Flying Pink Unicorns

The Federal Reserve Open Market Committee, which sets the key short term interest rate, is meeting this week, with the meeting concluding early Wednesday afternoon. The Fed will, as markets expect, cut short term rates a further 50 basis points (1/2 a percent) to 3%. This will be the lowest rate since May of 2005, and will cap a remarkable cut of 1.25 % in just 9 days, a truly breathtaking move.

Despite all of the pronouncements to the contrary by Bernanke and Treasury Secretary Paulson (who, unusually for a Bushie, has credibility with the wider world), the powers that be are in a state that can be fairly stated as just BARELY short of full scale panic over the impact of the subprime mortgage fiasco and the impacts of the credit crunch on the overall economy. From a policymaker's point of view nothing is worse than a financial institution led recession because it so hard to fix. If banks and other lenders can't or won't lend money, our economy simply doesn't function. We Americans are just addicted to easy credit. The fed well understands all of this, and is well aware of the lessons of Japan in the early 1990s--where a MASSIVE bubble in commercial real estate burst, banks' balance sheets went in the toilet, but the banks and the government took many many years to face up to it all. The result was essentially a 10-year long economic slowdown. Remember all of the news articles about the Japanese economic system being the best and taking over the world? Read any lately? Not so much.

It is my view that the fed is just short of terrified that major financial institutions such as Citigroup and Merrill Lynch could suffer enough losses to really impair their role as lenders or financiers of lenders, and that could have huge knock-on effects. I also think that the fed was concerned last week about a market crash, literally. That fear has likely not left either, which is why I'm very confident that the fed won't shock and disappoint markets this week by keeing rates the same. There is some change they signal caution by only cutting by 1/4 of a point, and a smaller chance they push the panic button in the open and cut another 3/4ths. But 1/2 a point is much the most likely, and coupled with cash infusions for the financial institutions, the bleeding may well be slowing down.

Watch my blog for a post about the idiocy of the agreed stimulus package.