Recently, Jim Cramer has been going absolutely Postal about the Fed's inaction on interest rates (see here). He was even on the national news this evening, and instead of giving us news, used his precious 30 seconds to demand the Fed lower rates ASAP.

His reasoning is this. The Fed has interest rates too low in 2002 and 2003. People then took on mortgages they could not finance, because the short end of the yield curve was only 1%, and now it's up to 5%, which for interest only loans is a huge increase. The rise in foreclosures is hurting banks, investors, and borrowers. The Fed created this mess by having rates so low, so they must bail everyone out.

The problem with this reasoning is that it merely compounds a mistake. Saying they were too easy in 2003, and using that fact to say you should ease again, is like saying you should get rid of a hangover by drinking vodka. It will merely push the problem into the future, and make it worse.

I remember William Greider's book on the Federal Reserve, and the only nice thing he had to say about it, was that the inflationary 1970's were a good way to transfer wealth from lenders to borrowers, because the unanticipated inflation helped people with nominal debts. But this ignores the lower productivity, the sharp recessions, that were directly related to containing the inflationary spirals.

This is where you have to have to look at not merely the first order effects, the direct effects, but the indirect effects. Lowering rates to bail out bad deals subsidizes more bad deals, and only works by inflating the currency, which then causes a greater misallocation of resources. Bear Stearns has recently fallen from 170 to 114 this year, but since the beginning of 2003, that's still a 14% annualized stock increase. If you start bailing people out for making bad investments, where does it stop?

The Fed should do nothing. Drinking more to get rid of a hangover is simply not good advice.