Federal Reserve Chairman Ben Bernanke finally took an aggressive step today and lowered key interest rates by ¾ of a point.  This is the biggest interest rate reduction in 23 years in a rare emergency action.  It was also the first time since the effects of September the 11th that the Fed has cut interest rates between meetings.  The message – the economic situation is now so bad that the Fed had to take a desperate action to try to save it.  The intention was to reassure investors that the Fed will do what it takes to rescue the economy.  But many investors are now even more fearful that things are worse than they thought.  This may trigger just the opposite effect of what Bernanke was trying to achieve, adding more uncertainty and fear in the markets.

The problem is not the interest rate cut – in fact, this was desperately needed.  The problem is that it came too late.  If you remember, in the Fed meeting last month, the Fed decided to cut interest rates by a ¼ point at a time when there was plenty of evidence that the economy was derailing and heading towards a recession.   There were wide expectations that interest rates were going to be cut by a more aggressive ½ point, but when that didn’t come, the markets globally concluded that this Fed Chairman just doesn’t get it.  That conclusion lead to the global stock market fallout that is still ongoing.

One might wonder what would have happened if Bernanke had followed his own advice and had acted aggressively when it became obvious that the economy was faltering and that the Fed had to interfere with the malaise caused by the credit crunch in the US.  One might also wonder how things would have been if Greenspan was still in charge.  My guess is that we would not be in the situation we are in today.

Remember that the economy is about perceptions and momentum.  The perception at the time was that the Fed was not going to act aggressively enough to save the economy.  This was the trigger to the negative momentum that unfolded.  Once you start going in a downward spiral it is very hard to stop it.  The trick is to act early enough so that you don’t get into the downward spiral.

What is ironic, and sad, is that Bernanke made his mark in academia by writing about the great depression and criticizing the Japanese policymakers for not acting early enough.  Bernanke recognized that the lack of proactive action by Japanese monetary authorities is that resulted in the “lost decade”, a long recessionary period that Japan has lived through in the 90s.  Just look at what Bernanke had to say about the Japanese:

“Japanese monetary policy seems paralyzed, with a paralysis that is largely self-induced.  Most striking is the apparent unwillingness of the monetary authorities to experiment, to try anything that isn’t absolutely guaranteed to work.”

Here is what Paul Mortimer-Lee, global head of market economics at BNP Paribas in London had to say about Bernanke’s knowledge of the importance of acting proactively and not reactively:

“When Bernanke and his colleagues look to the lessons of Japan, the lesson is not to wait too long until you act strongly… Bernanke knows that lesson terribly well.”

So I have just one lesson for Mr. Bernanke:

Why don’t you follow you own advice?

As a successful investor you should not try to be a market timer.  But we could all have done without this economic and market downturn.  My only hope is that Bernanke has finally seen the light, and will continue to fight this situation we are in aggressively by further cutting interest rates by ½ point in the next Fed meeting.

Greenspan, we miss you.