Friday, October 12, 2007

Are the Reckless Getting Relief?

Response to Fortune Magazine article Heads I Win, Tails I Get Bailed Out by Allan Sloan.

The main point of the article was to criticize Fed Chairman Ben Bernanke for cutting short term interest rates, because prudent investors actually suffer in the long run. Here are some highlights:

• Even though the Fed’s stated reason for cutting short-term interest rates by half a point was to help keep the economy from falling into recession, anyone who’s been paying attention knows that a major motivation—if not the major motivation—was to try to calm the turbulence that has been roiling the markets since August.

• Those who keep score in dollars are losing because the rate cut contributed heavily to the dollar’s recent sharp drop in the currency markets.

• Even though the Fed has cut short-term rates, long-term rates, which it does not control, have risen in reaction to the cut.

• Some junk mortgages will reset at lower rates, however, the cost of large, high-quality fixed-rate mortgages, which are tied to long rates, will be higher than they’d otherwise be.

I agree with Allan Sloan that the short-term cut actually hurts some investors. However, I believe Mr. Bernanke and the rest of the Federal Reserve Board was acting with the best of intentions.

Sometimes, short-term relief is enough to remove emotion from the market, which will have a positive effect long term. In doing so, investors jump back in, helping to divert a recession. The market has stabilized (at least for now); and struggling financial companies are getting back on track.

I don’t think the majority of investors see the short-term cut as a “bailout.” Moreover, savvy investors are in long term index funds, so the ups and downs of the stock market don't really matter anyway.