Fed takes action, but was it soon enough?

And as the Fed repeated in its official policy statement Tuesday, the credit crunch — so far —has not created serious problems for the broader economy. On the contrary, according to the Fed view, economic growth is still strong enough that inflation remains its primary concern.

That view is shared by a number of private economists.

“While Wall Street is clearly feeling some pain, Main Street is holding up reasonably well,” said Wachovia Securities chief economist John Silvia in a note to clients Friday.

One of the biggest problems confronting holders of thinly traded mortgage-backed bonds is that no one really knows what they’re worth.

So far, hedge funds, banks and other big investment funds have been carrying these bonds on their books based on what computer models tell them they should be worth. Now, with the Fed buying up these bonds and creating real market prices — some of these bonds are selling as low as 35 cents on the dollar — holders of this paper may be forced to take huge writedowns. And because much of this paper is held outside the banking system, no one — including the Fed — knows how big the hole it.

“The problem is now and over the next few weeks as these institutions mark things down,” said Mark Zandi, chief economist at Moody’s.com. “That’s why investors are so skittish because they know — or they sense — that there’s more coming and they don’t want to have a line of credit or a loan out to an institution that announces on Monday or Tuesday that they’ve got to bail out of a fund, or close a fund. Or that they’re out of business themselves."

The Securities and Exchange Commission is reportedly looking into the books of several big l Street brokerages to find out how vulnerable they are to potential markdowns of bad mortgage-backed bonds.

More problems could occur as investors demand their money back — or bankers demand more cash to cover margin calls on loans used to buy the securities.

“There's a lot of forced selling going on,” said Robert Doll, chief investment officer for equities at BlackRock. “Leverage, when it goes in the other direction, is not a pretty thing. That's a lot of what we're witnessing.”

If the panic continues next week, the Fed said it is ready to step in and buy more troubled paper. But if the credit markets don’t calm down, the Fed may have no choice but to cut rates aggressively.

“At that point, they’ve used that tool in their tool kits and they have to go to something bigger,” Doll said. “You don’t want to risk not responding aggressively enough and have confidence completely coming undone.”

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