A Tale of Two Unknowns: The Fed's Second 2007 Emergency Meeting

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Simply, Dudley raised the concern that if the 50-basis-point reduction in the discount rate triggered an avalanche of loan requests, the Reserve banks across the country may not have enough humans to deliver the funds.

The issue never arose, but the conversation offers a view of the uncharted landscape the Fed was about to wander through.

The other argument unfolded about a lack of bank participation.

The stigma to approach the discount window was that banks felt if they asked for loans from the Fed, then market participants would view those banks as weak. Stronger banks, the reasoning suggested, wouldn't want to do business with weaker banks, which would thusly exacerbate problems.

The Fed also didn't want to send the impression to markets that conditions in the financial services sector were spiraling (again, at that time, the Fed didn't observe the rising problems as a crisis of historic proportions).

What to do?

Fed Chairman Ben Bernanke and others recommended a 50-basis-point reduction, while others argued for a 75-basis-point decrease.

Those in favor of 75 basis points feared that 50 basis points wouldn't maximize the effect of bringing banks in need of liquidity to the discount window.

The argument about the difference of 25 basis points gripped the FOMC's conversation and weaved itself throughout the meeting. Ultimately, Geithner made the decisive argument for the 50-basis-point cut: If it didn't work, the Fed would know larger problems were brewing.

"If this does not have a desired effect, it will not be because we didn't do another 25. It will be because we're at the point where we're going to have to think about the fed funds rate," said Geithner, who then levied some dramatic irony. "So I don't think it is right ... to think that we will do it by just decision we will revisit that spread. We will have to think about more dramatic actions in that context."

On Aug. 17, 2007, the Fed issued this statement , which said it would cut the discount rate by 50 basis points and the target federal funds rate by the same amount.

"We are doing a very unconventional thing," Bernanke said at the end of the meeting.

-- Written by Joe Deaux in New York.

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