FED UP. Federal Reserve Chairman Ben Bernanke is the man of the hour. The stock market has rebounded in recent days because everyone now expects that the Federal Reserve, at the regularly scheduled meeting of its policy-setting open market committee Tuesday, will cut interest rates by a quarter-point or even a half-point. Some financial insiders even think Bernanke will cut more than that, in order to signal markets that he will do whatever it takes to contain the current credit meltdown. The Fed Chairman, facing his first serious financial crisis since taking office last year, was behind the curve in its first weeks, and is determined not to repeat that mistake.
However, even if the Fed delivers a big rate cut and the markets respond with a big rally, there is so much rot in the financial system that we are not out of the woods. The entire system of banks lending short term money to hedge funds, mortgage companies, and private equity firms was based on the premise that prices of assets would keep rising, and that some patsy could be found to buy the paper. Even with lower rates, that wild ride is over for now. Even cheaper money can't pump that bubble back up. The only question is how far is down.
The Fed itself is highly culpable in this crisis -- not for failing to give us low enough interest rates, but to failing to use its available powers to regulate the permissible temptations of cheap money. Every link in the daisy chain that brought us this crisis is essentially non-regulated. The mortgage companies, the hedge funds, and the process of private bond rating agencies certifying the soundness of the exotic investment instruments that banks created. Yet that banks that create, buy, and sell this stuff are in fact regulated and when they get into trouble the whole financial system is in trouble.
The Fed was given the mandate by Congress in 1994 to set lending standards for otherwise unregulated mortgage companies. Despite periodic prodding by Congress, the Fed failed to issue regulations. Only several months in to the sub-prime meltdown did the Fed finally, belatedly, reluctantly, promise to put out regulations by the end of 2007, long after the damage has been done.
I've got more on the Fed today over at the main site. Check it out here. --Robert Kuttner
