Bernanke Bernanke bo-ernanke, Banana fana fo-fernanke

So the Fed meets tomorrow. The futures markets are predicting a 25 or 50 bps cut, with the latter slightly more likely.

But the problem here is a credit crunch, not just a liquidity problem. Simply pumping dollars into the system will not help; they will just find their way into short-term T-bills instead of (say) commercial paper.

Perhaps the most interesting article in the past week was this Financial Times piece about the Fed “mulling its options”. I would love to know who “Krishna Guha’s” sources are… Clearly, the Fed has more weapons in its arsenal than most people realize, should it choose to use them. For example, a special facility to inject liquidity directly where it is lacking — lending against commercial paper at a punitive rate, say — might be where we are heading.

…but not yet. I predict the FOMC cuts the target by 25 bps to 5%, cuts the discount rate by 50 bps to 5.25%, shifts to a neutral bias, and issues a statement foreshadowing more unconventional actions.

I have no idea how the market will react — and neither does anyone else. So I will go against the grain and say not much happens until more of the investment banks report later this week.

Related articles:

Allen Meltzer says the Fed should hold firm. Perhaps, but then I do know how the market would react: Negatively. Very, very negatively.

Meanwhile, Bank of America sees a “meaningful impact” on their Q3 results. They do not report results until Oct 18, so why the heck are they warning right now? On the eve of an FOMC meeting? I am sure it is just coincidence.

Last but not least, do not forget to say a little prayer for Ben Bernanke. (It just never gets old.)