Federal Interest Rate

What is the Federal Interest Rate?

• When the Federal Reserve announces an interest rate cut/increase they are talking about the "nominal" rate, which is the rate at which Banks borrow money from the Federal Reserve.  
  

Why would the Bank ever want to borrow money from the Federal Reserve?

• Banks must maintain a minimum amount of cash reserve by law.  This reserve is usually 10% of the total amount of cash deposits held by the Bank.   When Banks want to make loans, they must ensure they have enough capital reserve to meet the minimum legal requirement.

When is it better for the Bank to borrow from another Bank?

• When the Federal Reserve raises the nominal interest rate, other Banks may have excess cash (borrowed at the lower nominal rate) that they can lend to other banks at a negotiated rate called the "effective" rate.  A basic rule of thumb is effective rate is always greater than nominal rate.  (E > N)

How does a Federal Interest Rate cut affect me?

• Lower nominal interest rates encourage banks to borrow more cash from the Federal Reserve and effectively encourages banks to loan money to you at a lower interest rate.

Why are Banks not loaning money?

• Banks are not loaning money because they no longer have enough reserve to cover the bad mortgages since Banks are no longer receiving payments for these loans; not to mention that the homes are now worth less than their original loan amount (called negative equity) so even selling these homes wouldn't pull Banks out of the "red".

So why isn't the Federal Reserve buying up bad mortgages?

• I don't know.