Yesterday the Federal Reserve Bank dropped the discount rate by a half point. Those whose lives revolve around the daily mood swings of the stock market cheered. The market indexes soared. But those who care about the integrity of our financial system know better, or at least they should. Mr. Bernanke and his colleagues, after months spent assuring us all of their diligence in standing guard against inflation, caved.
A week or so ago, Jim Cramer, host of a CNBC show called Mad Money, screamed – screamed - that the Fed didn’t have a clue about the panic lurking in the wings. If the Fed didn’t slash interest rates immediately, the market would crash, producing an economic catastrophe of unimaginable proportions. What happened to send Cramer ballistic? Countrywide Financial and Bear Stearns and KKR happened. Some investors were shocked to find that money market funds were not instantly convertible into cash after all. The Dow was making 9-G dives every other day. Investors were fleeing the market. If this kept up, they might turn off a stock-market-oriented cable TV channel. We can’t have that, can we? So the anchor of the hour, like the Wizard of Oz, kept urging us to stay focused on the strength of the economy and not to pay any attention to those 200-point drops, which were in any event just creating more buying opportunities.
Then the Dow broke 14,000, and they started singing a new tune: Yes, the economy would be fine - IF the Fed did the right thing and lowered interest rates.
As the Wall Street Journal editorialized today, “The same people who’ve been saying for weeks that all was well are now the loudest in urging the Fed to reflate the bubble.”
It is pathetic to see the Fed buckling under in this way. Yes, there was pain at the lending institutions, and there were scare stories about millions of sub-prime mortgage holders facing eviction. And investors were rattled by big portfolio losses. But when you borrow money, you enter into a contract, and the sanctity of contracts lies at the core of our financial system. When you buy a stock, you can lose money. When you buy a bond, your investment is only as secure as the issuer’s balance sheet. Those are the ground rules we operate by. Bernanke may not admit that he is weakening this foundation, but he is. Once the Fed is regarded as the white knight who will ride in to save you from your bad decisions, watch out.
Some will say that it is, after all, the Fed’s duty to keep its hand on the throttle. But a scheduled meeting of the Open Market Committee was only a few weeks away, and the sudden lurch to ease, following an “emergency meeting,” suggests two possibilities: (1) the Committee did in fact fold under pressure from the Wall Street walking wounded, or (2) the Fed knows something we don’t about the state of the economy.
Neither explanation is very comforting.
