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What will it take to free up credit?

interest rates paper

TEXT OF STORY

Kai Ryssdal: When I said this isn't a stock story up at the top a minute ago, what I meant was it's really a credit story, one that the Fed had hoped to at least partially solve yesterday with that big rate cut. It cut what's officially called the Federal Funds target rate: the rate the Fed hopes banks will use to lend to one another. The idea is that banks will then pass on that cheaper money to companies and individual borrowers. But it hasn't worked out that way so far. The rates at which banks lend to each other did drop slightly overnight, but they are still at record highs. From New York, Ashley Milne-Tyte reports.


Ashley Milne-Tyte: The Fed made a big deal of cutting rates. But the banks ignored it. The way they see it, their peers are too risky to lend money to at such a low rate of interest. Hugh Johnson is chief economist at Johnson Illington Advisors. He says the banks simply don't trust each other.

Hugh Johnson: One of the reasons they don't have a high level of confidence is because everybody's sort of wondering what are the potential losses that other financial institutions, be they investment banks or commercial banks or a combination of the two, what is the level of liabilities that they really face?

That fear of the unknown has translated into sky-high rates of interest, both for the banks and for regular borrowers. Nigel Gault is chief U.S. economist with Global Insight. He says in this climate, the Fed could slash its target rate to zero and it still wouldn't thaw the credit markets.

Nigel Gault: It may be that we'll have to go there eventually, or we will go close to zero, but on it's own, it's not going to do the job. You just have to look at the experience of Japan in the 1990s.

Back then, he says, interest rates plummeted; the Japanese government pumped money into the banks; but the banks still refused to lend. Sound familiar? This time round the U.S. government appears to be moving beyond rate cuts. It's talking about taking stakes in financial institutions. Gault says that could help restore confidence. Hugh Johnson says the idea will take some getting used to.

Johnson: We'd kind of like to keep the federal government out of the private sector.

He says buying bits of banks may be un-American, but at this point it's probably necessary.

In New York, I'm Ashley Milne-Tyte for Marketplace.

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Clearly the feds have not tried EVERYTHING. Why is reducing interest a solution to a problem of with banks lending money? Fundamentally, in a free market, lenders charges more interest to risky borrowers. Isn't the proper solution to encourage banks to part with their money is to increase fed funds rate? It seems to me that the last 6 months of lowering interests rate have been making the credit tightening only worse. As I understand it, the current problem is with the supply of money, not demand; meanwhile the fed is artificially forcing price of money down. It's no wonder banks refuse to lend. Sure the increase in cost to borrowers, with too much mortgage debt, will be catastrophic, but keeping the rates near zero can't possibly be a longer term solution.

If the government's previous actions haven't restored confidence, why would further government intervention? The word I keep hearing is "uncertainty." If that's what's freezing the credit markets, what's an accurate way for banks to know how much risk vs. capital other banks have?

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