There is a cost to borrowing stock. And this cost may not be 125 basis points but at some point it could be quite realistic to have DR interest (or some sort of charge) when shorting stock. My understanding is the cost to borrow stock could be as high as 100 basis points. This is the differance between what an IB customer receives on his normal CR int minus CR on shorts stocks. (Normal CR interest is Libor-25 basis points, CR int on short stocks is Libor - 125 basis points). It may sound funny now, but if the FED were to lower rates another 50 b.p's you won't be laughing anymore.
mskl, good and obvious point, i should have thought about that as I deal with it every day (in HK borrow rates out here average from 50 bps to 350 bps depending on availability and other factors. In addition, there is a clearing house charge of about $50 US per transacton). so i stand corrected, the rates can not be capped at zero as the lender charges a fee for the borrows, whether the haircut can be reduced is another story.
The cost to borrow stock should also depend on the cost to borrow in theory (similar to any investment). That being said, you would expect the cost to borrow stocks to decrease with the decrease in interest rates. This may in fact not be the case. Perhaps it is higher?? ie: when rates were 3%, we were getting 1.75% on our shorts or about 58% of the "real rates". Now we are getting only about 10% of the real rates. It would be interesting to know if the cost to borrow stock is the same today as it was when interest rates were 3%.