By: Larry MacDonald

U.S. banks are finding it difficult to raise capital and avoid a drastic restriction in lending, fanning fears of systemic meltdown and a plunge into a severe economic downturn. But maybe things aren’t all that bad: the Federal Reserve’s 2% discount rate is another avenue by which the banks can recapitalize.

So suggests BMO Nesbit Burns strategist Michael Herring in a recent publication. The banks can borrow the cheap funds and buy higher-yielding Treasury and agency bonds, pocketing the spread in yields to replenish their balance sheets over time.

This “carry trade” is what happened after the savings and loan crisis nearly 20 years ago. “The Federal Reserve held the Fed Funds rate at 3% for almost a year and a half so the banks could borrow cheap and buy U.S. government bonds to rebuild their balance sheets,” writes Herring.