Fed must save banks to save economy Looked at from a certain angle, the Fed's dramatic rate cut Tuesday morning is a bit screwy. After all, what got us into this mess in the first place was too much cheap credit that was used to buy houses, finance corporate takeovers and commercial real estate and speculate in commodities, driving up prices to levels unsupported by economic fundamentals. Now the bubble has burst and the prices of those assets are beginning to fall back to more reasonable levels. Why would anyone want to interrupt that process by bringing back the cheap credit? The short and oversimplified answer can be summed up in three words: the Great Depression. For that was very much the attitude of the Federal Reserve and other central banks after the stock market crash of 1929. Under Ben Bernanke, the Fed's policy is that it's not in the business of pricking bubbles, which it argues - unconvincingly - are recognizable only in hindsight. At the same time, the Fed stands ready to deal with bubbles when they finally burst and begin to have an impact on the "real" economy. As a practical matter, that means lowering interest rates when turmoil in financial markets threatens to drag the economy into recession, as now seems to be the case. At the moment, the Fed's big fear isn't a mild U.S. recession. It is a market meltdown in which the failure of one bank or hedge fund or insurance company triggers another and another as panicked investors and lenders all head for the exits at the same time. That's what central bankers confronted last week with the sharp sell-off on nearly all of the world's stock markets. Although Fed officials will claim in public that their three-quarter point rate cut was justified by risk to the economic fundamentals, simple logic tells you it ain't so. There's been nothing that has happened to the real economy in the past few weeks to justify an emergency meeting, let alone the biggest rate cut in more than two decades. Rather, the Fed's goal was to calm financial markets and take pressure off the balance sheets of troubled banks and insurance companies that benefit when borrowing costs are reduced. For the moment at least, it seems to have worked. After the announcement, stock prices in Europe rallied, recouping some of Monday's losses. Here in the U.S., the pent-up selling pressure from the market holiday subsided and the broad indicators were down modestly, from 1 and 2 percent. So is the Fed bailing out the big banks? Of course. It always does in these situations, even as it denies it. That doesn't mean that the banks' top executives won't lose their jobs - they often do. And it doesn't mean that the banks won't be required to come clean about their losses, even if shareholders wind up losing most of their money. But no matter how great the banks' folly, and no matter how much the Fed failed in its role as bank regulator during the bubble, the Fed will never allow them to collapse because the consequences to the financial system and the global economy would be too severe. Steven Pearlstein is a business columnist with The Washington Post.
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