Sunday, December 09, 2007

Fed likely to cut again as post-crisis transition period continues

Although the real economy is actually doing reasonably well despite the so-called subprime mortgage crisis, the Federal Reserve FOMC will likely cut the fed funds target rate by another quarter point on Tuesday. The real economy does not need lower interest rates, but Wall Street and other parts of the financial system need another dose of financial morphine to continue the cleanup of the financial mess created by the liquidity credit crunch mini-crisis that occurred in mid-August.

The latest monthly employment report was neither strong nor weak, which allows the Fed a free pass to give Wall Street more financial morphine to tide it over until enough writedowns of mortgage-related securities can be completed. The real economy doesn't need it (as evidenced by the relative strength of the stock market), but Wall Street banks do, or at least appear to need it or at least claim to need it.

To be clear, the actual credit crisis really is over, but there is still a lot of mopping up to do.

The big mortgage bailout being orchestrated by the U.S. Treasury is really simply a palliative to shore up confidence, but really is not necessary. Sure, there will be plenty of mortgage interest rate resets and foreclosures in the coming months, but the individual mortgage firms will more than likely fix up the mortgages that can and need to be fixed up and let the unfixable mortgages (fraud, speculators, income problems, falling home prices and equity, etc.) proceed with foreclosure as they ultimately will even with a so-called "bailout." Sure, this is a big problem, but it is not a true crisis and not is not anywhere near as big a problem as the worst-case analysis and pundits suggest.

Although there is a plausible chance that the Fed will make another rate cut at the end of January, I strongly suspect that the economic data and incremental improvement of balance sheets on Wall Street by then will actually have the Fed more worried about how quickly they can start raising rates again.

-- Jack Krupansky

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