The Fed’s Role In Maintaining Wall Street Stability

CNBC’s Mad Money host Jim Cramer went off on the Fed a few weeks ago over its actions in response to the market uncertainty and spike in interest rates coming off the bust of the sub-prime loan market (loans to customers with bad credit ratings.). The clip is very entertaining. Cramer’s solution is cut the discount rate/open the discount window (from what I gather, and I could be wrong, the feds offer short-term loans to banks trying to cover gaps in their money supply and Cramer is saying the interest rates on these loans should be cut to make it easier on these banks.).I believe a number of problems exist with this proposed solution, though. First, banks and investors assumed the risks by extending loans to these people with bad credit. Therefore, the Fed has not responsibility to bail them out.

Further, the Fed’s job is to maintain the long-term stability of the market by managing inflation. When they make decisions today, they are not trying to affect today’s market. Rather, they primarily try to affect the market two to three years from now. Therefore, for the Fed to take action today to affect today’s market is to sell out the long-term stability of the market.

Most moves to solve the problems, including some already taken, will include an influx of cash into the market. This influx, while maybe allaying some fears and propping up the market today, will increase inflation over the next year or more.

Further, investors have a short-term memory. A Fed bailout will alleve many risk-takers of having to bear the consequences of their lending habits. With Wall Street’s already short memory, lenders will soon be out assuming more high-risk loans.

The resilience of the stock market is, in large part, a result of the risk takers of society being free to work their magic. Soon, many who hit the bottom in the past month will be back on the street again. This is, in part, the beauty of a free market. It is also the bane.

It is not the Fed’s job to take the fall for Wall Street as lenders jump onto another passing train. The Fed should not intervene.

See “The Fed’s Alibi” for more commentary on the subject.

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