other government securities. Surprised lawmakers, wishing to avoid further turmoil in the financial markets, tread carefully when commenting on the Fed's actions. "Now that large investment banks are allowed to step up to the window, some greater degree of regulation should be examined," Sen. Charles Schumer, D-N.Y., the chairman of the Joint Economic Committee and a member of the Senate Banking Committee, told CNBC on March 18. Sen. Sam Brownback, R-Kan., Schumer's GOP counterpart on the Joint Economic Committee, praised the Fed's action. "Liquid and functioning financial markets are essential to our nation's economic system," he said in a March 18 statement. "The Fed's continuing vigilance and aggressive posture in addressing challenges in the financial markets is key to restoring confidence and vitality to struggling sectors of the financial markets." Collateral that is eligible for repurchase agreements arranged by the Federal Reserve Open Market Trading Desk will also qualify for discount window borrowing. Borrowers can also use investment-grade corporate securities, municipal securities, mortgage-backed securities, and asset-backed securities for which a price is available. Dealers seeking to tap the discount window must notify their clearing banks, which will verify that sufficient collateral exists and notify the New York Fed of the request. Once the collateral has been assigned to the New York Fed's account, the loan will be transferred to the clearing bank for credit to the investment bank. - Bill McConnell See Dealwatch: Bear Stearns - J.P. Morgan Categories Deal Video
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