Is the Fed or Market More Panicked?

Remember how Fed Chairman Ben Bernanke got his nickname "Helicopter Ben"? He said he'd rather throw dollars out of a helicopter than see deflation.

Apparently, he'd also do the same instead of see a recession. Or at least a jittery market. Where once it was feared he wouldn't live up to his name, now it seems the moniker is all too apropos.

Propeller-head Ben aimed his helicopter blades at interest rates and sliced 75 points off the federal funds rate, a week ahead of the Fed's regularly scheduled meeting. It's the first time since the terrorist attacks in 2001 that the Fed has made such a move, and it's the "biggest reduction in this target rate for overnight loans on records going back to 1990."

Apparently, he was watching the news shows and saw how the foreign bourses fell the past two days in reaction to concerns about the U.S., and he heard the reports that the U.S. indices would open more than 400 points down. All nervous and jerky, the Fed slashed the rates to bolster confidence.

There were a few winners, as is to be expected in such a panic attack. Bank of America (NYSE: BAC) shares were up today despite reporting a 95% drop in profits, as it had to write off $5.3 billion related to collateralized debt obligations. Wachovia (NYSE: WB) also rose, even though the bank saw its earnings fall 98% from last year.

In reality, all he's done is put off the day of reckoning and opened the floodgates for inflation. It's also possible he could cut interest rates again when the board does meet next week, but he doesn't have much more room to cut. When the rates get down to 3% or below, where's the flesh on the bone to pare?

The problem with the markets is that the Fed has had an easy money policy that allowed the housing and financial markets to reach bubble status in the first place. It needs to be allowed to correct itself, by itself. Like a dog chasing its tail, there were too many dollars chasing housing, which fueled builders' desire to build more, and the banks lent money to just about anyone who asked.

Now the dog's finally caught his tail, and the pain is making him yelp. Yet rather than allowing the market to correct itself -- that means housing prices need to fall, banks need more conservative criteria, and financial institutions must rein in their creative monetary strategies -- Helicopter Ben is reversing policy and keeping the cycle of easy money going. The rate cut certainly didn't hurt bond insurer Ambac (NYSE: ABK), which saw its stock jump nearly 50% despite a $3 billion loss this quarter, as it also announced a search for "strategic alternatives."

That's gotta be good news for hobbled Citigroup (NYSE: C), since a loss of a AAA credit rating by Ambac or MBIA (NYSE: MBI) would mean higher costs for the company when it tries to raise money. Citigroup's shares opened nearly 10% lower but have since climbed back to break even so far today.

There can be no other cure for the hangover than to let the market work. Instead, we have politicians hawking "incentive" programs and the Fed opening the cash spigots. What do we do when the markets continue to fall? Our international partners have little confidence in the ability of the stimulus packages being debated to have any salutary effect whatsoever. The markets have little faith in Bernanke's ability to be out in front of the curve with monetary policy.

The rate cut amounts to little more than a panicky reaction. At some point, the party needs to end, but Bernanke & Company are too afraid to turn the music off.