Yielding Wealth | Personal Finance

Yesterday’s Fed Rate Cut…And Today’s Liquidity Plan

by miranda on December 12th, 2007

The Fed is scrambling to figure out what to do in order to slow (maybe try to prevent) the coming recession. Some would argue that, really, it’s already here. At any rate, the Fed cut a key interest rate yesterday. Because Wall Street was really hoping for a bigger bailout (25 basis points just wasn’t enough), stocks had issues.

And, in an effort to ward off criticism that the Fed is more concerned with inflation than it is with the credit crisis, the Fed unveiled a plan this morning to inject cash liquidity into the financial markets.

But the bottom line is this: All of it is an effort to kowtow a bit to Wall Street. It’s not really about the “regular folks.” In USA Daily, Presidential candidate Ron Paul points out that, despite the perceived-conservativeness of the rate cut, inflation will still rear its ugly head:

“Inflationary monetary policies created the problems in the economy we are seeing, and these problems will be made worse, not better, by more inflation. And today’s action by the Fed is very bad news for American workers and retirees who are about to get hit with yet another jump in prices.”

And, of course, more liquidity didn’t solve problems back in the summer when the Fed tried a cash infusion. Will it work now, in the form of reserve auctions? Who knows…

Unfortunately, Fed rate cuts and cash infusions don’t solve the underlying problems of the mortgage market and the economy of easy money any more than the five year mortgage rate freeze will. The Wall Street Journal says it very well:

In any case, it isn’t at all clear that more liquidity is the solution to what is fundamentally a solvency problem. The world isn’t suffering from a dearth of dollars, but rather from the fact that mortgage and real-estate assets are worth much less than banks and homeowners once thought.

And don’t forget that part of this problem is caused by poor financial decision-making: lenders who lent to people that maybe shouldn’t have bought a home, investors who invested in the bad debt and homeowners who bought more house than they could afford. In order for true change to take place, and true economic recovery to manifest, a fundamental change in the way our society views and deals with debt must be made.

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