FED UP?

Quote: “We can’t solve problems with the same kind of thinking that created
them.”

Albert Einstein

Maybe it’s time to shake the cobwebs out, order another espresso (make it a double), and get to work. Historic changes are occurring right before our eyes.

Last week, the Federal Reserve Bank in an unprecedented move, offered JP Morgan a $30 billion credit line, to allow the investment banking firm to take over Bear Stearns, which had become insolvent almost overnight. The precedent established is something few of us can fully appreciate.

But in connection with this situation is a development with even more serious implications. The Fed “discount window” which previously provided liquidity only under extraordinary circumstances, and only to commercial banks, would now be made available to investment banks.

The Fed action in the JP Morgan/Bear Stearns deal, and others that will undoubtedly follow was probably necessary to head off a meltdown in the financial community. But a permanent policy change allowing the Federal Reserve to provide liquidity to these largely unregulated firms, well, that’s another story. It appears that this action is being considered an opportunity. These and other changes require our immediate attention.

Yes, immediate. As we speak, a battle for control and direction is developing. The Senate, as well as the Treasury Department, scrambles to propose legislation to reform a system no longer capable of dealing with financial services firms that cannot be restrained. This is what makes the recent Fed actions/bailouts alarming. It tells us what the next dropped shoe is likely to look like.

Recent related developments point in a similar direction:

• The infusion of capital by anonymous Sovereign Wealth Funds to Merrill Lynch, Citigroup, Morgan Stanley, and others. Potentially, the United Arab Emirates port security issue pales by comparison. It is fortunate that the general public doesn’t understand the implications of this.
• The AAA rating enjoyed by AMBAC and MBIA, insurers of municipal credit, are in jeopardy, compromised by liquidity issues. In essence, buyers of AAA rated tax-free bonds pay for coverage that is not really there.
• The Port Authority of New York and New Jersey struggle to find liquidity, unable to sell financial instruments they assumed would always have a market. Bridge and tunnel fares increase almost immediately.
• Treasury Secretary Paulson questions whether investors can rely on rating agencies. Lip service is given to corporate responsibility.
• On Thursday, Standard & Poors, a leading ratings agency, signals the “end in sight” to bad loan write-downs by firms.

Friday morning, the Fed steps in with a $30 billion line of credit to JP Morgan Chase, and the news of a virtually bankrupt Bear Stearns, a $2 a share buyout, rocks the markets.

So,

…..the decision will be made to create a completely new governance system, or put increased power in the hands of The Fed. The latter could prove to be disastrous.

And,

Using Al’s definition (Einstein, not Greenspan) we cannot ensure the responsible governance of our financial institutions, with what is already in place. That would be The Federal Reserve.

A lot can be learned by browsing the Fed website http://www.federalreserve.gov/

“Seven-member board that supervises the banking system by issuing regulations controlling bank holding companies and federal laws over the banking industry. It also controls and oversees the US monetary system and credit supply.”

...Its members are appointed by the President subject to Senate confirmation, and serve 14-year terms…

“The federal agency with rule-writing authority for the Truth in Lending Act, of which the Consumer Lending Act is part…

On the Federal Reserve site I also found the transcript of a recent speech made by Federal Reserve Governor Randall S. Kroszner at the American Bankers Association Spring Summit Meeting, Washington, D.C. March 11, 2008.

I’ve taken excerpts that I felt were important. There’s a lot more. Let me make this disclosure. I recognize that an address to the banking community might reflect a different, less confrontational tone. Nonetheless there are some telling comments.

“….in other words, it is good to have a few people within the institution (bank) who--to paraphrase a former Federal Reserve Chairman--know when to take away the punch bowl. Being the party pooper, however, can be very difficult in any organization…

“….Naturally, in very large organizations it is difficult for senior management to monitor each individual, so incentives need to be consistent, permeate even the lowest levels of the organization, and remind each individual that his or her risk-taking affects the whole enterprise.”

In other words:

Banks only need a few employees who are responsible fiduciaries. Whistleblowers, I imagine. All others, of course,“drink from the punchbowl”, getting drunk on profits, until something happens, or until they’re disciplined.

And:

This was not the fault of management, but of a system too large, too difficult to manage.

We would expect the support of business, the protection of corporate interests at all costs, in many places. We always assumed that the Federal Reserve would not appear on this list.

But this is not your Grandpa’s Federal Reserve…