Fed raises rate for emergency loans to banks

Consumer costs not affected by move to rein in aid

By Jeannine Aversa
Associated Press / February 19, 2010

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WASHINGTON - The Federal Reserve decided yesterday to boost the rate banks pay for emergency loans. The action is part of a broader move to pull back the extraordinary aid it provided to fight the worst financial and economic crisis since the 1930s.

The move won’t directly affect borrowing costs for millions of Americans. But with the worst of the financial crisis thought to be over, it brings the Fed’s main crisis lending program closer to normal. The Fed decided to bump up the so-called “discount’’ lending rate by one-quarter point to 0.75 percent. The increase takes effect today.

The central bank said the action should not be viewed as a signal that it will soon boost interest rates for consumers and businesses. Record-low borrowing costs near zero are still needed to foster the recovery, it said. The Fed repeated its pledge to keep interest rates at “exceptionally low’’ levels for an “extended period.’’

The Fed had signaled that an increase in the discount rate was coming. It made its announcement yesterday after the markets had closed. Investors, however, viewed the bump-up in the emergency lending rate as a step toward broader credit tightening. In after-hours trading, the dollar strengthened, yields on two-year Treasury securities rose, and stock futures dipped.

The Fed portrayed its action as moving its emergency program for banks closer to normal. But the markets saw it initially as a prelude to higher borrowing costs across the board.

“I think one man’s normalization is another man’s tightening,’’ said T.J. Marta, market strategist and founder of Marta on the Markets, a financial research firm, explaining the market’s reaction. Marta still thinks higher interest rates for American borrowers are months away.

“The Fed did extraordinary things from keeping the economy imploding during the crisis,’’ he said. “Now that that danger is gone, the Fed can take away some of those supports.’’

The economy is growing again, and financial conditions have improved. But unemployment is still near double digits, and demand for loans remains weak. Many ordinary Americans and small businesses have found it difficult to borrow.

When credit virtually shut down starting in 2008, banks had nowhere to go except the Fed to borrow. Banks can now more easily tap private lending sources than they could then. As a result, the Fed now feels more comfortable about boosting the rate banks pay on emergency loans.

Because conditions have improved, the Fed also said yesterday it will shorten the length of emergency loans drawn from its emergency lending program. They will go back to overnight loans, effective on March 18.