Commentary

The Fed to the Rescue!

Captain Ben, our rather green Federal Reserve Chairman, rode on his magnificent white pony named “Liquidity’ to rescue the panicking financiers on Wall Street, and, to be more accurate, the gambling dens, pits and crevices the world over. He valiantly slashed the discount rate – the rate charged by the Fed  to member banks for short term loans – to try and calm troubled financial waters.

It seems that a rather large number of banks and assorted investment houses are the owners of an alarmingly large amount of worthless subprime mortgage paper. Actually, these sordid creations are popping up all over the globe, from highly leveraged hedge fund portfolios to relatively staid pension fund ledgers.

This has caused bankers to cast a suspicious eye toward their fellow lenders, and has driven up the cost of overnight credit- the lifeblood of the financial markets- to unacceptable heights. It seems that the massive tide of liquidity is exiting the financial market’s shores, taking with it sky-high equity, speculative grade bond, and real estate prices.

Over the past two weeks, central bankers the world over have been injecting copious quantities of funds into the global banking system in order to keep the credit markets functioning.

And today, we witnessed empathetic Fed chairman Bernanke cutting the discount rate and offering to be the lender of last resort to an extremely nervous financial system, making this his boldest move yet in this sad, but predictable drama. Many financial pundits seem to feel that this is just a quarter-step meant to avert an immediate meltdown. It seemed to work immediately, all of the major indexes jumped today as a result of the Fed’s emergency move.

But, this action will only whet the appetites of the leverage-addicted plutocrats who are getting battered around by their reckless investment strategies. They are screaming for a cut in the Federal Funds rate, which is much more influential in setting market interest rates. This, the desperate, yet obscenely wealthy hedge fund managers and investment bankers believe, will stabilize the sinking housing market, and stop the hemorrhaging in the subprime mortgage securities arena.

I believe that if such an action is taken, it will merely rescue investments that should be allowed to fail. That is what markets are supposed to do. If rates are lowered to heal the wounds of wealthy fools, then a new round of speculation will ensue. The Fed will be seen as coming to the rescue, thus erasing the risk associated with investing – which is the root cause of speculative manias. It would be much better to allow certain investments to fail, and distressed assets to be sold off to willing buyers than risk a reintroduction of what started the trouble in the first place.

© 2007 Splendid Marbles.