Banks Cut Emergency Fed Loans As Credit Woes Ease

Banks borrowed less from the Federal Reserve's emergency lending program over the past week, a fresh sign that credit problems are easing.

The Fed, in a report issued Thursday, said banks averaged just $7.66 billion in daily borrowing for the week that ended Wednesday. That was down from $10.75 billion in average borrowing for the previous week.

Banks have been scaling back their use of the Fed's emergency "discount" loan window as financial conditions have improved. At the peak of the financial crisis in the fall of 2008, daily borrowing from the discount window reached $110 billion as banks found their normal sources of credit frozen.

Banks pay just 0.75 percent in interest on the emergency loans.

With the financial and economic conditions mending, the Fed in the past months has dismantled virtually all of its special lending programs set up during the crisis.

Just this week, the Fed ended on schedule a major economic-support program that has lowered mortgage rates and bolstered the housing market. The Fed wrapped up on Wednesday $1.25 trillion in purchases of mortgage securities.

At some point when the economy is on firm footing, the Fed may want to sell some of those securities, a move that would drain money from the financial system as the Fed tightens credit and seeks to prevent an outbreak of inflation.

"My expectation is that sales would be slow, gradual, announced in advance, and would not create undue market impacts," Fed Chairman Ben Bernanke explained to Congress last week.

Bernanke and other Fed officials over the past week have again suggested that they are in no rush to raise interest rates. Deciding when to boost rates will be the biggest challenge facing the Fed. Moving too soon could hurt the economic recovery; moving too late can risk unleashing inflation or feeding a new speculative bubble.

The Fed's balance sheet has exploded, reflecting the central bank's action to fight the financial crisis. It stood at $2.29 trillion for the recent week, more than double the level before the crisis struck.

"I think we would like to bring the balance sheet back to something consistent with where it was before the crisis," Bernanke told lawmakers last week. "And that would suggest something under a trillion dollars I think would be appropriate." The Fed has a number of tools to shrink its balance sheet when it moves to tighten credit.

Also this week, another another Fed program designed to spark lending to consumers and small businesses during the crisis was winding down. Most of the Term Asset-Backed Securities Loan Facility, or TALF, for short, ended on Wednesday. Use of that program averaged $47.3 billion over the past week. However, a component of the program that seeks to bolster the market for newly issued commercial real estate securities won't end until June 30.