Why The Fed Won’t Cut Rates

The two major reasons given in the media for the Fed to cut rates tomorrow are that fact that the stock market wants them to and that it might help the housing market.

At some point a pact may have been made between investors and the Fed, but the part about keeping the stock market high must not have made it to public attention yet. As far as anyone knows, the Fed does not owe the stock market a thing.

On the housing side of the ball, there is no strong evidence that a quarter point cut in interest rates is going to help people who have watched their home values drop 10% or seen their adjustable mortgages reset at much higher rates.

The Fed claims that it is concerned about inflation. And it should be. Gas prices are likely to rise. Employment levels are good and so is wage growth. Most Q3 earnings were OK, so corporate profits are not taking a beating outside the banking sector. The stock markets are at or near multi-year highs. In other words, the classic warning signs of the economy grinding to a halt are not there. Not now. If they start to come into view, the Fed can always move in December.

The other "hidden" reason that the Fed might want to cut rates is to help shore up pools of mortgage-backed securities. Whether this will work is impossible to say. The financial instruments built around them are too complex. The banks are already creating a "super-fund" to help their own cause.

Even if banks have to go through another round of very painful write-downs on mortgage-related securities and LBO debt, it is not the Fed’s role to put an artificial net under the country’s largest financial institutions. Both Buffett and Greenspan have said that there is no way for the market to know what kind of mess it is in until investors get to see the evidence. Short term loans to keep weak pools of money from being marketed to market is the antithesis of that philosophy.

The Fed does not need to cut rates. The economy and markets are too good. And, if holding rates flushes out the largest problems in the financial markets, let it be so. It is a boil and needs to be lanced.

The Fed should let the cards fall where they may.

Douglas A. McIntyre