The Wall Street Journal reports that primary dealers have been loath to use their new-found access to the discount window (technically, it’s a “temporary clone of the discount window”), despite the favorable rates on offer. Why? For commercial banks, the assumption is that only the distressed would go to the Fed for dough (the discount window was originally designed for emergencies). In these jittery and rumor-prone markets, the last thing you want to do is create concerns. Bear’s liquidity went poof in a mere three days.
This response was entirely predictable. As we said when primary dealers were granted access on Monday:
This move is intended to last only for six months, but if the financial markets continue to be rocky (likely) and broker dealers use the facility, it’s hard to know how long it will take to wean them off it. However, use of the discount window has been seen as a sign of weakness, and use has therefore been minimal. That may mean this move proves to be largely symbolic, since the broker-dealers may not avail themselves of it either. The next measure would then be to allow them to use the TAF. Expect that to come soon.
Indeed, we saw the same behavior the Fed lowered discount rates last August to encourage greater use. But it got few takers, even though four big firms, Bank of America, Citi, J.P. Morgan, and Wachovia each took down $500 million each to try to alleviate the negative taint. But of course, Citi was considered a strong player back then.
The Federal Reserve’s emergency decision last weekend to extend borrowing to investment banks was designed to stem a worsening credit crisis ravaging the financial markets. The question is: Will it work?
Wall Street firms were reluctant to borrow from the program Monday out of concern it could be seen as a sign of weakness, if their identities became known.
Late yesterday, Lehman Brothers borrowed a small amount, according to a person familiar with the transaction, and Goldman Sachs is likely to do the same before the end of the week. Because Goldman Sachs is seen as financially stronger than some of its counterparts, that could diminish any stigma and encourage other firms to step forward….
The new loan facility works much like the Fed’s discount window, the central bank’s traditional tool for lending directly to banks. Banks, which hold customer deposits and are regulated by the Fed, have long been able to use the discount window to meet emergency funding needs. But they have been somewhat leery about using it, because of concerns that if word got around, they might be stigmatized as distressed institutions….
Fed officials maintain that just the existence of all of its expanded lending programs is an important confidence builder. Even if the new program for securities firms isn’t used much at first, “the Fed may decide it doesn’t mind making this a remote backstop,” said Lou Crandall, chief economist at Wrightson-ICAP.
Firms are expected to use the new program to help get financing for clients, such as hedge funds, that are facing liquidity problems.
The Fed did say at the time of the announcement that the primary dealers could act as conduits and submit collateral on behalf of counterparties. But how will Main Street react when it learns that the Fed is helping hedge fund while individual borrowers are under stress?