The Fed cut may have been intended more for Europe and global anxiety than for the U.S. economy

Thinking more about the Fed's surprise half-point rate cut yesterday, I now suspect that the intent was that the cut would benefit Europe and the global financial system rather than being specifically intended to benefit the U.S. With plenty of money poised to gush into the U.S. financial system in the coming weeks as the big bank bailout kicks in, the very idea of cutting the rate for banks who are not capitalized to lend right now anyway simply does not make a lot of sense by itself. As a global confidence move the rate cut makes a lot more sense. Europe desperately needed to cut rates dramatically, but the lack of a simultaneous cut by the U.S. would have sent currencies spiralling downwards against the U.S. dollar.

There is only one job that Treasury and the Fed need to focus on right now and that is recapitalization of the banking system. Nothing else is even a close second. This is no longer a liquidity or "trust" issue, but simply a matter of the banks needing to have a significant excess of capital so that they can both lend significant amounts of money and have enough money left to convince people that thery are very safely solvent.

Actually, there is a close second, the need to backstop the commercial paper market which is part of the so-called "shadow banking system" and provides short-term financing to businesses, but with cash from money market funds rather than from banks. The Fed is working on this now.

Another second or third issue is re-booting the variable rate demand note (VRDN) market which is needed to finance state and local government borrowing (e.g., Arnie out in Cali.) Once again, money market funds have been providing the cash, but in this case they also need banks to offer the backstop guarantees that allow the money market funds to sell the debt on short notice. Lehman was a big provider of liquidity for VRDNs, but they are gone now. The Fed probably needs to step in here as well.

In any case a lower interest rate is simply not a "power" tool in the current U.S. financial environment. It is about as powerful as your bank handing out lollipops.

Actually, interest rates do have a role, which is that banks can offer well-above market rates to attract cash for money market accounts and CDs, and that cash is as good as any bailout money from the government. Traditionally banks offerred dramatically lower rates than money market mutual funds, but that has been changing lately. But, this is something that individual banks do and is independent of the Fed and interbank lending rates. Check your local bank for new rates even within the past few days.

-- Jack Krupansky