By Carl HoweYesterday's Wall Street Journal notes that Citigroup (C), Bank of America (BAC), J.P. Morgan Chase (JPM), and Wachovia (WB) all borrowed $500 million from the Federal Reserve discount window. The description:
The move came five days after the Federal Reserve cut the rate it charges for discount-window loans on so-called primary credit to 5.75% from 6.25%. It also lengthened the duration of the loans to as long as 30 days from the previous one-day limit. Fed officials then held an unusual conference call with bank executives in which they encouraged banks to tap the window. Deutsche Bank AG borrowed from the discount window the same day.
It was part of a concerted effort by the Fed to restore confidence to credit markets, where losses on subprime mortgages have rippled across numerous markets and have made investors reluctant to lend to any but the most creditworthy borrowers. Fed officials acknowledge banks don't need the money but hope some will lend the money to creditworthy borrowers facing difficulty financing themselves in the current environment.
So investors, home-owners, and lenders should now feel confident that the credit crunch we had last week is now under control, right?
Actually no. What you saw yesterday was a marketing campaign, pure and simple, probably orchestrated by either the Federal Reserve or by US Secretary of the Treasury Paulson. Instead, what is really going on is that the Fed is softening up the market for more bad news.
How do I know this? Simple -- the story makes no financial sense. After all, why would Citicorp or BofA borrow money from the discount window at 5.75% interest, when they could have borrowed it at the Fed Funds rate of 5.25%, or on the open market at a rate of between 4.54% and 5.03%? Even for Citicorp, a half-point of interest on half a billion dollars isn't something you happily pay when you don't have to. And when four banks all borrow the same amounts at the same unfavorable rates, you know something is up.
Now we're all in favor of marketing; after all, it's our business. Marketing is about communicating a value proposition that convinces prospective customers to buy. That means that the Fed orchestrated this event to send a specific and carefully honed message.
So what is Fed-crafted marketing campaign trying to say to investors and lenders? It's saying that despite the fact that the Fed discount windows has traditionally been the lender of last resort, it's now just another source of money that lenders can tap. It's saying that the good times for lenders haven't ended, regardless of how bad their loan portfolios are. It's saying that the Fed won't let any major institution actually fail, regardless of the kinds of trouble they've gotten themselves into.
These big banks announced yesterday are just window-dressing; they don't need the money. They're there at the discount window to hide the ones in the next round that do, where the Fed actually will be the lender of last resort. The fact that the Fed has gone to the trouble to orchestrate this response means that it knows there are more troubled financial companies out there that haven't gone public yet. And that means more bad news yet to come.