I was puzzling and thinking if I were Bernake what would I do? Many are crying raise the darn interest rates. Many are saying lower to give the companies a break. Bernake though does not strike me as an individual that leaves a statement. He strikes me as an individual that tries to do the right thing.

So if I were Bernake and his personality here is what I would do:

  1. Drop interest rates. Yes you read that right drop interest rates. He wants to do the right thing and give home owners a break. But he is not dumb.
  2. Tighten liquidity quite a bit. Let LBO’s and the likes squirm and struggle.

The Fed has problem in that the stock market, and investment banks have been drunk like a pirate on cheap credit. On a positive note cheap credit has helped the consumer purchase houses and from what I remember Bernake likes people buying homes as that creates a neighborhood (his words).

So by dropping interest rates home buyers get a break. But, by tightening liquidity investment banks are caught in a bind because there is cheap credit that they cannot take advantage of. Will that increase bond prices? Hmm, don’t know… Not a fixed income person.

What I am also thinking is that this approach would solve his problems, and surprise the market. At first smell the stock market will rally and be happy. But that happiness will fade since liquidity is tight. People can’t go on leverage, and those expensive derivative products will suddenly become expensive. Thus there will be unwinding, and a “value” purchase at the same time. A directionless market that will hurt many investment houses. This probably is also to Bernake’s liking since it would shake things up a bit without causing a collapse.

If Bernake does take this approach I am sure the “quants” will be in tail spin as their “models” will not work worth a darn!