Friday, August 17, 2007

Half empty or half full?

Everybody and their second cousin has already commented on the Fed's "surprise" cut of their discount rate and their change in outlook (summary here)

So, what's the deal? Enter the proverbial glass.

The half full interpretation: The Fed is only soothing irrational panic in the markets that could, if left unchecked, turn into a full-blown credit crunch. Once everyone realizes that the world isn't coming to an end, things will get back to normal, investors will be a bit wiser and credit spreads will return to saner levels.

The half empty interpretation: The Fed knows that there's going to be a major blowup one of these days that could maybe pose a systemic risk to the capital markets. Hence, it's paying the first installment in what promises to be a series of cuts to avoid a total meltdown. Cutting now makes sense in order to avoid a huge cut later on that will give the impression of true panic.

Which is true? I don't think anyone really knows (not even Ben Bernanke), but I lean towards the half-empty version.