Fed Panic Reaction to French Bank Fraud?

Tuesday morning, as stock prices plummeted, Federal Reserve Chairman Ben Bernanke pushed the panic button and announced the largest U.S. interest rate cut in over 20 years.

In the cold light of morning, however, the Fed's move could well be chalked up as a too-quick reaction to a simple, if large, fraud case an ocean away, one that is still unclear in scope and, ultimately, importance.

Less than two days later, French bank Societe Generale revealed the issue at hand.

It announced that the bank had uncovered a massive problem on the Friday just before the Fed cut — a rogue trader had accumulated extremely large long positions, reported at the time to be more worth more than $60 billion, in European stocks.

So markets across the globe did what markets do — they sold on the rumor.

Monday morning, Societe Generale went to work, quietly unloading the positions. Selling as quickly as they could into a declining market led to results any trader would expect — a large decline in the markets.

The next night, Asian markets recovered, but European markets were again down sharply as Societe Generale continued selling.

Although the Fed likely didn't know or understand really why, it turns out the markets were almost done selling.

Yet the "panic" cut came anyway, and the markets turned sharply higher the next day, right before Societe Generale announced that it had completed selling a large position at a loss of more than $7 billion.

While Bernanke was trying to reassure financial markets with the rate cut, he may well have limited the effectiveness of future cuts.

At the time of the action, prominent market participants questioned the wisdom of the cut.

Morgan Stanley’s Asia Chairman Stephen Roach questioned the timing, "The next meeting is in seven days. What's the difference if they move [on Tuesday] or in seven days?"

Speaking to FT.com's View from the Top, global financier George Soros said the Fed was cutting rates in a "rather panicky way . . . because people fear there are hidden problemsâ€