The latest balance sheet of the Federal Reserve makes me wonder whether it's solvent. That's because its balance sheet has clearly deteriorated in the last year. And with $40 billion in capital, that deterioration could take a big bite out of the Fed's capital.

Unfortunately, I do not know enough about how the Fed gets its capital or how it accounts for the value of its assets and liabilities to be able to do more than raise questions. But here are three things that concern me:

• Declining asset quality. The total value of the U.S. Treasury securities on the Fed's balance sheet declined by $312 billion between July 2007 and this July -- a 43% drop in this highest quality asset.
• Increase in shakier assets. During this same period, the balance in Term Auction Facilities -- the credit line that investment banks are using to get their shakier assets -- such as Collateralized Debt Obligations (CDOs) off their balance sheets --increased from $0 to $150 billion. Another $29 billion in assets come from Maiden Lane, LLC -- the entity created for the Fed to take on the toxic waste that sank Bear Stearns.
• High leverage. While the Fed has more capital backing up its assets than the typical investment bank -- which holds $1 of capital for every $32 in assets -- the Fed is still highly leveraged -- with only $1 of capital for every $23 of assets -- it borrows the rest. Put another way, if the Fed was forced to account for its balance sheet on a mark-to-market basis, a mere 4.5% decline in the value of the Fed's assets would wipe out its capital.

These observations raise questions in my mind:

Are the days of wine, roses and interest rate cuts over? The answer for now seems yes.

In a statement released today, the Federal Open Market Committee said it decided to keep its target for the federal funds rate at 2% because data indicates that labor markets have soften further and financial markets remain under stress. Moreover, the credit crunch, the lousy housing market and rising energy prices are "likely to weigh on economic growth for the next few quarters." No kidding.

The FOMC's decision, which comes amid growing fears about the outlook for inflation, should not have come as a shock to investors. Federal Reserve Chairman Ben Bernanke and other top bankers have hinted for months that the days of wine, roses and interest rate cuts would be coming to an end. In fact, the market seemed to have already absorbed the market. The major stock market averages barely budged after the announcement was issued.

Ever had too much to drink and been cut off by a bartender? Federal Reserve Chairman Ben Bernanke did the same thing to the U.S. economy today, and investors reacted as if they had been denied their favorite alcoholic beverage, angrily sending the stock market tumbling.

In a speech today to the International Monetary Conference in Barcelona, Bernanke pointed out that the Fed has "eased monetary policy substantially and proactively to address the sharp deterioration in financial conditions and to forestall some of the potential adverse effects on the broader economy. . . . For now, policy seems well positioned to promote moderate growth and price stability over time. We will, of course, be watching the evolving situation closely."

Bernanke also expressed concerns about the weak U.S. dollar, which has helped boost the earnings of some large multi-national companies. The Fed is "attentive" to the implications of the declining greenback for inflation and inflation expectations. In other words, investors expecting yet another Fed interest rate cut should not hold their breaths. Bernanke is going to close the candy store sooner rather than later.

But unfortunately for investors, this news came amid growing worries that Lehman Brothers Inc. (NYSE: LEH) may report its first quarter loss and raise billions in new capital. This comes a day after Wachovia Corp. (NYSE: WB) ousted its chief executive Ken Thompson. Shares of Merrill Lynch & Co. (NYSE: MER), Morgan Stanley (NYSE: MS) and Bank of America Corp. (NYSE: BAC) also tumbled.

This really may be the last call for lower interest rates for a while. A bartender realizes that drunks will keep buying as many drinks as they pour. But the benefits of increasing the bar's bottom line are outweighed by the dangers caused by an intoxicated person getting behind the wheel of a car. The same tough love is being applied to investors and though it may be painful at first, it's the right thing to do in the long run.

It seems that the Fed just got done cutting rates. Now, it may want to raise them. Inflation appears to be getting bad enough so the the agency could need to up interest rates to keep prices from overheating. According to Reuters, "Two Federal Reserve policy makers warned on Wednesday that interest rate increases might be needed before too long to curb inflation." And, the FT writes,"A sell-off in the US bond market pushed the yield on 10-year Treasuries above 4 percent on Wednesday for the first time since January, as investors bet that pressure from record oil prices would force the Federal Reserve to raise interest rates this year."

In other words, two different papers using two sets of reasoning to come to the same conclusion. Great minds thinking in the same direction but coming at it from different points of view. In all probability so many smart people are probably not wrong.

But, what about that recession? If credit is tight and housing markets continue to fail, where is the relief for consumers? Their spending did drive the economy for half a decade. If they do not return to their old habits, how does the foundation of a recovery get built?

The answer may not be very attractive. Inflation may be cut down by Fed increases, and the lack of credit may drive the economy further into a deep downturn.

It may be as simple as realizing that both problems cannot be fixed at once.

Douglas A. McIntyre is an editor at 247wallst.com.

Many people are saying that the rise in oil prices is the result of loose monetary policy. They say that there is an easy solution to the problem. Raise interest rates substantially, and the problem will be solved. Since the rise in oil is also the primary cause of rising inflation, the inflation problem will be resolved as well.

