Insights from a wasted morning

Posted by Deepish Thinker on August 18, 2007

Having wasted a good part of the morning watching CNBC, I now know that practically everyone involved with Wall Street wants, needs and expects the Fed to cut interest rates. What I don’t know is whether, objectively speaking, this is really a good idea.

From Wall Street’s perspective a rate cut is a no-brainer. If the Fed declines to act a great many investment bankers, hedge fund managers and other assorted masters of the universe will suffer from severely depressed annual bonuses, which could disastrously affect the sales of designer handbags and German sports cars.

Looking from outside the hot house of Wall Street the case for a cut looks somewhat more ambiguous. On one hand there is obviously a danger that the problems in the credit markets will spill over into the real economy. On the other the Fed risks creating significant ‘moral hazard’ problems if it starts stepping in to prop up the markets every time investors get into trouble after making questionable decisions. In addition, a rate cut could cause a slide in the value of the dollar, which in turn could re-ignite inflation. Perhaps even more important, a significant rate cut could diminish Wall Street’s incentive to sort out the significant problems in the mortgage backed securities market.

While I would hate to see the economy tip into recession, I would also hate to see the clearly dysfunctional mortgage industry avoid a much needed shake out.