The Fed's "emergency" interest rate cut has reignited concerns that offering cheaper money as a solution to problems rooted in excessive lending and mispriced assets merely stores up problems for the future.

For the third time in less than 10 years, the U.S. Federal Reserve suddenly changed the course of monetary policy, slashing borrowing costs by 50 basis points on Tuesday in response to unexpected stresses in the global banking and financial system.

Just six weeks ago it was saying the predominant policy concern was keeping a lid on inflation.

The European Central Bank and the Bank of England may not yet have followed suit, but both have effectively put planned rate rises on ice and injected emergency funds into the financial system as a result of the global credit seizure. Traders are now betting on a UK rate cut at least by January.

Analysts say such sudden policy switches are laced with moral hazard that stoke long-term risks in the global system.

Some reckon the Fed was left with a stark choice between the half percentage point cut it made in its key lending rates, or the risk that doing nothing could see a major bank failure after six weeks of financial market credit crunch.

But critics say the cause of the credit crunch the Fed was responding to has been uncertainty over the value and quality of U.S. subprime mortgages -- losses in which have been a direct result of what many see as years of ultra-cheap, lax lending.

Pouring in cheaper credit on top of that may ease the worst of the pain from the crunch, but the worry is that it does not solve underlying problems and risks losing focus on inflation.

"This is a problem where people have lost faith and trust in the quality of capital and it's not clear to me a half point cut in interest will restore that," said Avinash Persaud, chairman of financial risk consultants Intelligence Capital.

That policymakers see lower interest rates as an instant and appropriate response to banking problems, but doubt the effectiveness of higher rates to control asset bubbles fuelled by unfettered lending, is disturbing, Persaud said.

"This asymmetry is helping to destabilize the financial system," he said, adding the long-term risk was the problems would be "socialized" in the form of higher inflation.

EXCESS

Although world stock markets rallied more than 1 percent on the Fed's twin half-point rate cuts, interbank lending premia -- a key illustration of the credit crunch -- eased only slightly.

U.S. Treasuries fell, pushing yields on the benchmark 10-year note to 4.55 percent, as some investors worried that the cut would feed inflation, with crude oil hitting record highs, gold rebounding and the dollar dropping.

The main issue preventing banks lending to each other has been uncertainty of how the value of previously top-rated asset-backed securities will affect the viability of many of their sponsored investment vehicles and their balance sheets. This will take more than a rate cut to resolve, analysts said.

"This (Fed) action will ease the constraints of the current liquidity trap for some banks, but it will not combat the real cause of the current crisis," Jochen Felsenheimer, economist at UniCredit in Munich, said in a note to clients.

"We continue to think that excessive lending, excessive risk taking, and excessive leverage -- against a background of excessive use of structured instruments -- created a level of leverage with the financial system that now has to be removed."

And the inability of the world's major central banks to encourage commercial banks to start lending to each other again in recent weeks raises questions about whether they have lost control over increasingly complex financial markets.

If the only effective response to financial dysfunction is to inject "confidence" via lurches in overall monetary policy and official interest rates, then long-term consequences are a concern if such crises reappear every three years or so.

On Wednesday, credit rating firm Moody's -- itself at the heart of the recent crisis because of concerns over the high ratings it assigned to repackaged debts containing some toxic subprime loans -- highlighted problems in the modern system.

A reasonable repricing of risk, following five years of bullish sentiment and historically low credit spreads, turned into financial panic because of untested financial innovation and a presumption of liquidity, it said in a report.

The modern financial system is built on leverage, which is only possible with the presumption of liquidity, Moody's said.

"Panics remove that presumption, and it can only be restored by the authorities, who must ensure that systemically important bank and non-bank actors do not fail and trigger a systemic crisis," it said.

But Moody's also acknowledged the real solution lies in a better understanding of the financial risks that have accompanied breakneck innovation.

"A way to look at the current crisis is to say that financial deepening and sophistication has outstripped the available information resources in the system, and when things turn sour, it aggravated the information asymmetries," it said.

Others feel the Fed genuinely responded to the wider U.S. economic risks emanating from the contracting housing market.

Recent data showing a fall in U.S. payrolls even before the crisis really kicked in will also have been a key factor.

But even those who applaud the Fed's decision on economic grounds acknowledge that it will only be effective if it imbues banks with enough "confidence" to resume lending to each other.

The jury is still out on whether it would be enough.

"What happens in the interbank money markets over the next few days is absolutely vital because if it doesn't clear up, then this is not the end of the problem," said Jim O'Neill, chief global economist at Goldman Sachs.

(Additional reporting by Natalie Harrison)

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