The U.S. Federal Reserve cut the rate at which it makes direct loans to banks, sending a signal to Wall Street that it is aware of the credit contraction that has hit global financial markets

National Review, Sept 10, 2007

The U.S. Federal Reserve cut the rate at which it makes direct loans to banks, sending a signal to Wall Street that it is aware of the credit contraction that has hit global financial markets. At the same time, the Fed wisely refrained from lowering its target federal-funds rate, through which it controls monetary policy.

Demagogic politicians (and frantic investors) have shown less self-control, and the inevitable pressure to "do something" is bound to intensify. The Fed should resist this pressure. For one thing, the current crisis is unlikely to affect the economy in any significant way. As that becomes clearer, the hysteria will subside. For another, it is necessary that those lenders, borrowers, and investors who created the sub-prime mortgage mess bear its consequences. What we are seeing now is a necessary market correction. Several years of poor lending and borrowing decisions in the sub-prime mortgage market have resulted in a large increase in the number of foreclosures this year. Accordingly, Wall Street is reevaluating the credit quality of billions of dollars' worth of mortgage-backed securities and making the necessary adjustments. It's a painful process, but a poorly thought-out policy that prevented the market from righting itself would only compound the damage.