Fed Raises Discount Rate. It's Only A Start

Last Updated Feb 19, 2010 9:38 AM EST

How does a lion eat an elephant? One bite at a time, says the aphorism. So goes the Fed's approach to normalizing the many and unusual steps it has taken to ensure that all financial institutions have as much money as they need. Last yesterday the Fed raised its discount rate, which is the cost of short-term loans to banks, to 0.75 percent, up from 0.50 percent. It's not a major step, but it does represent the first of many the Fed will need to take to exit, gracefully we hope, from the record easy money policy of the last 18 months, as the U.S. economy gets back on its feet. An announcement last week notwithstanding, the bond market registered a modest surprise yesterday.

The Fed's discount window is a petty-cash drawer for banks that need overnight funds right away. In a more normal economy, raising the discount rate is a major step, intended to both raise banks' costs of borrowing, and provide a signal to the markets.

Yesterday's move was more of a signal, since there are just $15 billion in loans outstanding from the discount window, compared to the zillions provided through other means (this I heard on CNBC this morning, although Tiger Woods got more coverage). But it shows the Fed is ready to act. It's also a reminder that the other Fed programs are drawing to a close soon.

This is the first little bit of great news, folks. The Fed has clearly outlined the measures it will take, and is now showing to the market that it will mop up the liquidity mess in an orderly fashion.

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