Reflections on the Federal Reserve's Recent Actions

As follows are some of my personal reflections on The Federal Reserve's actions of 9/18/07.  If you have any questions or comments, I may be reached at
Scott Middleton, CFA, CIMA

1) Did the Fed ‘do the right thing’ for the capital markets?

Yes.  On Tuesday of this week the Fed lowered the Fed Funds rate to 4.75% from 5.25%.  It's interesting to note that the 90-day U.S. Treasury Bill dipped below 4.75% over five weeks ago on August 10.  The fact that Fed Funds was higher than the short-term T-bill for that long of a period was one indication that the markets thought that the Fed was too slow in cutting short-term rates.  In recent weeks the financial markets appeared to become increasing unnerved not only about the spreading credit crunch from the subprime lending crisis but about the Fed appearing to be asleep at the wheel of the economy.  The economic car has hit some rumble strips, and the Fed has apparently woken up before going into a recession ditch.  Time will tell if they acted quickly enough or how much additional action may be needed.

2) Did the Fed ‘do the right thing’ for inflation?

Probably.   Inflation is always enemy number one for the Fed.  The core rate of inflation (assuming that no one eats or drives) has risen at a slower pace in recent months to the high end of the Fed's comfort zone.  So the Fed's action of cutting short-term rates was a clear signal that they are currently more concerned about the economy veering toward the recession ditch than getting overheated.  Ongoing inflationary pressures include the price of crude oil, currently at over $80 per barrel, higher food prices and the weakening U.S. dollar.

3) Does the Fed’s action send a “perverse incentive” to Wall Street that its mistakes will always be bailed out?

I hope not.  The financial markets are manic-depressive by nature, and the Fed's action on Tuesday may provide some temporary relief from depression.  However, I believe that no action of the Fed will bail out the daredevil speculators and those who prey on the economically vulnerable.  Over time, risk and reward go together, though we have seen that most anything can happen over the short-term.

4) Should Alan Greenspan follow up his book by writing a thank-you note to Ben Bernanke?

I doubt that he would see any need to do so. In his interview with Lesley Stahl aired last Sunday on CBS' "60 Minutes," Greenspan appeared to me to be quite sensitive to both praise and criticism.  Alan Greenspan clearly has remarkable intellect, and Ben Bernanke seems to be doing a good job so far.  However, at the end of the day, steering the monetary policy of one of the world's largest economies is an inexact science run by very capable, but fallible, people.

The opinions expressed herein are those of the author and do not necessarily represent the views of Innovest Portfolio Solutions, LLC.  Innovest does not warrant the accuracy or completeness of the information contained herein.  Such information is subject to change and is not intended as specific investment advice.