How is the Fed Going to Increase the Money Supply to Help Lubricate the Markets

The Fed appears stuck trying to increase the money supply to buoy the those portions of the credit markets that are illiquid. I still think the best place to be in this process is on the sidelines as a spectator. The winners and losers still have not been determined. Text in bold is my emphasis. From Bloomberg:

Federal Reserve officials, who are forecast to lower their main interest rate next week, are signaling that they are looking for additional ways to increase credit to companies and consumers.

The Fed may lower the discount rate -- what it charges banks for short-term direct loans -- by a quarter-point more than the benchmark rate after Vice Chairman Donald Kohn and San Francisco Fed President Janet Yellen publicly expressed frustration that previous rate cuts haven't encouraged banks to lend to one another.

Such a move would narrow the gap between the two rates -- normally 1 percentage point -- to a quarter-point. Economists said that may spur lending by easing the stigma of borrowing at the discount rate, letting firms claim they are taking advantage of a better deal.

``The Fed has to re-liquefy the markets to reduce the risk of a financial accident,'' said Lou Crandall, who used to work at the New York Fed and is now chief economist at Wrightson ICAP LLC, a Jersey City, New Jersey-based research firm that focuses on government debt.

Policy makers are struggling to contain a crisis of confidence among banks that sent the cost of three-month loans between lenders to the highest in seven years. Failure to head off a credit crunch may send the economy into its first recession since 2001, economists said.

Crandall predicted the Fed will lower the discount rate by half a point, to 4.5 percent, and the main federal funds rate target by a quarter-point to 4.25 percent when it meets Dec. 11.

Futures prices indicate a two-thirds chance of a quarter- point move in the federal funds rate next week and a one-third chance of a half-point reduction. That compares with about a 50- 50 probability yesterday, . . . .

. . . . . ``The Fed is frustrated they can't get anyone to come to the discount window,'' said Ethan Harris, chief U.S. economist at Lehman Brothers Holdings Inc., and a former head of domestic economic research at the New York Fed. ``If the Fed lowers the discount rate closer to the funds rate, banks can represent their decision as merely borrowing at the best place to get money, rather than an act of desperation.''

The Fed has other options to ease the funding crunch besides reducing the penalty for discount-window borrowing.

One possibility is tripling the length of discount-window financing to 90 days from 30, said Stephen Cecchetti, a former research director at the New York Fed. The central bank, in its Aug. 17 decision to lower the discount rate a half-point to 5.75 percent, also extended the terms to allow 30-day financing instead of just overnight loans.

``Lengthening the term of the lending would really be more important,'' said Cecchetti, now a professor at Brandeis University in Waltham, Massachusetts.

Demand for cash typically rises at the end of the year as banks conserve funds to buttress balance sheets before closing their books. This year, that has combined with concerns about mounting losses on securities linked to mortgages at risk of default to cause borrowing costs to climb.

The three-month dollar London Interbank Offered Rate, a benchmark for corporate borrowing, climbed to 65 basis points more than the Fed's target federal-funds rate yesterday. Excluding Sept. 18, when the Fed lowered its rate by half a point, that's the widest spread since May 2000, a period that includes the last U.S. recession in 2001.