The WSJ blog noted some arguments regarding the Fed’s discount window, which the Fed has encouraged the big banks to use, with some obviously orchestrated success.
A very interesting article by Anna J. Schwartz addresses historical misuse of the discount window to prop up insolvent institutions rather than simply provide emergency liquidity. She argues that the discount window should be eliminated … for all my laissez-faire ideals, I find that a little hard to swallow. Her argument rests on the footnoted phrase:
Credit-worthy banks can borrow at market rates, large ones in the Fed Funds market, small ones from their correspondent banks.
That sounds to me like an overgeneralization. When fear takes over, I am more inclined to agree with Larry Neal and his diagnosis of informational asymmettry exemplified, he says, in the Panic of 1825. Few lenders even have the desire to determine creditworthiness – especially if they have potential obligations that they may have to meet – and those few that do may set the “creditworthy” bar uneconomically high.
I agree with her whole-heartedly, however, when she decries the extended provision of credit to an insolvent institution.
[…] do agree that propping up an insolvent institution would represent a misuse of the discount window – or equivalent […]
[…] is a vital difference between “illiquid” and “insolvent” banks, and that the Fed should not prop up the latter. Have the Europeans learnt the same […]