Ben Bernanke, meet Jerome Kerviel. Kerviel is reportedly the rogue futures trader at Société Générale, one of France's largest banks, who made over $7 billion in fraudulent trades that his employer was forced to unwind on Monday amid a global selloff that sent markets in Asia tumbling while U.S. investors on holiday could only watch in horror. Federal Reserve Chairman Bernanke, who has been pilloried by intense criticism in the financial community, was watching too. Throwing caution to the wind, he jumped into the fray Tuesday morning, slashing the fed funds rate target at the opening bell by 75 basis points -- the first emergency reduction of that size since 1982 -- signaling that the economy was facing a crisis of historic proportions. Like everyone else, Bernanke was unaware of the massive trading fraud in France that almost surely tripped the panic wire in a global market already shell-shocked by a relentless credit crunch. When Société Générale disclosed its problems on Thursday, a fresh round of finger-pointing ensued on Wall Street. In a note to clients, Fusion IQ CEO Barry Ritholtz, a contributor to TheStreet.com's sister site RealMoney.com, called the Fed's trigger-happy response to the market selloff "sheer folly and utter irresponsibility." "Tuesday's panicked 75 basis cut will prove to be an historical embarrassment, a blot on the Fed for all its days," wrote Ritholtz. "Failing to understand what their responsibilities are is bad enough; allowing themselves to be bossed around by futures traders is inexcusable."
Meanwhile, expectations for further easing from the Fed at its regularly scheduled meeting declined. On Thursday afternoon, fed funds futures were pricing in a 66% chance of a 50 basis point cut next week, down from the 76% chance that was priced in on Wednesday. Moreover, traders were pricing in a 34% chance that next week's move would be a 25 basis point reduction on Thursday -- a big increase from the day before when the possibility of a quarter-point cut was viewed as a long shot. "We went from looking at 50 to 75 basis points next week to 25 to 50 instead -- this whole thing really has markets torqued," says T.J. Marta, fixed income strategist with RBC Capital Markets. "It wasn't the Fed that panicked on Tuesday -- it was the market that panicked and the Fed reacted appropriately. It's bad enough we have a financial crisis that we can't get our arms around, but now we have this friendly-fire at the Fed to deal with as well." Subodh Kumar, chief investment strategist with Subodh Kumar & Associates, says the situation in France did little to diminish the peril that's facing global financial markets. "It's not unusual to have scandal emerging when you have a financial crisis," Kumar says. Former Fed governor Lyle Gramley rejects the idea that the Fed overreacted on Tuesday. "We've seen significant deterioration in economic growth, evidenced by weak durable-goods order figures in the past several months, disappointing holiday sales, weak December jobs report and slumping consumer confidence," Gramley says. "At the same time, the Fed has come to recognize that it has been way behind the curve and it simply under-estimated the seriousness of what we're going through." Gramley notes that the Fed said last spring that the meltdown in subprime lending would be limited to that sector -- a bad forecast. In August, the Fed said its predominant concern was inflation -- a bad choice of priorities. In October, the Fed said the risk was balanced between growth and inflation. "In my judgment, that's awfully hard to believe, so I think the Fed was trying to make up for lost time when it took action on Tuesday," says Gramley. "Two weeks ago, Bernanke promised substantive action in a timely and decisive manner. He has lost a lot of credibility by being very timid in his approach to this crisis in the housing market and credit markets. If, while watching the global market selloff, Bernanke had yawned and said 'well, we'll do something next week,' whatever shred of credibility the Fed still had left would have disappeared."
But, should the Fed be reacting to swings in the futures market? "It's the Fed's role to demonstrate to the public at large and the financial community that it's prepared to exercise leadership in a time of crisis and that's what it has not been doing," says Gramley. "Either way, this has not been the Fed's finest hour." The U.S. stock market has stabilized, thanks to a 600-point swing and a ninth-inning rally that made Wednesday that best day for stocks of 2008. The rally continued on Thursday, with the Dow Jones Industrial Average adding 0.9%. The Nasdaq Composite rose 1.9% and the S&P 500 was up 1%. Google ( GOOG), which was hammered on Wednesday along with Apple ( AAPL), rebounded up 4.7%. Finally, the outlook for Friday looks favorable. Microsoft's ( MSFT) second-quarter profit topped analysts' expectations after Thursday's closing bell, up 79% on strong sales of Windows-based personal computers. Also, London's Evening Standard reported that billionaire investor Wilbur Ross is holding serious discussions to buy troubled bond insurer Ambac Financial ( ABK). On top of that, the Fed will likely keep easing at its meeting next week. "Bernanke will lower rates by at least 25 basis points," says Gramley. "I don't see 50 unless we see further deterioration in financial markets."