The Fed did the right thing today by cutting the Fed Funds rate by 50bps rather than the 25bps that most market participants were expecting. The liquidity and credit crunch in the financial markets is still serious and the downside risks of a hard landing (recession) are now large enough that doing 50bps was the minimum necessary to try to prevent a hard landing. In my view this is still too little too late.
 

In 2001 the Fed started to aggressively cut the Fed Funds rate in early January – at an inter-meeting date – by 50bps and it pushed down the Fed Funds rate all the way from 6.5% to 1.75% by year end. Still, that aggressive Fed easing that continued throughout 2001 did not prevent a hard landing, a short but still painful recession in 2001.
 

The reason was – in part - that we had then a glut of tech capital goods and the demand for capital goods becomes interest rate insensitive when there is a glut. In situations of glut easing rates is like pushing on a string. Today, instead of a glut of tech goods, we have an unprecedented glut of unsold homes that is getting worse, a glut of autos and motor-vehicles and a glut of consumer durables. Thus I fear that, while a Fed easing may put a floor to the size of the hard landing, it may not prevent it for the same reasons why it did not prevent a hard landing in 2001. 

Also, today we have a credit crunch – on top of a liquidity crunch – that is caused by the fundamental insolvencies and distress of many over-leveraged households, mortgage lenders, home builders, some financial institutions and even parts of the corporate sector. You cannot resolve fundamental insolvencies with monetary policy injections alone. Those insolvencies and financial distress will take time to work out and will imply tight financial and credit conditions regardless of what the Fed does. For example, with high yield junk bond spreads higher by 200bps relative to the pre-crisis period, lower Fed Funds rates and even lower riskless government bond yields still imply significantly tighter financial and credit conditions and much higher real borrowing rate for such corporations. The same is true of a variety of other credit spreads that are now much higher in real terms. The real cost of capital is now much higher for households, corporations and financial institutions and will remain higher if credit spreads remain high because of a fundamental repricing of risk.

Thus, while the stock market is now cheering the Fed doing more than they had expected it remains to be seen if this Fed easing ends up being too little too late. Certainly in 2006-2007 – like in 2000-2001 – the Fed incorrectly assessed the risk of  a hard landing and kept a tightening bias for too long before being forced by the real and financial facts to switch – in a matter of a few weeks – from a tightening bias to an easing bias and then to an actual 50bps cut. The Fed argued for too long that the housing recession would "bottom out", that its spillovers to other sectors and to private consumption would be "modest", and that the subprime problem was a "niche" and "contained" problem. Now the economic and financial facts have forced it to play catch up with reality. I thus remain of the view that 50bps is too little too late and that we will experience a hard landing.