Managing panic or creating liquidity

Wall Street Journal Editorial:

Yesterday's emergency rate cut by the Federal Reserve seems to have stalled a global selloff in equity markets, and for that we can be grateful. We'd have preferred a narrower pledge of liquidity for all comers through the discount window, but then riding shotgun in a stampede can sometimes call for improvisation.

And such a panic is unfortunately what we have. The Fed explained its 75-basis-point move a week before its regular meeting "in view of a weakening of the economic outlook and increasing downside risks to growth." The central bankers are especially worried that struggling regional banks have stopped lending to small and medium-sized businesses, which are the U.S. economy's chief job creators. The job market has been the last bastion of growth amid the housing recession and credit crunch, so the Fed's concern is understandable.

The rate cut will reduce the cost of borrowing by lowering mortgage and other benchmark interest rates. In the best case, the lower cost of capital will give banks more confidence to lend, and in the process increase the demand for money, which might ease any inflationary pressures from monetary easing. As we say, this is the best case.

The worst part of yesterday's decision is that it looked like more Fed appeasement of banks and equity traders, suggesting even a hint of panic by the Fed itself. Chairman Ben Bernanke had already signaled that the Fed would cut rates sharply at its regular meeting next week, and in retrospect that candor only invited more Wall Street agitation to speed it up. Mr. Bernanke's interest in more Fed transparency is admirable, but we'd prefer if he saved his explanations for when he acts.

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The editorial goes on to discuss other legitimate concerns about the Fed move. Indeed there is reason for concern because of the campaign being waged by Democrats who want to raise taxes and investors will have incentives to cash out now rather than wait and pay a higher tax price later.

However, I think the bigger concern for the Fed has to be liquidity. A great deal of wealth has disappeared because of the losses incurred what has happened in the mortgage market. These losses had the effect of sucking capital out of the institutions that would normally be lending money or facilitating the sell of equity needed for businesses to grow. If the rate cut provides more money for borrowers and firms up the markets it can reverse the choke hold the markets were putting on capital formation and business development.

There are legitimate concerns about the "stimulus" plan that Congress and the President are looking at. One of the side effects appears to be the President's stepping away from a plan to issue an executive order to block earmarks. In effect the earmarks will be a part of a Roosevelt era stimulus package. The real stimulus would come from making the tax cuts permanent.