Thursday, January 31, 2008

Fed – Finally Some Action

With two back to back deep interest rate cuts, Fed has reduced the cost of borrowing for all Americans. Regardless of what many say, in short term this is the right and good thing for both the overall economy and to the average consumer.

It may be the case that in itself it may not avoid the recession, but it will at least help to reduce the impact. Fed correctly diagnosed that the benefits of lower interest rates are (fundamentally attacking the market credit crisis, subprime crisis, higher exports and lower imports) larger than the cost of inevitably increased inflation at some point in future. The time passed will help to ‘heal’ the financial challenges and will give room for Fed to fight the inflation battle tomorrow.

The real test for Fed is how does it administratively control the ‘credit bubble’ which gets fueled by these lower interest rates. Greenspan refused for any such meaningful and possible controls. Will Ben Bernanke be wiser than that? It is okay for Ben Bernanke to miss some ‘time windows’ to cut the interest rates, but it will not be okay for Ben Bernanke and Fed to be lenient in various credit controlling and supervising mechanisms. After all banking and credit regulation is the key administrative mandate for the Fed. If Fed thinks that recent credit bubbles were caused by new types financial units beyond banks (hedge funds, private capital pools, Countrywide Financial type financial companies and mortgage brokers cum mortgage sourcing organizations) where it does not have authority; then it needs to implore Congress to initiate actions in that regard. Fed, SEC or any other new organization as needed; are the entities which will need teeth to manage today’s ballooned global economy which impacts financial well being of every country.

Meanwhile, lawmakers will continue their game of ‘stimuli. It is more of a political stunt than of any real use. Of course, all those eligible will love the proposed rebates. Now that politicians have dangled the carrot, it will be impossible for lawmakers to stop this largesse. For those who over qualify for the rebates, the other provision of increasing ‘conforming loan limit’ will be the windfall. There is something for everyone in the stimulus package. The only question is how much useful and effective it will be.

But when would lawmakers start addressing the long term economic challenges - tax reforms, reforms to regulate new financial entities, controlling budgetary expenses, reducing war expenses, reducing federal debt and policies with incentives towards ‘saving’ rather than credit funded consumption? Looks like it will be only after the Presidential election. Too bad, until then it takes more than $150 Billion to sustain the sense of ‘relevance’ for these lawmakers.

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