Not quite true. The banks which lent directly to hedge funds -- prime brokers -- were not depository institutions and, until last week, they couldn't borrow fr

Not quite true. The banks which lent directly to hedge funds -- prime brokers -- were not depository institutions and, until last week, they couldn't borrow from the Fed. These were institutions like Bear Stearns or Morgan Stanley. Besides, even depository institutions are reluctant to borrow at the Fed's discount window. Pretty much all bank borrowing is either through short term loans at LIBOR or overnight loans via the Fed funds system. (Note that the Fed funds rate is the rate at which banks borrow from each other using the Fed's system, it is NOT the rate at which banks borrow from the Fed. That's the discount rate.) Regardless, it still makes plenty of economic sense for a bank to lend to a hedge fund, whether or not the Fed is involved. This type of lending is typically short term and rolled over as loans expire. If a bank lends to another bank, it only receives LIBOR, but if it lends to a hedge fund, it can charge slightly higher, say LIBOR + 40bps. Given that the bank itself can borrow at LIBOR, this is a decent way to make money. It's really no different than short-term lending to any other kind of corporation. I won't deny that credit has greatly expanded lately. I just don't think the expansion of credit to hedge funds has much to do with the Fed.