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, scramble
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 here: 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…