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Marketplace Morning Report
Fallout: The Financial Crisis

Fed acts to boost interbank lending

Nancy Marshall-Genzer Oct 22, 2008
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Kai Ryssdal: The Federal Reserve, meanwhile, is fixated on interest rates. While short-term credit markets do seem to be easing — that is, it’s looking like credit’s easier to get — the Fed’s in the middle of a tug of war over who is going to control interest rates on those loans that banks make to each other.

Marketplace’s Nancy Marshall Genzer explains.


Nancy Marshall Genzer: The Fed is a control freak. Right now, banks will only make overnight loans to each other. So many are willing to make quickie loans, the interest rate has fallen below 1 percent, way below the Fed’s target. Interest rates on of one-to-six months loans are a lot higher. That’s because banks still aren’t lending to each other long term.

So the Fed is raising the interest rate it pays banks to stash excess money in Fed accounts. That should suck up some of the cash now going into overnight loans. Ken Kuttner is a former Fed economist, who now teaches economics at Williams College.

Ken Kuttner: The Fed is really trying to strike a balance between making sure there’s sufficient liquidity to get the system unfrozen, while at the same time maintaining control of the interest rate.

So now, the Fed will take those cash deposits from banks and increase the number of long-term loans it makes to banks.

Brian Sack: So, the Fed is inserting itself into the market and being a much larger provider of credit than usual.

Brian Sack is with Macro Economic Advisers. He’s also a former Fed economist. He says the Fed hopes banks will follow its lead and start giving each other those long-term loans. Now, I know you’re wondering why on earth you should care if banks lend to each other? Listen to Sack explain how we fit into the banking food chain.

Sack: What the Fed is trying to do is fix the markets through which the banks, you know, fund themselves and hope that they will then be willing to go out and start lending to firms and to households.

But Sack says, that’s not likely to happen until the middle of next year.

In Washington, I’m Nancy Marshall Genzer for Marketplace.

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