Wild Week in the Market Causes the to Fed Intervene

by Jason Dean 

stocksTen days ago, I wrote an article entitled The Federal Reserve and the Stock Market. Why am I covering the same material again so soon? Because in this market, ten days is an eternity!

In the span of just two days, major big-cap financial firms like Wells Fargo and JP Morgan Chase have swung as much as 24% in price. Typically, it might take a company of that size a year or two (or more!) to see such a mammoth swing — but it happened in just two days. Clearly, the markets are going haywire.

Ten days ago, I wrote how the stock market crashed on the news that the Federal Reserve would not be cutting interest rates but then staged a rally later in the day as inflation hawks interpretted the Fed’s inaction as a sign of a low-inflation future.

Well, in the time since that decision, all heck has broken lose. The market has taken a dive day after day, and it got so bad that the Fed had to call an emergency meeting to cut the discount rate by fifty basis points (0.50%) — twice the size of the moves it has been making for the past several years.

Immediately, the market staged another huge rally — up 233 points, to be exact. But what does this mean for inflation? It can’t be good. After all, the primary cause of all the bad news on Wall Street has been the sub-prime mortgage crisis, which itself was exacerbated by the Fed’s low interest rates. There was too much liquidity in the market, and as the Fed began to raise interest rates in 2005, the crisis began. So as a solution, the Fed provides more liquidity? It doesn’t really make sense: It’s like trying to put out a fire with the only handy liquid — which happens to be gasoline!

Also, I was shocked to see the economic ignorance of several “financial reporters” exposed today. More than one “analyst” on CNBC said that the Fed had cut the discount rate today, but not the fed funds rate. Here is a simple fact that most of the talking heads on CNBC don’t seem to know: The Fed can only cut the discount rate — it cannot “cut” the fed funds rate. The discount rate is the rate the Fed charges to its member banks. The fed funds rate is the rate the banks charge each other. The discount rate is set by the Fed. The fed funds rate is determined by the member banks via supply and demand. It truly is amazing how few people seem to know this.

So what’s in the future? It’s hard to say. Some are predicting a serious recession. Others think the Fed can save the day and happy days will be here again, soon enough. It’s probably best to have one foot in each camp, thus holding a diverse portfolio of growth stocks, as well as investments that do well in a bearish market, such as gold and foreign currencies. One thing’s for sure: If you have money in the market, you haven’t been bored this past week!

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One Response to “Wild Week in the Market Causes the to Fed Intervene”

  1. The Simple Dollar » Carnival of Personal Finance #114 on September 23rd, 2007 11:53 am

    [...] Wild Week In The Market Causes The Fed To Intervene (@ smart money daily) [...]

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