More Exuberant Irrationality (August 20, 2007)

Last Friday, the Federal Reserve lowered the “Discount Rate” it charges commercial banks for the money it loans directly to them by a substantial half a percentage point.  The Fed also suggested that it might take more action to cushion the economy from tightening credit.  The “Discount Rate” is not the same as the Federal Funds Rate (FFR) which is the interest rate at which depository institutions lend balances at the Federal Reserve to other depository institutions overnight.  The Discount Rate is the rate charged by the Fed to a bank; the FFR is the rate charged by one bank to another.  Banks typically do not borrow from the Fed, so the Discount Rate does not usually impact the economy as substantially as the FFR.

As a professor, the Chairman of the Fed, Ben Bernanke, studied the impact of illiquidity on the Great Depression.  He also has stated that the Fed should be concerned primarily about “price stability” or in popular parlance should set rates to avoid inflation.

Junkies crave junk.  The purveyors of junk bonds/stocks (collateralized mortgage loan obligations and the like) are seeking a bail out from the Fed.  Bernanke’s concern should be the impact on the economy not on those who were and are part of the problem.  The concern should be with Main Street not Wall Street.

The meeting of the Federal Reserve Open Market Committee (FOMC) on September 18 may be the most important gathering since Bernanke began his term.  The underlying economy is unsound.  [See the e-ssay dated January 30, 2006 entitled “Greenspan’s Legacy – Apres moi, Le Meltdown”].  The dilemma is that there is both stagnation [see the e-ssay dated August 7, 2006 entitled “The Fed: Deal With ‘Stag’; Deal with ‘flation’?”] and inflation [see the e-ssay dated July 16 entitled “Back Door Inflation”].  Reducing interest rates will encourage inflation and promote more debt.  Raising interest rates will both contain inflation and attract private funds.  Tough call.

Bumper sticker of the week:

I want to be irrationally exuberant again

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