There are several problems with this line of reasoning. Oil continued to rise as the Fed began to increase interest rates in 2004. Prices doubled as the Fed substantially tightened monetary policy. Europe also has the some of the same inflation issues that we face despite the refusal of the European Central Bank (ECB) to lower rates.

Then, there are the big questions. Why are oil prices rising? What is the short-term solution?

I believe that the main reason for the rise in oil prices is the rise of the developing world. The two nine hundred pound gorillas in this equation are India and China. Automobile demand is increasing in these countries and is likely to continue in the near future.

This is similar to the rise in oil prices in the late 1960's and early 1970's. After World War II, the United States was the primary industrial power. As the world industrialized, demand for oil increased. The United States was not the only nation driving cars extensively. Supply constraints were also introduced in the mid to late 1970's with the Arab oil embargo and the Iranian revolution.

The Fed's job is to control inflation. But is was established originally to keep financial panics from getting out of control. Since last August, it has reverted to its original role and failed miserably. Since it began cutting its Fed Funds rate 57% from 5.25% to 2.25% the price of a barrel of oil has risen 62% from $71 to $115. Simply put, the weaker the dollar, the higher the price of oil. Bloomberg News proves it -- noting that in the last year, there was a 0.96 correlation -- a correlation of 1.0 would be a completely safe bet -- between the Euro-dollar exchange rate and the price of oil.

If it bothers you to pay $3.66 for a gallon of gasoline you can thank the Fed along with cheerleader, Hank Paulson who brags that he's been talking about the U.S.'s strong dollar policy consistently. Of course saying and doing are two different things. Since January 2001, the dollar has lost 70% to the Euro. And since oil is traded in dollars, a drop in the dollar leads to a rise in price. And lower interest rates erode further the value of the dollar since it pays government bond holders a lower rate of return so they sell the U.S. currency and buy higher yielding ones.

But it's unfair to give the Fed all the blame. After all, we have been running the Federal budget at a deficit -- expected to hit $413 billion this year. Since the Fed has started cutting rates, other factors such as speculation by leveraged traders -- relying on the 0.96 correlation -- and political instability seem to have remained at the same level -- although the degree of speculation seems difficult to measure. And U.S. demand has declined due to the economic slowdown. So it looks like those dollar-weakening rate cuts are the one factor powerful enough to offset the demand slowdown to drive prices up.

Ted Allrich is the founder of The Online Investor and author of the just released book: Comfort Zone Investing: Build Wealth And Sleep Well At Night. In this weekly column, he'll offer advice to investors who are just getting started.

Any investor looking to the Fed to bail out current credit problems is looking at part of the answer. The Fed can only do so much. It can lower interest rates. It can add money to the economy. But that isn't going to be enough to cure all the bad mortgages or delinquent credit card payments. And if the Fed adds too much money to the economy, it feeds inflation. The Fed needs help from Congress and the President and mostly business, particularly the banks and thrifts that made the loans.

Here's the essence of the problem: even if rates go much lower, if people don't have jobs, they won't borrow money because they don't have the means to pay it back. Furthermore, banks won't lend money to the unemployed or underemployed. They've already done that. That's why we're in this mess. And they should be the ones to pay for it, not taxpayers. The lenders need to face these problems squarely and take the necessary measures to work them out.

Reuters reports that jobless claims jumped to their highest level since 2005. Specifically, U.S. workers applying for unemployment benefit rose by 38,000 last week, posting the highest reading since September 2005. I guess Fed Chairman Ben Bernanke had the statistics on his side when he testified that "It now appears likely that real gross domestic product [GDP] will not grow much, if at all, over the first half of 2008 and could even contract slightly."

The key is how the statistics performed relative to expectations. The 407,000 jobless claims reported in the week ended March 29 was way above economists' estimates of 370,000. If consumers lose their jobs, they'll have even more trouble borrowing to pay their rising costs of living. Although government statistics hide it -- anyone who drives or buys food knows that prices are rising.

Bloomberg News reports that job losses are coming from homebuilders and housing-related businesses, including lenders and financial service companies with exposure to mortgage-backed securities, are also stepping up firings. It also quotes an analyst who said, "400,000 is usually a trigger point when we consider recessionary times." I credit Bernanke for knowing a bit more about what's going on -- unlike the President who was shocked to learn about $4 a gallon gas. .

Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter.

BusinessWeek reports that the $29 billion "loan" that the Fed is making to finance JPMorgan Chase & Co. (NYSE: JPM)'s $1.2 billion acquisition of The Bear Stearns Companies (NYSE: BSC) is really an equity investment in $30 billion worth of mortgage-backed securities (MBSs).

If that investment goes sour, taxpayers will suffer. I think we deserve to know more of the details of those MBSs before the deal closes. For instance, what would a buyer be willing to pay for those MBSs in the open market? If the answer is 10 cents on the dollar, why should taxpayers be on the hook for the losses?

