is that important.
Of course arbitrary financial regulations give the impression that it can be tamed for the "greater good", but we all know better than that.
I am not up on banking regulations, but in general, if a bank is Fed approved (another arbitrary decision) it can borrow free money (almost free) and lend for a profit.
I think what you are referring to is the repo market. The Fed window has normal business hours. In a liquidy pinch, when the window is closed for the day, a bank can call their buddy up over in Europe or Asia and borrow money to satisfy their liquidity needs for a point or so above the discount rate. I think these types of loans are usually settled up as soon as the window opens the next morning because it is simply cheaper money. I don't know if there is a reg. requirement.
There are banks that only lend to other banks. In fact there was a fairly large one that went down during the 2008 ordeal (I think it was Citi. Different than the still standing CitiBank.)
A bank has to make a risk assessment. "If I lend this money out at a "Y" profit margin, what are the chances of default and is that probability small enough to make a profit over the long haul if I make additional nearly identical loans?"
Without the FED and with market driven interest rates the same risk assessment is at play, but the price of money is different and therefore different decisions are made.
Look at it this way.
Let's assume that you are FED approved which means you get free money. A smart man would borrow a bazillion dollars and put it into treasuries or some other AAA investment and milk a penny out of every dollar. Roll a few pennies back into the investment and spend a few.
No need to pay the loan back since it isn't costing you anything.
But of course you are not FED approved so if you wanted to borrow money it will cost you. In fact the price of money for you or me exceeds the return you get on Treasuries and other AAA investments so that is not an option. You have more limited options available to you if you are looking for a return that will allow you to make a profit with relatively low risk of default.
Whatever investments are made at the arbitrarily low discount rate that would not be made at market driven rates is the malinvestment bubble.
Most recently that was mostly mortgage backed security since they were considered AAA because they were collateralized and risk models assumed real estate prices never went down and the return was higher than treasuries or other financial instruments and there was liquidity in the market since Fannie and Freddy would cash you out if needed.
Ironically, arbitrary low rates reduces risk taking on small businesses, start ups, and venture capital, which are the real engines of growth and prosperity.
Double whammy. Big Bubble and low growth.
Additionally, low risk investments tend to be to wealthy clients. A concentration occurs. The poor get poorer. The not so wealthy get poorer. And the wealthy get wealthier.
Triple whammy. Less people with less money means less consuming and lower GDP.
And that is the snowball that just gets started down the mountain. One can only imagine the consequences when the snowball finally reaches the bottom.
Want DP delivered to your inbox daily? Subscribe here: