But first, for those who are unfamiliar with options, what is a "put"? The purchase of a put option gives one the right, but not the obligation, to sell a specified amount of something at a specified price within a specified time frame. What does that mean? Ask your insurance agent. Seriously.

Think about your car for a moment. Most states require you to buy some type of insurance on your car. That insurance requirement?  That's basically a put option. How does it work?  Well, in simplest terms, when you go to an insurance agent and take out a policy on your car, you are buying the right, should something bad happen to your car,  to "put" (sell) it to the insurance company in return for an agreed upon amount over a specified time. 

If you buy the most expensive insurance policy available, then you cover the total cost of replacing your vehicle. 

If you buy the most inexpensive insurance policy available, then you may be just covering the cost you would have to pay if your vehicle injures someone else.

The Bernanke Put falls somewhere in between a full coverage insurance policy and the most basic liability insurance policy. 

How so?  Let's go back to his speech from 2007.

"It is not the responsibility of the Federal Reserve--nor would it be appropriate--to protect lenders and investors from the consequences of their financial decisions."

This is the statement from last year every news outlet and financial commentator in the world is focusing on. It suggests that the comprehensive policy is out of the question. But they are missing the point, which is: what IS covered by the Fed's insurance policy? 

"But developments in financial markets can have broad economic effects felt by many outside the markets, and the Federal Reserve must take those effects into account when determining policy," Bernanke added.

Bear Stearns, Fannie Mae (FNM) and Freddie Mac (FRE) certainly qualify as institutions where "developments" can produce "broad economic effects" even if the vast majority of Americans don't even know what any of those institutions really do (or did).

Remember the velocity of money issue we discussed? The Bernanke Put means the Fed will essentially do whatever is necessary to try and maintain a certain velocity of money.

"The further tightening of credit conditions, if sustained, would increase the risk that the current weakness in housing could be deeper or more prolonged than previously expected, with possible adverse effects on consumer spending and the economy more generally," Bernanke said.

Yes, velocity of money, acceleration of credit demand and consumer spending must be maintained.


4.  Coordinated Fiscal and Monetary Response

As I outlined in the the special Five Things on the Credit Crunch (What Does "Credit Crunch" Mean? Number 5), the tools for halting a credit crunch will include monetary stimulus from the Federal Reserve as well as a Fiscal response.

• STOCKS
• RELATED ARTICLES
• ALSO BY...

SEARCH:

Quote, Unquote: Biased Credit Rating Agencies?
Airlines: People Won't Fly, So We'll Raise Fees
Trading Radar: GDP Highlights a Thin Week
California Oversteps with HDTV Regulations
Goldman, Beaten But Unbowed

Five Things: The Ever-Sensational Looming Global Economic Collapse
Five Things: Social Mood Fuels the China Bull
Five Things: The Economic Crisis Takes a Virulent Turn
Five Things: Two Economies, One Deflation
Video: Q&A With Robert Prechter

What about financial markets?  Are we really lurching toward a full scale deflationary credit crisis?  Remember, the end of this credit cycle will be a long-term series of events, not a defined process.  What do we mean by that?

If we do fall into a full-scale deflationary credit unwind, it will eventually look like this: stocks decline, interest rates move lower, bonds move higher, yet the dollar goes up. Because dollars are used to pay down debt, they become more valuable. CONTINUED...