Seeing as how everyone feels financials will see tough times tomorrow I think I'll go the other way. The Fed is showing resolve to keep the financial system afloat. The Fed has the guns to see the sub-prime problems to its conclusion. Bear Stearns has been dealt with. 1/4 point reduction in discount rate will be followed by additional. They won't let the system fall apart. If need be other central banks will quickly join the fight.

The Fed is pushing on a string at this point. Their only weapon is inflation - flood the system with money and hope someone borrows it. But it's too late for that. No one knows how much exposure anyone has, so lending has dried up. With home prices falling worldwide real estate is no longer available to inflate, and govt. bonds are now the most crowded trade on the planet - negative real returns and a serious risk of decline there. With hedge funds deleveraging, equity players are sitting on their hands waiting for lower prices, so no help from the stock markets either.

So, what's left to inflate? Commodities? Unlike asset inflation, that has a real effect on prices, so all you get is reduced consumer demand which feeds negatively into the total problem. This is classic debt trap dynamics of the kind Austrians have been warning about for decades.

What needs to happen is the market needs to clear. This will happen anyway - all the Fed can do is slow down the process and cause further distortions. In the end, price discovery will prevail, bankrupt institutions will disappear, people will rebuild savings, and we'll start building capital again from a new, lower base. This process will take years, but the alternative is far worse: govt. control of every aspect of the economy with all that it implies: higher taxes, currency controls, trade barriers, a truly horrible situation that will perpetuate poverty for a generation or more.

The Fed needs to get out of the way here. Let the markets clear, let interest rates rise and flush out the bad debt and let the free market find an equilibrium. All that intervention does is create a bigger mess that gets pushed into the future. Something our children will ultimately have to deal with, and will probably curse us for.

ebear