What I gathered was the Fed's release banks from having to hold on to the current minimum cash requirements, which allows them to loan out more cash reserves.
One of the broadest tools the Fed can apply to the supply of money in the system is raising or lowering the amount of reserves that banks are required to hold in their accounts. Raising reserves means banks have to hold onto more money, which tends to tighten credit. This works fine as long as the borrowing you’re trying to manage is coming from banks. These days, much of the credit at the center of the current financial turmoil is coming not from banks but from the global money markets, where bonds are bought and sold and the market sets interest rates.
That’s where the other two main weapons in the Fed’s arsenal come in: 1. raising or lowering short-term interest rates and, 2. what are called “open market” transactions.
Setting interest rates is the most visible and important tool because it essentially sets the “wholesale” cost of money. If you make money cheaper, it tends to move more quickly through the system. So if the economy is sluggish, a rate cut perks things up. If the economy is strong, raising rates is supposed to prevent the economy from picking up too much speed. Under those circumstances, too much money in the system feeds inflation.
Open market transactions are more limited, but have a more immediate impact. That’s why the Fed turns to these when the financial markets get into trouble, as it did on Friday. The specific mechanics of open market moves are pretty simple.
The Fed operates a trading desk in New York through which is can buy or sell bonds. If it buys bonds, the broker-dealer that sold them gets cash in return. That cash then flows through the system. If the Fed wants to soak up money, it sells bonds from its account — taking cash from the dealer that bought them and taking it out of the system (or "draining" money.) The Fed maintains its own account, so any money being “injected” into the system is not coming directly from the tax dollars collected by the Treasury.
Considering that the Federal government is in debt for more than 9 Trillion dollars..(as of March 2008) isn't this just playing with cash that really doesn't exsist? They allow the banks to deplete their cash reserves for loans, they don't get paid back and then the Fed has to bail them out?
I know this is over simplified, but in the end isn't this what is happening? Similar to using one credit card to make a payment on another, or gambling in Las Vegas.
Does anyone have a better understanding of all of this?