One widely unappreciated aspect of true free market capitalism is the limited liability of failures. When a business fails and goes bankrupt, it is not only the owners' liability that is limited, but also society's. We don't have a bankruptcy system to keep individual's from ruining themselves; we have it to keep them from inflicting too much damage on the rest of the economy. If we give someone an infinite credit line, then in theory, that one person can take everything down.
I keep saying this, but I'm more certain every day that it's true: These guys are creating the very problems they claim to be solving.
Reserve ratio thoughts:
A bank's reserve ratio is the percentage of total demand deposits that the bank is capable of paying out now. Basically, reserves are cash in the vault plus some electronic entries at the Federal Reserve which, in theory, could be immediately delivered as cash. The rest of deposits are lent to customers and cannot be accessed by the bank. The Federal Reserve sets the minimum reserve ratio allowed.
The discount rate is the rate at which member banks can borrow from the Federal Reserve.
The federal funds rate is the rate at which banks borrow (overnight) from each other. This rate floats, but the Federal Reserve intervenes in the market, by buying or selling U.S. Treasury securities, to keep it close to a target. When reporters speak of the Fed lowering or raising rates, it is this that they refer to.
A bank executive in the current financial crisis is likely to do one of two things:
1) If the bank is in bad shape, he is going to be risky in a way that doesn't appear too reckless, lobby for federal help, and try to keep the party rolling a few more quarters to squeeze out a few more paychecks. Maybe get lucky in the process and pull the bank out of failure. There is little cost to reckless lending for a bank on the brink of failure.
2) If the bank is in good shape, he tries to ride out the storm, tighten up lending standards (but lend freely to people with secure jobs, really good credit history, etc.), try to increase the deposit base, look for really cheap acquisitions a year or two down the road.
It seems to me that keeping a low discount rate / Fed Funds rate encourages both of these, but reducing the reserve ratio only encourages the first, as the second type is likely to keep increased reserves as a matter of internal policy. This, I believe, is why the actual fed funds rate has been below 2% (the current target) for the past two weeks.
Maybe if we do see Bernanke reduce the reserve ratio, it will signal the end, that he has given up and decided to throw the Hail Mary.