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.

Not the First Time the Fed Screwed Up

You may ask, who in the heck am I, a two-bit hedgie in West Conshohocken, Pa., to dare instruct the Federal Reserve Board? Well, I denounced Greenspan for his participation in the new era/tech bubble stupidity. That appears correct. I called the Greenspan 1% rate cut

a hoax motivated by his desire to goose the financial markets and economy until his retirement. With hindsight, that sounds about right. And let's not forget

my criticism of the "Greenspan put".

I then turned against

the last few Fed rate hikes and maintained that a 5%-6% fed funds rate would generate a recession. I was not "data-dependent" but rather was anticipating the effects of the many rate hikes and the real estate bear market we were entering.

At first, that seemed wrong, as the economy held up fairly well through the last few hikes. But by the end of this summer, the economy was looking very top-heavy, and for the past few months I have resumed my call for quick and substantial short rate reductions.

I blasted the Fed for terrible oversight in the banking and mortgage industry, permitting, some would ever say encouraging, irresponsible lending practices in the housing market. Finally, in 2005

I predicted an RTC II. That agency will open in 2008-9.

Apparently, my advice has no standing in Washington whatsoever. But I believe my commentary regarding the Fed mis-execution over the past decade can stand on its own. The Fed has created big problems overreacting to data in the past. It needs to be more forward-looking than "data-dependent."

Getting a Handle on the Problem

This fall, the Fed needed to understand that the consequences of a major debt reliquification and real estate bear market were far more potentially damaging than $100 oil. It didn't. The central bank is waiting for the recession before getting serious about rate cuts.

If you want a financial implosion, the Fed is your guy. But I don't believe the economy needs a severe, general recession. Nor do I believe the Fed wants to precipitate one. I believe a mid-cycle slowdown would have been healthy. The housing market bubble did need to deflate, and the excesses in the financial market from absurd risk-taking did need to clear.

But the Fed's unwillingness to anticipate changes in the economy, on both the upside and downside, has contributed to bubbles and busts -- the tech, real estate and the current financial-leverage/risk-taking bubble and bust. And now, when it really needs to be preemptive, it is still data-dependent. That's another term for backward-looking. That's another term for wrong.

The Fed needs to figure out some way to get things right. And today, the correct position, in my humble opinion, is to slash short rates to help mitigate some of the problems they created themselves. Nominal cash returns will help the markets resume more normal working conditions. The Fed seemed to have learned the lesson overreacting all to well.

But sometimes, on rare occasions, overkill is necessary. This is one of them. Even the bears get that, and they are cheering for the implosion. We have a developing real-estate/fixed-income market crisis. It time for Uncle Ben to get rates shockingly lower now. In case of emergency, break glass and pull down rates. If not, Ben will be firing up the fleet of helicopters later.

At the time of publication, Marcin had no positions in the stocks mentioned, although positions may change at any time.

Robert Marcin is the founder of Defiance Asset Management, a private investment management firm. Client accounts managed by Defiance Asset Management often buy and sell securities that are the subject of commentary by Marcin, both before and after it is posted. Under no circumstances does this column represent a recommendation to buy or sell stocks. This column is intended to provide insight into the financial services industry and is not a solicitation of any kind. Neither Marcin nor Defiance Asset Management can provide investment advice or respond to individual requests for recommendations. However, Marcin appreciates your feedback;

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