Should Fed Step In To Save Credit Markets?

A: There is talk on the street about whether or not Bernanke & Company at the fed should jump in and become the savior, or ‘lender of last resort’ to help the credit markets in their time of turmoil. Barry Ritholtz recently criticized Jim Cramer on his blog, The Big Picture, for practically begging the fed to step up and cut the fed funds rate! In my opinion, this would be a drastic mistake and I am not betting on any rate cut by our fed at this time; agreeing with Barry's ultimate conclusion that its not the fed's job to bail out speculators and 'guarantee a one way market', as he says. The fed meets on Tuesday and I'm betting on no change, with hopefully an adjustment in the issued statement removing the 'tightening bias' phrase so that a neutral bias is put in place for future meetings/actions; slow and steady.

First Off - Check out the Jim Cramer Madness on CNBC late last week. The blowup happens halfway through the video:



The fed’s job is not to bail out bad bets. It is the markets job to correct itself and the environment we are in right now, the re-pricing of risk is the markets way of fixing the current credit mess. These funds that are in trouble made tons of loot during the past years with their high risk high reward bets. Sometimes it doesn't work out. You can't just expect the fed to come to the rescue every time this happens. One could easily argue that one of the reasons we are in this mess in the first place is because Alan Greenspan cut rates so drastically from June 2000 to October 2002 (from 6.5% all the way to 1%), pumping the system with liquidity to stimulate the economy after the dot com bust and 9/11. The result was excess liquidity which led to a housing boom, that of course was unsustainable. This time around, let the markets adjust and hopefully get help from our corporate leaders! A 5.25% fed funds rate is not restrictive given the global boom and worldwide inflation concerns that are still in place.



During Friday’s 2PM Bear Stearn’s conference call to investors, the CFO of the company described the current credit environment as the “…worst in 22 years”! While this may be true, the problems are not big enough to warrant any fed action in monetary policy at this time!

Let the markets re-price risk on their own and let the companies who made bad bets take their losses and write-offs! This is extremely important if we are to get though this mysterious crisis! I’ll repeat:

LET THE COMPANIES WHO MADE BAD BETS STEP UP TO THE PLATE, PUBLICIZE THEIR LOSSES, TAKE BOOK VALUE & LIQUIDATE BAD HOLDINGS IN ORDER TO WRITE OFF THE LOSSES! ANNOUNCE A RE-STRUCTURING EFFORT AND PUBLICIZE EXACTLY WHAT IS BEING DONE TO FIX THE PROBLEM & BRIEF INVESTORS ON THE FUTURE DIRECTION OF THE COMPANY

Transparency in the corporate world is crucial to the timely recovery of the current credit crisis! Bear Stearns seems to be on this path with publicly acknowledging 3 funds failures, declaring bankruptcy protection for these funds, and announcing executive changes as I posted yesterday when the Co-President resigned.

By coming out in this manner and letting the current value of their holdings to actually trade and liquidate would allow the financial markets to weed out the bad bets made and the losses to be written off. While it will be painful for the companies and their investors to do this, it will be better for the overall credit mess and it will allow the markets to function more effectively in re-pricing the risk so that we can move past the mysterious problems that we now face. It’s the uncertainty right now that is killing equities.

If the fed comes out and cuts interest rates to help the current credit problems, it will come off the wrong way and will be interpreted as an acknowledgment by our monetary policy makers that there are major issues that are seriously bothering them right now. While stocks will likely rally due to the surprise of action, in the longer term it will spook investors and not have the desired liquidity effect of the fed coming to the rescue. Lets not forget, a rate cut now is only good for psychological reasons and will not 'kick-in' until 8-12 months down the road. Lets see things get way worse before any fed action is put into place so that a more planned and systematic course of action could be put into effect.

Instead of cutting rates at Tuesday's meeting, in my opinion the fed should:

1. Remove the tightening bias in the statement. Excessive growth should no longer be a concern and inflation, while still a global threat, seems to be moderating here in the US.

2. Take a balanced stance between growth & inflation. Perhaps mention that credit concerns are being monitored.

The fed meets Tuesday and I’m betting on NO CHANGE in rates with hopefully an updated statement as I noted right above.