Ken Fisher on solving the credit crunch (he failed to see coming)

The Fed has several powerful tools that it hasn't used. When banks fail, by definition they had inadequate reserves. So when you have a bunch of banks failing, you drop reserve requirements.

The other thing you do [is] manipulate, planfully, the spread between the discount rate, the Fed funds rate, and the T-bill rate…The way to end the liquidity crisis is to drop the discount rate relative to the Fed fund rate, which then motivates banks which are troubled to go to the discount window, plead baby shoes, get cheap money at the discount window, and then turn their rear ends around and lend it out at the Fed fund market rate because it’s free money. You borrow at the discount window cheap, you lend it to the safest bank you know, and now that bank has excess reserves, and they lend it out. The way the Fed has always unlocked liquidity freezes is to increase the spread between the discount rate and the fund rate. If you want to get more extreme, drop the discount rate below the T-bill rate, and now you have a riskless transaction.

~ Ken Fisher, "Catching Up With: Ken Fisher," Investment Adviser, November 1, 2008, by James J. Green