The Fed: Doin’ What It Can? (September 24, 2007)

Reducing the FFR by .50 and the discount rate by .50 may work.  May not.  The Fed is mainlining more junk to the junkies who marketed and continue to market junk.  “Easy” credit in recent years produced “hard” credit this year.  Providing more “easy” credit may soften the current credit crisis for a few weeks or even months.  The availability of ARMs (adjustable rate mortgages) in recent years and other dubious instruments allowed individuals to acquire and occupy a house and use it as an ATM (automatic teller machine).  With a short term decline in interest rates, a few ARMs may not reset upwards as quickly.  The fix is only effective in the short term.  The underlying problems are unchanged.

In a rising real estate market, prices often accelerate quickly because buyers try to outbid each other.  In a declining market, prices do not fall quite as quickly because many sellers refuse to outbid each.  Some homeoccupiers will not lower a sales price lower than 1) the price they paid for the structure, and/or 2) the amount due on the loan.  Some borrowers fear paying all of the deficiency that would become due immediately if they sold for less than the remaining obligation, so they hold on for a few more months.  This “stubborn irrationality” offends economists, but they live with it.  This propensity to repudiate the market in the short term is ineffective in the intermediate run, although it slows what otherwise could be a spiraling decline in prices.

The financial markets, however, could enter a declining spiral with little notice.  The financial markets are benefiting from the recent flood of money.  However, even those who want to appear to believe in the Economy so that others stay in the game and hold up the market will get spooked.  Those who invest other people’s money (OPM) are not particularly concerned because they benefit as prices gyrate; those who are investing their own money do not want to be the last one to sell and end up the last chump standing.  The Economy is best served by a soft decline rather than one that accelerates downward uncontrollably.  In light of the fundamentals (realistic profit predictions; realistic price/earnings ratios for the respective industries), a Dow (Murdoch ?) of 12,000 is more realistic.  However, the “exuberant irrationality” that underpins the financial markets could drive the Dow (Murdoch ?) down even lower in a panic.

Bumper sticker of the week:

Do Anything.  Something.

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