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Bernanke Doesn't Budge

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Ben Bernanke stood his ground today, keeping the Federal funds rate steady at 2%. Was it the right thing to do? As AIG (NYSE: AIG  ) totters on the brink of disaster, Lehman Brothers (NYSE: LEH  ) fades into memories, and Merrill Lynch (NYSE: MER  ) is now in the hands of Bank of America (NYSE: BAC  ) , it's clear something has to be done to right the financial system. But would interest rate cuts do the trick?

I can think of a few reasons why ol' Ben may have left rates alone today. For one, if the economy gets worse and rates truly needed to be lowered, he'd be out of options. Slicing rates down to levels approaching zero is akin to running out of ammunition as you're heading into battle. The question now is whether the war is over, or if Bernanke is staring at more combatants that need to be gunned down in the future. I'm sticking with the latter.

Besides, rate cuts probably won't do much at this point, anyway. The Fed has already cut rates down from 5.25% last year to 2% today, with the economy getting steadily worse throughout the cutting campaign. You'd be hard pressed to find someone who'll tell you another 0.25% cut will do the trick.

What lower rates will accomplish, however, is providing a psychological boost to investors' confidence. Great, right? Maybe. Much of that gain could be short-lived once people realize the bulk of the issue -- lending people money who can't pay it back -- won't be solved by lowering rates. Cutting rates could be analogous to, may I, putting lipstick on a pig.

If the financial system needs liquidity (which it does), it's probably a better bet to set up lending facilities for the particular banks that need it, rather than flooding the entire economy with more cash than it can handle. After all, it was the low Fed funds rates (bottoming out at just 1% in 2003) imposed after the dot-com bust and 9/11 tragedy that helped fuel the housing and credit bubble in the first place. Why bring insanely low rates back?

Well done, Ben. You hang in there.

For related Foolishness:

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. Bank of America is a Motley Fool Income Investor recommendation. The Fool has a disclosure policy.

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