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Five Things You Need to Know: Special "Whew" Edition!


What you need to know (and what it means)!


Minyanville's daily Five Things You Need to Know to stay ahead of the pack on Wall Street:

Only two words describe how we feel this morning: Whew! Wait, isn't that just one word? Not when you pronounce it the way the market did this morning - Whhhhe - ewwwwww!

"The market thinks Bernanke is a rock star!"
- CNBC reporter Bob Pisani

You know that old joke about "What happens when you play a country song backwards?" You sober up, get a job, your wife comes back and the bank un-forecloses on your home. We think there may be something about a dog in there too, but you get the point. Anyway, to hear the spin on the Street this morning, you would think that's exactly what the Federal Reserve did by cutting the discount rate. "Shove this job and take it," Federal Reserve Chairman Ben "Johnny Paycheck" Bernanke said in a statement (we're paraphrasing). "Here we ain't working? No more!," he added. Indeed.

1. So, What Did They Do?

This morning at 8:15 a.m., the Federal Reserve cut the discount rate by 50 basis points. This is different from the Federal Funds rate, which is what the Fed normally "adjusts" to carry out monetary policy. We'll get to that in a moment. But first, let's step back and try and get a handle on what is happening in "normal-person speak."

2. What Did They Do in Normal-Person Speak?

The discount rate is the interest rate charged to banks on loans they receive from their regional Federal Reserve Bank's lending facility. There are 12 regional Federal Reserve Banks.

Image:Federal Reserve Districts Map.png

Source: Federal Reserve

These banks are the "operating arms' of the central banking system. What does that mean, "operating arms"? Among other things, these banks hold cash reserves from banks and make loans to them, move dollars and coins in and out of circulation, collect and process checks, and help the Federal Reserve implement monetary policy.

The Fed lowered the discount rate to try and increase the amount of money in the financial system.

3. What Did They Really Do?

OK, but why did they cut the so-called discount rate and not the Federal funds rate, the one they usually mess with?

The discount rate is the cost of money available to Big Banks through the Fed's discount "window." Or put another way, the discount rate is the "Big Boys" rate... sort of like the rate mob bosses charge one another. The Fed Funds rate is the rate for all other banks... sort of like the rate the loan sharks who work for the mob bosses charge one another. You and me? We get charged whatever the individual loan sharks decide.

4. So This Discount Rate Cut is a Good Thing, Right?

Is it a "good thing" when Legs Diamond has to go to Owney Madden for cash?

The Fed is normally considered the last resort for banks, which usually borrow from each other. And once upon a time it was considered pretty embarrassing to borrow money through the discount window. Why? For the same reason Legs Diamond doesn't want to be seen showing up hat in hand at Owney Madden's place asking for a loan. People, they get ideas, see. And when people get ideas, that's no good! No good!

The discount window is a "safety valve" and helps relieve liquidity "strains". The New York Federal Reserve explains it on their web site this way:

"The Discount Window functions as a safety valve in relieving pressures in reserve markets; extensions of credit can help alleviate liquidity strains in a depository institution and in the banking system as a whole. It also helps ensure the basic stability of the payment system by supplying liquidity during times of systemic stress."

Oh, so the Fed is just acting to preserve basic stability by supplying liquidity during a time of systemic stress. Whew! That's a.... wait, systemic stress?

5. Play it Again, Ben... Backwards This Time

Yes, well, now we've come full circle... to our backwards-playing country song. Can't we just play this song backwards and undo what we've done?

You know what keeps that old backwards country song joke in business? The reality underneath. If only we could sober up. If only our boss would call us up and give us our job back. If only our wife would come home. If only those foreclosures weren't real. If only.

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No positions in stocks mentioned.

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