Fed dilemma

The point of hiking interest rates is to inflict economic pain. In a perfect world, it would be spread evenly and fairly, the economy would slow just enough to bring inflation back into balance.

But interest rates are a famously blunt tool.

As it stands, the burden falls highest on people in precarious positions: those who borrowed too much and can't make the payments. We collectively accept that families will suffer to bring inflation under control.

What if, instead, that burden fell on banks and venture capital?

Would that be a good thing? Sure. Those are supposed to be the risk takers in an economy.

Is it what's going to happen? I'm not so sure.

In a perfect world, venture capital would get cleaned out and banks would tighten lending. That would mean the Fed wouldn't need to hike as much and it would give those indebted consumers are fighting chance of survival.

The problem for the Fed and Treasury is that it's tough to contain a banking crisis. If they allow the fire to spread -- like officials did with Lehman Brothers -- it could get out of hand quickly. My belief is that the financial crisis didn't need to happen. It would have been expensive but a quicker combination of rate cuts, QE and government money would have been far cheaper than what unfolded. That lesson hasn't been forgotten in Washington.

So what will happen?

Maybe I'm cynical this is an easy choice for the Fed and Treasury: They'll save the banks and hang consumers out to dry.

Squeezing the economy slowly with rate hikes is a tried-and-true method where policymakers can feel like they're in control. A banking crisis is playing with fire.

In a future post I'll write about why the Fed and Treasury should resist the impulse to race to the rescue.