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Fed Rate and Bank Reserve Change, Might be Smart

Yesterday the Fed lowered interest rates and at the same time removed the 10% on hand requirement for Banks.

Swing Away Merrill! (Signs)

This may be smart for 2 reasons:

  1. More borrowers will deposit cash when they close on loans.
  2. Takes the FDIC risk somewhat off the public and puts it more inline with banks and institutions, including the Treasury.

First, as long as lending requirements remain the same, every loan will be closed with a cash deposit, which alleviates some of the problem of making more cash available through Fed Funds. Nothing new, just more of it. This brings more cash out of personal accounts of citizens and puts it back into a more active monetary system, it moves faster.

Second, because the lending increase is being created in the banks, with deposits for loans, the risk factor we witnessed previously in the real estate downturn will be more institutional, so they don’t have to go back to mom and pop and foreclose.

Basically, the Fed/Treasury has decided to fund and guarantee just about every loan that meets good lending criteria while at the same time freeing up cash from static accounts, and thus placing it back in circulation. This gives banks a reason to write more loans without underwriting departments worrying so much about the Bank Owned Property side of the ledger. It is a higher level of Full Faith and Credit to the banks. “Swing away Merrill!” (not a reference to Merrill Lynch)

This does not mean they will stop making more money, just that they have a way to increase business, banking, loans, cash flow, and GDP all at once.

This really could be one of the smartest moves they ever made. The downfall would be rising real estate prices that freeze lending. If they guarantee the loans at low interest, and nobody cares about rising prices vs the low cost of capital, then higher prices may not matter, for a while. Remember, when they eased before, the banks were afraid to lend. Not this time, hopefully.