(Update1) Fed Takes Unprecedented Actions to Unfreeze Marketsby Tim Manni
The Federal Reserve has wasted no time enacting unprecedented actions designed to jump-start credit markets by promoting both public and private borrowing. The Fed has increased both the 84- and 28-day Term Auction Facilities (TAF) to $150 billion each. This increase, the highest ever offered by the Fed, will simply allow more financial institutions to apply for term lending through the Federal Reserve.
In an action that was not due to take place until October 1, 2011, the Fed has begun paying interest on the commercial bank reserves they hold, retroactive October 1, 2008. “Paying interest on required reserve balances should essentially eliminate the opportunity cost of holding required reserves, promoting efficiency in the banking sector,” said the Federal Reserve in a released statement. This also helps institutions to grow their reserve base organically without going to markets. The recently passed $700 billion financial-rescue plan accelerated the Fed’s ability to pay interest on the deposits they hold.
The Federal Reserve has also begun paying interest on the excess reserves that they hold. This will “permit the Federal Reserve to expand its balance sheet as necessary to provide the liquidity necessary to support financial stability while implementing the monetary policy that is appropriate in light of the System’s macroeconomic objectives of maximum employment and price stability,” said the Federal Reserve in a released statement.
With the Fed paying interest, banks will benefit by producing a source of income from parking their money with the Fed. This initiative will aide banks in growing their capital base. Under the current economic conditions, it has gotten extremely difficult for banks to go out into the market and seek additional capital. Undercapitalization has been a main reason many banks have failed. Recently, when word spreads that a certain bank is seeking additional capital, it inducing customer fear which can result in a run on deposits.