Fed Chair James Cramer -- or was that Ben Bernanke? -- announced that the Fed was cutting its discount rate 50 basis points this morning.
If you have not watched James Cramer's tantrum about interest rate cuts, view this clip. I heard about this rate cut as I was driving this morning at 8:30 -- NPR reported the Fed had cut the rate by half a percent to 5.75%. The important thing here is that the Fed cut the Discount Rate -- which is largely symbolic since it is a rate charged only to qualified banks -- not the one that Cramer was ranting about. That rate, the Fed Funds rate -- which affects rates that consumers pay on various types of loans -- remains at 5.25%.
Cramer sounded ecstatic on CNBC this morning. He predicted that today would be the biggest point move in history. Now, he said he "loves" Bernanke. Yesterday's goat is today's hero.
Markets have responded with jubilation this morning. But it remains to be seen how much of that jubilation is traders covering the short positions they put on after watching Asian markets tumble. The bigger issue is that the Fed obviously is scared of something big that we don't know about. It decided that the negatives of the rate cut -- bailing out Wall Street for its risky bets and taking the pressure off persistent inflation -- are dwarfed by something much worse.
I recall the last time the Fed announced such a big rate cut in the face of tumbling markets was back on January 3, 2001. Then, the NASDAQ had slid 51% from 5,068 to 2,471 between March 2000 and December 2001. Greenspan cut the Fed Funds rate from 6.5% to 6.0% and the NASDAQ rallied 197 points that day. It then proceeded to fall another 53% -- bottoming out at 1,172 in September 2002.
The Fed still has the possibility of cutting the Fed Funds rate. Since it's been buying back mortgage backed securities (MBSs) as collateral for loans to banks, today's announcement might simply be ratifying the additional money supply the Fed has been adding for big banks.
It also remains to be seen whether the Fed even has the tools at its disposal to cure the fundamental problem. What is that? To start with, institutional investors have borrowed an unknown amount of money from banks. The banks see some of the collateral -- such as MBSs -- as worth less than they previously thought. So the banks are demanding that the institutional investors pay back the loans. And the investors lack the cash to do so.
Will a cut in the discount rate help this problem? I don't know, but I am wondering what Bernanke saw that made him cave in to Cramer's tantrum.
Peter Cohan is President of Peter S. Cohan & Associates, a management consulting and venture capital firm. He also teaches management at Babson College and edits The Cohan Letter.
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Reader Comments (Page 1 of 1)
8-17-2007 @ 11:08AM
sarai said...
what a bunch of #%#%#%#%#%#%#%#%#%.
8-17-2007 @ 12:15PM
Ned Didry said...
Oh, well, then they’ve confirmed that this is, indeed, “calamity”:
“Poole Says Only `Calamity’ Would Justify Rate Cut Now…”
That’s from only a little over 24 hours earlier on Bloomberg and the story is still sitting on their site.
The economy is controlled by mouth-foaming mad dogs. Go buy some stocks.
8-17-2007 @ 12:41PM
mgrund said...
Do not underestimate the impact of the discount rate.
If AAA paper is not moving,and is being discointed as collateral then banks can not function
With the flight to quaility forcing yeild down on T-bill, and the Discount rate at 6.25 ( with t-bills at < 4) banks are very reluatant to use the discount rate due to the permium charged. As Kudlow has noted the fed rate was below target which means that the fight to quality is freezing out everyone else.
They are allso taking AAA paper as collateral This is critical as it tells the world that AAA still means something.
It is more than symblolic. It is less than a full rate cut. It may pervent goos firms from going down with the bad. The market paniced.The Fed is not.
BTW Cramer is right about the impact on the economy. The Fed is allways a half step behind the markets in this respect, but that is ok, they shuld move slowly and deliberatly, however if they get a Full step behind,we are toast.
I prefer not to be toast thank you. BTW I have a fixed at 4.25. I have no other debt.
Jumbo morages are a read hearing as well. The limit has not kept pace with nominal inflataion much less the housing inflation. The costs NY and CA are of course subject to much higher prices,so the existing limits are usless in these areas. The caps must be indexed,and they must be adjusted for local conditions otherwise Freddy and Fanny are joke.
I also not that the FDIC limt on insurance has not been indexed either and the limit has not been lifited since the 1930's. I mention this becuse some comentators, who are no doubt short, have suggested a banking failure. If this happens we are way under insured . Thank you Washington.
8-17-2007 @ 1:42PM
Richard said...
Mr Cramer seems to be slow in doing his homework on the economy and his job responsibility. His reluctance in cutting the Federal Funds Rate has only
magnified the subprime mortgage problem, which should have been addressed months ago. These people are low income and are drowning in debt from
VAR's going too high. The Fed Chairman favors the
Banks too much and worries about inflation too much.
Supply and demand takes care of inflation primarily on
its own. Banks are too greedy and Cramer certainly
adds to their favor. When is the Fed Chairman going
to help the working class people instead of insuring
the continued growth of the wealthy over the poor?
8-17-2007 @ 5:36PM
mgrund said...
Mr Crammer was the first to make the call weeks ago.
I assume you mean the Fed is slow. ALso Mr crammer was very early in claiming that the fed should have keept rates low, that was months ago.
No, I think in this case he may have been to early, but he was not wrong. Will inflation be an issue? maybe. Is a recesion worse, with deflation to boot? I think so, and I think the Fed now agrees.
8-17-2007 @ 7:26PM
mgrund said...
I need to corect the record as my comment above are based on out of date information The FDIC limits are now allowed to be indexed starting in 2010.
http://www.fdic.gov/regulations/laws/federal/2006/06final912.pdf
So they are just late. As usually. I appologise if I mislead anyone. My post was in good faith and so I am correcting in the same spirt.
Sorry for the error.