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The Fool Of Last Resort

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by Felix Salmon
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Mar 12 2008 12:00am EDT

The Fool of Last Resort

The Fed is worried about a lack of liquidity in the credit markets. The Fed acts to make the markets more liquid. Is the Fed's action foolish? We hope so!

We like to think: "market -- trade -- liquidity -- good, etc.", forgetting the Glosten-Milgrom point that liquidity often rests upon the presence of fools.

If the problem is that there are too few fools in the market, it might make perfect sense for the Fed to step in as a fool of last resort. With any luck, once the Fed starts acting foolishly, other market participants will follow suit.

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