Monday, August 20, 2007

Cramer, Bernanke, and rate cuts

I just viewed this clip on YouTube. If I read the information correctly, this was a piece from August 3rd on the "Stop Trading" segment with Jim Cramer.

People have, since, criticized Mr. Cramer for his emotional plea for a Discount Rate cut. Some commented that he was trying to have the Fed bail out his Wall Street friends; a move that would create a moral hazard by not penalizing those who took excessive risk in hopes of huge profit.

It's easy to see how Mr. Cramer's comments could be interpreted in that fashion, and perhaps that's what he meant. It is not, however, what he said.

Mr. Cramer is a graduate of Harvard Law, so I expect that he selects his words very carefully. If that is true, then Chairman Bernanke (and the rest of the Financial Reserve Board) took two weeks to do exactly what Mr. Cramer wanted.

In my opinion, at least, pricing the Discount Rate closer to (but still above) the Federal Open Market Committee's target rate for Fed Funds did not create a moral hazard; rather it prevented a run on banks. To the best of my knowledge, no adjustable rate mortgage is tied to the Discount Rate.

The only parties that benefit from having the Discount Window available on cheaper, and easier, terms, are the financial institutions (banks, savings and loans, etc.) that can borrow from the Fed. Participants in the Fed Funds market were making it very difficult for some institutions to meet their reserve requirements, because of default fears. This created a liquidity problem in the banking system.

Now, institutions needing capital can more easily borrow at the Discount Window of their regional Fed branch, avoiding potential bank failures (at least any necessary institutional reorganizations/liquidations can be done in a controlled fashion.

This is why, in my earlier post, I called the Fed Move a master stroke. It dealt with a problem in the banking system, it didn't bail out investors who took a risk.

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