Dollars and Jens
Friday, August 17, 2007
The Fed Reacts
I'm more interested in my brother's take than in my own, but I'm here and he isn't.

When I got online this morning and saw the news, I thought it was the federal funds target that they had cut. Even though there had been talk of cutting the discount rate while leaving the federal funds rate alone, I still saw "FOMC cuts rate" and thought it was the federal funds rate. And a 50 bp cut in the federal funds rate struck me as excessive, but when I realized it was a 50 basis point cut in the discount rate, I was pleased. Especially since they also, according to CNBC, told banks that use of the discount window was encouraged. An immediate, steep cut in the federal funds target would have struck me as bailing out the financial markets, but they seem to be simply stepping up and emphasizing that there is a lender of last resort, and doing it in a more forceful way than they did last week. Financial institutions that take bad risks should be left hanging, to the extent that this can be done without greatly imperiling others. But financial institutions that can't borrow money just because everyone is panicking should be backed up.

The open market committee also released a statement indicating more bearishness than they previously had. Apparently, people are expecting roughly a 40 basis-point cut in the federal funds rate at the September meeting. I have no argument with that, but I hope they haven't committed themselves to anything before they see what results from today's action.

My fear for the economy in the next year is less of financial institutions going down than it is the subprime borrowers. While loan defaults aren't good for the people who own the loans, they don't indicate good times for the people paying them, either. And I think the blunt instruments available to the Federal Reserve will be less useful for dealing with that side of the mess (though I suppose a rate cut would help). OFHEO might have a role to play, though I haven't thought this all through.

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