March 31, 2011

Fed Discloses Discount Window Info: What's all the commotion about?

The debate surrounding the Fed's disclosure of its discount-window information can be very confusing. Check out Mercatus scholars Satya Thallam and Anthony Sanders break down the issues in regards to transparency, the financial crisis, and future lending. Professor Sanders has also put together a graph of discount window borrowings from 2006-2011.

Satya Thallam, director of the Mercatus Center’s Financial Markets Working Group:

“The issue of disclosure, is understandable,” said Thallam. “It’s like revealing which kid has lice, and all of a sudden everyone stays away from him and parents start pulling their kids out of school. But I’m not sure the use of the discount window necessarily has that stigma or signals that the borrowing institution is in all that much trouble.”

Stress tests very much do, however, indicate “who is sick” and are probably much more meaningful, he said.

“In any case, when a bank goes to the Fed window, it does indicate there is some problem, but not that it is fatal and not that it doesn’t have the means to weather them,” said Thallam. “Ultimately disclosure will probably raise the implicit cost of borrowing from the Fed, which means heavier reliance on other forms and probably less risk-taking, which isn’t a bad thing.”

Anthony Sanders, professor of finance at George Mason University and member of the Mercatus Center’s Financial Markets Working Group:

Institutions knowing that they can go to the discount window in times of poor liquidity does not encourage prudency, says Sanders. It’s another safety net  that can actually increase risky behaviors.

“The discount window should be transparent rather than opaque,” said Sanders. “To the extent that institutions would be hesitant to use the discount window because of transparency, is a good thing. It is better to discourage reliance on bailouts, whether credit or liquidity-based.”

Some believe the Fed’s ability to act in secrecy trumps the public’s demand for information, he said.

“The Fed and discount window users will claim that capital market participants will use the information to take advantage the users,” said Sanders. “But that is the same argument Fannie Mae and Freddie Mac used for years. we now know how the failure of Fannie and Freddie to disclosure critical information contributed to their staggering losses.”