The Time for Fed Overkill Has Arrived

The Fed needs to cut the fed funds rate to 3% yesterday. And then it needs to get serious about further rate cuts on a temporary basis.

It needs to understand the deflationary effects of a collapsing real estate market. It needs to understand the impact a frozen financial market can have on the real economy. It needs to understand that commodity inflation is the result of global-demand factors and an ill-founded domestic energy policy, ethanol.

Solutions, but the Wrong Ones

I have heard many talking heads prescribe a solution to the developing U.S. economic malaise. Some say we need a recession to purge financial evil from the markets. I disagree. Some say we need a government bailout of the housing market. Some argue for more liquidity injections. Some contend we need a change of political parties. Others maintain that we need fiscal policy changes to spur growth. Some are always looking for an excuse to cut taxes for the capital class.

All of these actions may help, but what we really need is the resumption of normal financial risk-taking. Financial market participants have gone from moronic levels of risk-taking in the past year to complete risk-aversion, from one extreme to the other without so much as a breather in between. And that is a big problem.

In my opinion, the Fed needs to take money market rates back down to 1%-2% to mitigate the collapse in real estate pricing, as well as nudge the financial markets back into more normal risk-taking mode. Nothing will get investors more interested in looking out on the risk curve than cash returns approaching nothing. It worked under Easy Al, and it would help now.

So that's what we need: 1%-2% returns on cash. And the Fed should make it clear that it will be retracted once the financial markets start functioning in a normal manner. I maintain that the Fed should take the base rate down to 3.25% this month. And then, to reflect the temporary nature of an incremental cut, add a 100-basis-point sur-cut, the opposite of a surcharge. The sur-cut would be removed once the financial markets and risk assumption returned to more normal levels.