Wednesday, January 23, 2008

The Fed did panic

The FED did not panic writes one business blog:
Let us scotch one foolish and dangerous notion already gaining
acceptance. Those who accuse the Fed of acting out of panic in slashing rates 75 basis points on Wednesday do not grasp the seriousness of the situation.
The move was imperative to prevent a grave financial crisis spiraling into disaster. The threat of a melt-down in the $2.4 trillion market for US municipal bonds had suddenly moved from possible to imminent. No monetary authority could ignore such risks.

I have two questions for this kind of reasoning. First, how can a rate cut prevent an imminent crises in monline insurers? Making the cost of money cheaper does by no means implicate it gets where it is most needed. To the contrary if history has told us one thing it is that cheap money leads to accesses that eventually have to be deflated again. Second, why then slash rates? The answer is very simple: panic and overreaction. The Federal Reserve panicked in an attempt to halt a plunge in the stock market. While they were partially successful they could not prevent a further decline in the markets. According to billionaire investor George Soros "Central banks have lost control". Only today after the government announced a plan to inject liquidity into monoline insurers did the markets rebound.

No comments: