A Fed Opportunity

Let's look at some of the potential reasons and personal benefits for the Federal Reserve to have cut rates by 50 basis points yesterday.

A perusal around the web and even mainstream economic outlets described the Fed as being between a rock and hard place. Article after article talked of how inflation pressures remained while a crashing housing industry was in need of assistance. Almost every article mentioned how desperately Wall Street was looking for a rate cut.

A rate cut was seen as being good for stocks and corporate America and as being a possible life boat for struggling American consumers and home owners. Those calling for a rate cut felt that the need to save the housing industry and stimulate a falling economy outweighed the risks of inflation.

At the same time a rate cut was seen as a potential kiss of death for the dollar and a risk of ushering in high inflation for the overall economy. With oil and gold near important break out levels many figured the Fed would not want to send them an inflationary message.

When trying to understand the actions of the Fed it is important to realize they are a private financial institution who is concerned with their overall economic success as anything else. Often times I read articles talking of how the Fed is more concerned with their "friends on Wall Street" than anything else. There might be some truth to that sentiment, but one must put it into context.

Like any profit based business the Fed is more concerned about their bottom line than anything else. Therefore, it may be true that they are not as concerned for the economic welfare of the average citizen as they like to portray themselves to be. Yet, their relationship to Wall Street isn't totally benevolent either.

Most of the time the economic health of Wall Street is a boon to the bottom line of the Fed. Since the Fed loans out money to the economy they stand to benefit by fostering a climate of expanding corporate profits. Corporations which are making money are ready to borrow to fund their growth and expansion.

Yet, like every business in a competitive economy they are ever vigilant for opportunities to increase market share in their field of interest. If you look at the Federal Reserve as a banking institution then it would be only logical that they would like to increase their market share in the banking industry. Since they are not in the business of mergers and take overs their ability to get increase in market share is somewhat limited.

Yet, in the current environment of potential financial and credit crisis their does appear to be a window of opportunity. While most commentators are labeling the Fed's actions of late towards the banks as a bailout, I see something different.

The way I see it the Fed is not bailing out the banks, but rather putting themselves in a power position. The Fed is not taking on bad loans and subprime toxic waste. What they are doing is giving out short term loans to banks while using their best assets and loans as collateral. In essence this means that the bank is losing their good money to the Fed while taking on more debt without getting rid of their defaulted loans. While appearing to be bailing out the banks they are actually lowering the credit rating of the banks by taking away their assets while adding to their liabilities.

What this means is that the Fed stands to benefit from the financial crisis in a number of ways. First, they will make money off of the banks whether they fold or recover. Second, they are not endangering themselves by taking on poor quality loans. Third they position themselves to be able to a creditor that a failing bank is beholding to, and could be in a prime position to take over the bank after the liquidation period. In other words the Fed could increase their market share by taking over failed banks.

Now, the fact that the Fed is not taking on bad debt shows that they have no desire to become sacrificial lambs or financial martyrs. In fact they are finding ways,like any other competitive company, to benefit from the current turbulence.

This analysis still leaves open the question of why the Fed cut rates. In fact the cutting of rates would seem to be counter intuitive to my argument of the Fed just being concerned about their economic survival. As I mentioned earlier most feared cutting rates would cause a dollar crash and a gold boom like none we've seen in our lifetime.

If the dollar were to die or gold became king, then it would seem logical that the Fed itself could cease to exist. After all the Federal Reserve is the reserve for the US dollar and if the dollar were to crash it would seem natural that the Fed would suffer or completely fail.

My assumption is that the Fed is self-serving and relatively intelligent and therefore they are not afraid of a dollar crash or gold/commodity bubble forming. So given the Fed's actions of cutting rates how could they be so sure that this popular logical scenario is not going to happen.

Well, if the Fed sees recessionary deflation on the horizon then the dollar would likely rebound as investors go to the dollar as a safe haven during a stock market crash, and likewise gold and commodities would tread water or go down due to deflationary pressures.

In such a scenario most people would suffer, but the Federal Reserve would stand to gain market share and possibly increase their wealth not only in relative but in real terms.

Maybe, I'm wrong and the Fed is not looking out for number one, but is rather a benevolent socialist leader of the welfare state. Yet, I see no evident to support that notion, do you?

Jim Guido