Wednesday, October 8, 2008

Rate cut not a great cut

Surprise!! Rate cut jumps out of cake...
In a surprise move the Fed, the BOE, the ECB, the central banks of Canada, Sweden and Switzerland took their lead from the Reserve Bank of Australia that had cut rates just a day before. The Reserve Bank cut rates by a percentage point while the coordinated move on Wednesday morning embraced a cut of 50bp. Its a step in the right direction, but only a modest one. It was a relatively larger step for the ECB, however, that joined a global effort despite domestic inflation being so far over its ceiling.

Hunt to avert a Red October
Markets rallied sharply in reaction to the rate cut. Then during the session stocks gave up ground. Prices become volatile they regained ground in the afternoon before the Dow closed lower by nearly 200 points. So while the reaction has been largely positive markets had the good sense to conclude that a 50bp reduction in rates does not solve the problem. This is the central banks getting in the hunt, not the end of the chase.

I have no problem with the Taff, nor the Tarp. The $700 bln asset buy-back is just great. Having the Fed as the lender of last resort for the short term market of first resort (CP) is terrific. Rate cuts tell us central banks are with the program. Rate cuts from around the world tell us all the central banks see it. BUT... In his own testimony Henry Paulson had said that housing was at the bottom of the problem. If housing weakness continues to deepen the securities linked to housing will weaken further as well. AND that has been where the problem is. So until we do something for housing the basis for the financial crisis continues to get worse - not better despite all the moves we have made above.
We all know the story of the little Dutch boy who stuck his finger in the dam. Suppose he had a bucket and simply let it fill and threw the water back over the top of the dam? In time the leak would have gotten bigger. He would have had to have bailed faster and faster but as he did the hole would get bigger and the flow would increase. Of course unless help came very soon the Dutch boy himself would be washed away.

So we too need to FIX THE FOUNDATION rather than just bailing out firms around the perimeter. Direct assistance for housing is needed.

The G-7 is meeting this weekend. So what will it do? We have the answer. Bold moves made like this coordinated rate cut right ahead of a major collaborative meeting tell you that each country has decided to do what could ahead of the meeting. There will be no new initiatives from the G-7. Don't get your hopes up.

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