Deft dodge (for now)

As everyone knows by now, the Bernanke Fed resurrected the discount rate lever from obscurity on Friday, lowering the rate at which members of the Fed system can borrow against collateral from the Central Bank.

As a practical matter, lowering the discount window "penalty" rate is a red herring. Members of the Federal Reserve banking system can borrow short term from each other at a Fed Funds rate which is lower and devoid of the stigma attached to the discount window as financing of last resort. And extending the financing period from overnight out to 30 days is also not by itself going to relieve the credit conditions in the middle tiers of the commercial paper market that seemed to be a main area of concern.

However, in m*'s view this slight maneuver shows the Fed is clear about what it wants to do and in the short run deftly accomplishes several of its policy goals. Friday's action allows the Fed to demonstrate that it is in tune with the markets and Main Street to "do something", thus remaining relevant to the crisis and on the right side of public pressure. Its promise of unlimited liquidity at the discount window directly addresses the fear and uncertainty in the markets while sidestepping the moral hazard attached to a Fed Funds rate cut that would undoubtedly boost support for speculative positions. Lastly, it does not contradict the Fed's inflation policy stance despite uninformed commentary to the contrary now hitting the tape.

m* reminds readers that these analysts have gotten this Fed wrong since Bernanke took over. While the Fed is quite correctly concerned about the potential vulnerability of the economy to credit tightness (and addressing that tightness via the discount rate), it is not yet addressing the fact of a weakening economy (with Fed Funds) that the bulk of the vested (long) analyst and housing and automotive CEO community is so vocal about.

In short, this is the reasoned, measured, and pragmatic type of Central Banking that was missing from the Greenspan Fed and shares much with the Mervyn King led BOE, who's response thus far has been to remind people that his discount window is also open, albeit at 100bp premium to interbank rates. ECB has approached its informational deficit on this issue somewhat differently, giving away free beer in order to estimate total beer demand in effect, but its philosophical view about how and where to intervene is more or less similarly aligned.

What m* also suspects though is that this Fed wants de-levering to occur and is very reluctant to interfere in what it views as a long overdue cleansing of the system. What if, with his tenure on the board nearly up, "Calamity" Poole feels free to say just what he thinks, but also what the others are not free to say? That the Fed is "behind the curve" these analysts will readily attest. That the Fed may not even be in their corner and has not been since this business got started is perhaps only slowly dawning.

Nevertheless, when the economy does begin to exhibit more dramatic signs of a slowdown, perhaps this year into the back to school season, perhaps further along into next year, pressure will mount anew for rate cuts, and the Fed will most likely oblige. By then however, asset prices will have more than just fear and uncertainty to cope with. They'll have real economic weakness coming into play too and what de-levering is postponed now will likely begin again in earnest.