For those of us that haven't seen the throes of a detoxing addict first hand, there have been plenty of TV shows and movies that have let us see roughly what it's like from a safe distance (if you don't know what I'm talking about, rent Trainspotting). The process is nasty, and it applies to whether that person is detoxing from chemicals or some non-chemical addiction such as gambling.
Recently it has been interesting for me to watch the behavior of many of the market participants as they try to swallow the fact that the Fed may not step in to the same extent as it has in the past to bail out those that got in over their head during the past few years.
Whether you're talking about Mad Money's Jim Cramer absolutely losing it on the "Stop Trading" segment of CNBC, or the various pundits and executives skewering Fed chief Ben Bernanke for being "too academic," I think the whole scene is reminiscent of an alcoholic having his bottle taken away. I guess you could also liken it to a kid having his favorite toy snatched from him.
Personally, I think that Bernanke's measured approach to the situation is smart. After all, it was arguably the aggressive and deep cutting of interest rates a few years ago that laid down the tinder for this current mess.
Short term pain may be a necessary evil to purge some of the poor loans and lousy risk management that has been dogging the markets. Lenders like Countrywide (CFC) and Wells Fargo (NYSE:WFC) as well as some of the i-banks like Lehman (LEH) and Bear Stearns (NYSE:BSC) -- among others -- may gripe, but that doesn't mean you do should whatever they say.
The addiction that the market is detoxing from is often referred to as the "Greenspan put." A put option gives the buyer the option to sell a security to another party at a pre-determined price. This is often used as a backstop on a risky or volatile security. For example, if you buy Accredited Home Lenders (LEND) at the current $8.74 and a buy a put at $6, you can guarantee that you won't lose more than the $2.74 difference plus the cost of the put.
In the case of the Fed, the 'Greenspan put' referred to the fact that many took it for granted that the Fed would bail out the markets at the first sign of trouble. This meant that market participants -- relying on this implied backstop -- were free to pursue riskier opportunities than they otherwise would.
All that said, I wouldn't hope for the Fed to sit on its hands and do nothing. The problem with this situation is that legitimate corrections could lead to high levels of fear and an over-estimate of risk in the market. That, in turn, could lock up certain areas of the market and hurt real economic growth (as opposed to free-money-inspired speculative growth).
Bernanke's approach to the markets creates different implications for the outcome of the September Fed meeting. If the Fed keeps the Federal Funds Rate steady, it would imply that they are comfortable with how the situation is working itself out and they don't see it as a threat to economic growth.
However, if they lower the rate, they would in effect be saying that the problems are still very bad and might have an impact on underlying growth. A cut larger than 25 basis points would amplify the concerns.
In other words, assuming Bernanke isn't the dummy that some seem to think he is, no rate cut in September would be the better outcome. Of course, you trying to tell the heroin addict that he's really better off without a needle in his arm...