Bernanke Wisely Holds The Line

BloggingStocks congratulates Ben Bernanke for not lowering the Fed prime rate today. He deserves it. It would have been easy to cut rates and hope that a shot of liquidity would help the markets.

It wouldn’t. Instead, it would have created an even bigger inflationary threat than we have now. Cutting the interest rate would further threaten the weakened dollar, making things even worse for the economy. Our current problem stems from too much money being unwisely given out. Making it easier to hand out more loans is like giving an alcoholic a little hair of the dog to cure a hangover.

Like any good hangover, the only real cure is time, and the markets are going to be reeling for a while now. Then again, one of the purposes of a hangover is to remind us not to drink too much—and the markets need to learn that lesson if we’re to move forward and get our financial house in order. More bailouts, like a Fed bailout of AIG or New York’s idea of letting AIG borrow against its own subsidiaries will only exacerbate the situation. The Fed could ruin that recovery by subsidizing risky behavior—and thankfully the Fed doesn’t seem inclined to do so.


Oh, You Have GOT To Be Kidding…

The Fed is going to bail out AIG.

Scratch pretty much everything I’ve written—apparently the price of failure is now a nice government bailout. This is a phenomenally bad precedent, even if it saves the markets some short-term pain.

UPDATE: Jim Cramer was pushing for an AIG bailout tonight. If AIG had gone down, would the financial markets have gone down with it? Would the Dow have dropped another 1,000 points? Perhaps.

The problem is that by buying AIG, the damage is still going to be done, it’s just the taxpayers and AIG shareholders who end up holding the bag. Perhaps that’s the best that can happen here, but that doesn’t mean that anyone should like it. The U.S. government should not be in the business of bailing out insolvent corporations. That creates a major problem with moral hazard that can’t be ignored.

What we’ll get out of this (regardless of who wins in November) is more regulation—and not necessarily better regulations. We’re still capitalizing profits and socializing risks, and that’s exactly what got us into this mess.

Saving AIG might have saved the Dow from crashing below 10,000—or it might have set the stage for more problems in the future. Sometimes avoiding short-term pain produces long-term sickness.


Feeding The Panic

Larry Kudlow has effusive praise for the Fed’s massive rate cut which slashed interest rates this morning.

I’m not so sure. Right now the markets are panicking, and such a massive rate cut reinforces the idea that there’s some major short-term problem on the horizon. We got into this mess because of over-lending, and it’s hard to imagine how over-lending will get us out of it. The markets are correcting, which is what a market should do in this situation. What I’m concerned about is that the Fed has bought into the panic psychology and is trying to get a quick fix in that will make things worse rather than letting the storm pass.

A rate cut and an economic stimulus package are both short-term solutions that will only blunt the effects of an economic downturn. We have a set of policies that are based on trying to calm fears in an election year rather than making the set of structural reforms that would actually solve the underlying problems in the US economy.

There are things that can be done—such as reducing taxes on business assets, fixing depreciation tables and reducing unnecessary regulation. Instead, we’ll get a “stimulus” in the form of a couple hundred dollars in tax rebates that will end up being used to pay down credit cards and the like. Depreciation tables don’t make for good campaign ads, but tax rebates do, even though tax rebates don’t do anything to fix recessions.

The fundamentals of the US economy remain strong, but the Fed keeps sending the wrong signal and is feeding the global panic. Even if an additional shot of liquidity is the right prescription, the Fed’s dramatic rate cut may only make nervous investors even more skittish rather than reassuring them into stopping the fall of global markets.