Federal Reserve Stands Pat as Stock Market Burns

"Bernanke needs to open the discount window—that's how bad things are out there...Open the darn Fed window!"

That's a choice hunk from CNBC's Jim Cramer now famous rant about the dangers that the subprime mortgage crisis poses to Wall Street and the need for the Federal Reserve to take action. But Cramer is far from alone. Here is my guy Ed Yardeni of Oak Associates—a guy who's been very bullish on the U.S. and global economies—in his morning economic note to clients: "The Fed needs to wake up. Perma-pause is over. It's time to ease. I think they will do so at the September 18 FOMC [Federal Open Market Committee] meeting, though probably sooner given how quickly credit conditions are seizing up." Actually, let's give Yardeni some length:

My assumption has been that ample global wealth would absorb the kinds of shocks we've recently experienced. That's been more or less the case so far. And I expect it will continue to be the case. However, the problem is that some panicky investors are trying to liquidate some of their portfolio investments. This is creating the potential of a "run on the banks." In the current environment, this means they might scramble to bail out of mutual funds and hedge funds invested in the riskiest and now most illiquid assets. Some funds are reportedly selling their higher-quality and liquid assets to raise cash anticipating withdrawals. News that a handful of these funds (so far) are suspending withdrawals because the assets can't be priced or have lost most of their value only adds to the risk of a run.

In short, he's worried that panic selling might turn what should be a crisis in a small sector of the economy into a full-blown, catastrophic contagion. For a more upbeat take, here is another of my favorite guys, Don Luskin of TrendMacrolytics:

The price of risk in credit markets has returned to normal levels, but for those who gorged for years on a zero price of risk, it feels like whiplash. So some credit markets are temporarily frozen, while it gets straightened out. This is a Wall Street phenomenon, not a Main Street phenomenon. It has little power to affect the overall economy, any more than the terrible but local damage in the Gulf Coast from Hurricanes Katrina and Rita did. Stocks are a buy here for sure.

My take: I'll give you 525 reasons why I am still upbeat on the economy—the 525 basis points Ben Bernanke has to play with. If it sees fit, the Fed can cut and cut a lot. (Already traders are betting that a rate cut is a sure thing before year's end and more likely than not within a month.) Core inflation is under 2 percent, and oil prices are dropping. I'll tell you one thing: If the Fed stands pat at this point, Bernanke will certainly have gone a long way toward creating a reputation as a hard-core inflation fighter. It's kind of like when a guy goes to prison and the first thing he does is sucker punch the biggest, baddest dude he can find. He makes his rep. Bernanke may now be making his rep.