Amateur Hour At The Fed

Monetary Policy: Treasury Secretary Henry Paulson says he has "great confidence" in Federal Reserve Chairman Ben Bernanke and his handling of the credit panic. Wish we could say the same.

The former Ivy League professor can be expected to make some rookie mistakes after stepping into longtime chief Alan Greenspan's shoes. But has he learned from them?

Rewind to March. In testimony before Congress, Bernanke insisted the damage to the markets and economy was "contained" within the subprime mortgage sector. "At this juncture," he intoned, "the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained."

In fact, it had spread like wildfire. By August, investors had learned that Alt-A mortgage lenders, investment banks and even foreign mutual funds had been exposed to the subprime rot.

On Aug. 7, with Wall Street in turmoil, the Bernanke Fed met and acknowledged the crisis. "Nevertheless," it said in a statement, "the economy seems likely to continue to expand at a moderate pace."

So it stubbornly kept interest rates tight, against the better advice of many (including this paper).

Two days later, a reporter asked President Bush about the market meltdown. "I am told there is enough liquidity in the system to enable markets to correct," he said.

He was told wrong. Stocks tanked the very next day, forcing Bernanke to pump some $40 billion into the very system he apparently had assured Bush had plenty of liquidity. He since has injected $60billion more in liquidity.

But the bad news just kept coming. So last week, Bernanke took the rare action of lowering interest rates between meetings. It appeared he finally had seen the error of his ways. After months of assurances that the subprime rot was contained and underestimating the liquidity needs of investors, he finally abandoned his academic models and faced up to the reality on the street.

"Financial market conditions have deteriorated, and tighter credit conditions and increased uncertainty have the potential to restrain economic growth going forward," the Fed said Aug. 17 in a statement. "The downside risks to growth have increased appreciably."

Only, the about-face didn't come with a cut in the federal funds rate -- the Fed's benchmark rate. Bernanke instead cut the discount rate, a largely symbolic move.

Banks only go to the discount window in emergencies -- when they can't get overnight loans from other banks charging the fed funds rate. Very few dollars are lent through the discount window.

It's almost as if Bernanke doesn't want to admit he was wrong not to lower the fed funds rate on Aug. 7, when he had a chance.

Whatever his reasons, the coy discount-rate move didn't calm market fears. It may no be enough to avert a recession.

There are signs the mortgage meltdown is bleeding into the economy. Payroll job growth is slowing. This week, Capital One Financial Corp. announced it would slash 2,000 jobs.

Bernanke is paid to read the tea leaves. Can he not see that the subprime debacle is only the tip of the iceberg?

Trillions of dollars worth of adjustable-rate mortgages will reset in the next few years (see chart). Falling home prices across the country will make it harder for borrowers to refinance. Foreclosures surged 93% in June from a year earlier, hitting a record high.

The wave of resets could kill consumer spending -- and economic growth -- if the Fed doesn't pre-empt the looming disaster with a 50-basis-point cut in the fed funds rate.

It should act now and not wait until next month's meeting.