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Thursday, November 1, 2007

The economy? No. Fed action is to benefit the financial sector

If Fed action is supposed to forestall a downturn in the economy, there is a small problem. Interest rate cuts work into economic results only after a lag of about 18 months.

The Fed action is really about bailing out the financial sector. Banks are in big trouble, with their off-balance sheet vehicles threatening to come onto the balance sheet when more CDOs turn bad. The so-called Super Conduit, or whatever its current name is, will only push the problem out six months. When the borrow short, lend long SIVs come back home to live, the sheet will hit the fan.

At least $400 billion is likely tied up in this mess.

And to be fair, the Fed didn't pretend that this was an attempt to improve things on Main Street. Their statement began:
The Federal Open Market Committee decided today to lower its target for the federal funds rate 25 basis points to 4-1/2 percent.

Economic growth was solid in the third quarter, and strains in financial markets have eased somewhat on balance. However, the pace of economic expansion will likely slow in the near term, partly reflecting the intensification of the housing correction. Today’s action, combined with the policy action taken in September, should help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and promote moderate growth over time.
(emphasis added)

There is panic in the big banks.

The problem is too big for the only tool the Fed ever uses, the interest rate, to solve. Rate cuts are no doubt the wish of everybody on the FOMC's cocktail circuit and these banks and bankers will call the tune for the Fed, but this is not a moral hazard we're driving a golf ball into. This moral hazard is a sinkhole swallowing the dollar.

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