The Bernanke Pacifier

The Fed's large 75-basis-point rate cut will have many benefits for sure, not the least of which will be the reduction that it brings in debt payments on a variety of obligations tied to the prime rate, including, for example, $500 billion of home equity loans and about 40% of the nearly $1.5 trillion of commercial & industrial loans outstanding.

The decline in LIBOR will also help cut payments on the other $40 trillion of debt owed by the U.S. private sector. The savings will take time to have meaningful impact, although the benefits begin to accrue immediately.

The downside of the Fed's action is that it sets a precedent that will take time to reverse regarding demands by the markets for the timing of changes in the federal funds rate. The Fed has now lost control of the setting of monetary policy that it must eventually reassert. When it does, there will be dislocation.

It would have been better, for example, for the Fed to have chosen a 50-basis-point cut today and another 25 basis points (or at most another 50 basis points) to help differentiate the reasons behind the cuts: chiefly, that some of the actions taken were in response to increased economic risks posed by the tightening of financial conditions, with the balance intended to address recent signs of slippage in the U.S. economy.

Now, if the Fed were to refrain from acting next week or move by less than the markets expect, dislocation could result, creating new economic risks. To regain control of the setting of monetary policy, the Fed must disappoint the markets at some point.

The Greenspan put was thought dead. I never believed that it was as large as many believed it was, as evident in the gradualism Greenspan was often cited for.

In its place is the Bernanke pacifier, an image that will take time to reverse. I am more critical of the timing of Bernanke's actions, which have been out of sync with his communications, the economic calendar and the mood of the markets.

The jump in the unemployment rate reported Jan. 4 was one of the several missed opportunities for the Fed to act on behalf of the economy without having to deal with the accusation that it was pacifying markets. The jump in the rate was a clarion call that the Fed missed. Even in the early days of Greenspan gradualism, when acting aggressively on rates was considered unusual, the Fed cut rates on employment Fridays.

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Tony Crescenzi is the chief bond market strategist at Miller Tabak + Co., LLC, and advises many of the nation's top institutional investors on issues related to the bond market, the economy and other macro-related issues. At the request of the Federal Reserve, Crescenzi is a regular participant in the board's Livingston Survey of economic forecasters. He is also the author of the revised investment classic, The Money Market, first published in 1978 by Marcia Stigum, and The Strategic Bond Investor. At the time of publication, Crescenzi or Miller Tabak had no positions in the securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Crescenzi also is the founder of Bondtalk.com, a popular Web site covering the bond market and the economy. Crescenzi appreciates your feedback; click here to send him an email.

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