Smoke-Filled Rooms - TheStreet

WASHINGTON -- "Do Something!" is what the market is screaming at world economic leaders, who are convening here for a Group of Seven summit and the IMF-World Bank Annual Meeting.

Stock indices are tumbling, so the panicky calls for action can only be expected. The failure of

Treasury Secretary Robert Rubin

and other finance ministers to come up with more than words may seem alarming. Especially when Brazil is peering over the edge of the cliff and the

Dow

looks 7000-bound. But considering the challenges they face, a bit of caution is in order.

Bailouts Take Time

The delays and disagreements are a necessary part of formulating policy responses that are relevant, effective and safe. You can't build a "new financial architecture" overnight. And leaders here definitely don't want to be frightened into actions they'll later regret.

Take

President Clinton's

proposal last week for a large new emergency credit line. Run by the IMF and funded by both governments and the private sector, the fund could be drawn upon by countries being "unfairly" hit by financial panics.

George Soros

, whose hedge-fund business has been ravaged by the crisis, added his support to such a facility today.

The Clinton-Soros fund throws up all sorts of serious dilemmas, which have not escaped the attention of senior policymakers within the IMF who would be charged with running it. "How long do you let a credit line run? Who gets to go on it and how do you get a country off one?" asks Jack Boorman, director of policy development at the IMF. "These are some of the difficult questions."

The moral hazard risk is enormous in such a venture. Even if the credit line comes with high interest rates -- as has been suggested in some quarters -- it could be used to duck carrying out reforms. Unless, of course, it carries strict conditions.

The test case will be Brazil, which is on the verge of receiving a $30 billion to $50 billion credit line to help the country avoid devaluation. This is the nightmare scenario: The country gets the money in the next few days and gives only vague promises for a fiscal adjustment in return. As a result, the country's budget deficit stays high and the market eventually runs out of patience and kills off the real. Such a chain of events would show that the emergency fund is merely a slush fund for headless chickens. Its credibility would be shot.

Chances are, however, that tough conditions will be imposed on Brazil and any other future recipients. Remember, the IMF and world leaders had the stomach to let Russia go in August, despite all the warnings that, if they did so, the country would turn into a nuclear Nigeria.

Turning the Screws on Japan

Frustration among world leaders seems to have reached a new peak this weekend with Japan, whose recession is putting an awful drag on the world economy. This at least increases the chance that the country will consider stronger stimulus measures and an ample-sized bank bailout scheme.

Don't get this wrong, Japan is not about to announce these measures any day soon. But the U.S. and others are certainly upping the ante. This weekend, Rubin brushed off Japan's offer of $30 billion in aid for Asia with the remark that the country could best help the region by getting its domestic economy growing.

And you've got to ask yourself why, at this juncture in the crisis, U.S. financial officials leaked to

The New York Times

Monday that they were having conversations with Japan about the dire state of its banking system.

Further,

Bank of England

Governor Eddie George, also in Washington, joined the "Bash Japan" gang. He today said that interest rate cuts in the U.S. and Europe "cannot hope to compensate for the continuing weakness in Japan. That would build up unsustainable imbalances."

Leaving the Best till Last

While George is right, the beauty of interest rate cuts is that -- unlike emergency bailout funds -- they don't require a global consensus. The

Fed

, once it has an internal consensus, just goes ahead and cuts.

The market, judging by the U.S. yield curve, expects the Fed to cut its fed funds rate from the current 5.25%. While a much looser U.S. monetary policy would take a while to boost emerging economies, it may help mitigate what some figures are already showing may be a sharp credit contraction in the U.S.

Indeed, at a seminar Saturday, Paul Krugman, professor at

Massachussets Institute of Technology

, said that whenever he gets overcome with gloom about the state of the world economy, he consoles himself with this thought: "The Fed still has the room to ease by another 525 basis points."