Watch for After-Effects of Regulatory Action

Over the past year, officials and investors have been wrestling with three-pronged threat: a profound crisis in the financial markets and the circuit of capital, the loss of economic momentum, and inflation pressures that are largely but not wholly a function of higher food and energy prices. Nearly every country is experiencing these threats, though the potency of each individual threat and the institutional capacity to address the challenges vary widely.

The U.S. conceit is its flexibility, and the current crisis has seen this flexibility exercised. The Federal Reserve cut rates fairly early in the crisis and fairly aggressively. It innovated with new liquidity provision facilities, though it seemingly felt compelled to wait until after a large failure (Bear Stearns) was threatened.

In an unusual step, it took on some of Bear's assets onto its balance sheet. Fiscal policy has also been deployed. It is striking that the charge for tax rebates was led by the U.S. president who is a lame-duck, as is the vice president. Efforts for a second round of fiscal stimulus are making their way through committees, but given the summer recess and the November elections, it is difficult to see such a plan passed over Bush's opposition, barring a significant deterioration of U.S. economy in the coming months.

Further Innovation

What appears to be a rolling financial crisis -- subprime, real estate, commercial paper, high-yield bonds, leveraged loans, auction rate bonds -- raised concern about viability of Fannie Mae (FNM - commentary - Cramer's Take) and Freddie Mac (FRE - commentary - Cramer's Take).

Once again, U.S. policy makers demonstrated willingness and capability to innovate. The Federal Reserve indicated it would allow the government-sponsored enterprises to borrow from it at the discount rate. What follows from having access to the Fed's funding is that one must also become more subject to Fed oversight, and this seems to be what will happen in this case as well, though regulatory overhaul will more likely have to wait for next administration.

---

Marc Chandler has been covering the global capital markets in one fashion or another for nearly 20 years, working at economic consulting firms and global investment banks. Currently, he is the chief foreign exchange strategist at Brown Brothers Harriman. Recently, Chandler was the chief currency strategist for HSBC Bank USA. He is a prolific writer and speaker and appears regularly on CNBC. In addition to being quoted in the financial press, Chandler is often a guest writer for the Financial Times. He also teaches at New York University, where he is an associate professor in the School of Continuing and Professional Studies. While Chandler cannot provide investment advice or recommendations, he appreciates your feedback; click here to send him an email.