To do the deal, a Delaware-based limited liability company (LLC) will receive the $30 billion worth of Bear MBSs. The Fed will "lend" $29 billion to that company, which will pass all the money along to JPMorgan. JPMorgan will contribute a $1 billion loan to the LLC and BlackRock ­Financial Management will pay back the LLC's loans by gradually liquidating the assets. The Fed gets paid back fully before JPMorgan gets back anything on its loan. And if, after JPMorgan gets paid back, there's money left, the Fed gets it all.

The Bear Stearns (NYSE: BSC) deal happened fast, almost overnight. Some analysts think buyer JP Morgan (NYSE: JPM) got a great deal because the Fed is backing almost $30 billion of Bear Stearns asset values. Within days of an announcement of the buyout, the big bank had 39.5% of BSC shares, a lien on its headquarters, and a very firm deal at $10 a share.

According to The Wall Street Journal: "Indeed, it's possible a Delaware court could find these features coercive, and depriving shareholders of a true vote." It is true that Bear's shareholders did not have much time to consider the idea. The Fed and JP Morgan would argue that there was not time. The brokerage was about to go under.

As is true with most visible deals that involve shareholder rights and employment, Congress may decide that it wants to look at the transaction, as if it did not have better things to do.

The perverse argument here is that shareholder rights trump the company's survival. It leads to a conclusion that the holders of Bear Stearns stock should have been able to accept or reject the JP Morgan bid, even if it caused Bear Stearns to go under. In essence, shareholders have the right to lose all of their money, if they wish.

Douglas A. McIntyre is an editor at 247wallst.com.

It has happened before. The cuts were especially deep after the market crash in 1987. New York City now believes that Wall St. will cut 20,000 jobs over the next two years. The number seems too small.

Accoding to Reuters: "The city's Independent Budget Office, in its report, estimated that Wall Street's profits for 2007 will sink by more than 80 percent to the lowest level since 1994." Financial firms account for almost 35% of all income in NYC.

While this would seem to be a local problem, that is not entirely true. Companies that sell luxury items from Tiffany (NYSE:TIF) to BMW will take some hit from falling employment among workers at big banks and brokerages.

Just as important, all of these people pay a hefty federal income tax. As unemployment grows the government will see receipts from the IRS fall. The more of the rich who move off the payrolls, the more difficult it will be to cut the Federal deficit and fund agencies like the Fed.

Douglas A. McIntyre is an editor at 247wallst.com.

Today the market is closed for Good Friday. Maybe the market can use the day off.

The market is bipolar. Rising from stratospheric highs to crushing lows at the flick of a switch. Mind you, sometimes it takes a big event to turn the market on and off and sometimes it doesn't take much of anything. That's what makes the market so maddening to follow.

Bloomberg News argues that the market's reaction indicates that Federal Reserve Chairman Ben Bernanke's strategy of aggressive interest rate cuts is working since commodity prices had a huge sell-of this week.

"The Standard & Poor's 500 Index posted its first weekly gain in a month, and the dollar leapt from its lowest level since 1973 after the Fed stepped in March 16 to rescue Bear Stearns Cos. (NYSE: BSC), the fifth-largest U.S. securities firm, and expanded its role as lender of last resort to embrace the biggest dealers in Treasury notes," the news service reported. "The Reuters/Jefferies CRB Index of 19 commodities tumbled 8.3 percent this week, the most since at least 1956, after touching a record on Feb. 29."

But any rejoicing may be premature. Consumer confidence remains shaky amid continued worries about the real estate market. Applications for unemployment benefits soared to their highest level in nearly two months, according to the Associated Press. In short, there is plenty to worry about.

The trick for investors is not to panic and do anything rash. Markets aren't volatile forever and do eventually sort themselves out. Getting to that point may cause quite a lot of pain in the meantime.

I have friends who work at Bear Stearns (NYSE: BSC) and one of them in a very senior capacity. Believe me, they are not laughing and this is actually quite a sad moment for them and their colleagues. Bear Stearns had an 85-year history having come through the Great Depression and several recessions. Bear was a proud trading house and took great pride in its trading prowess. Sure, the naysayers will argue that Bear bit off more than it could chew and that Bear was a greedy Wall Street firm. But there is more to the story and it should be told.

Bear Stearns was the second-largest packager of mortgage backed securities only surpassed by Lehman Brothers (NYSE: LEH). As we saw these past couple of years, the quality scale on mortgage-backed securities slid down to lousy, risky sub-prime mortgages. But keep in mind that the $400 billion worth of securities that Bear Stearns underwrote and managed were not all lousy credit risks. The biggest part, more than $300 billion worth were of the highest quality. Bear Stearns facilitated a market that needed facilitating!

In the old days, only major banks underwrote mortgages and they typically kept and serviced the loans. But as the American population and economy expanded these past 20 years, mortgage companies were formed and needed to "sell the loans off" as they did not possess the capital base of say a Bank of America (NYSE: BAC) or a Wells Fargo (NYSE: WFC). Firms like Bear Stearns became adept at packaging these loans and re-selling them to major pension funds and hedge funds globally.

The Fed has opened itself up to take some fairly weak securities from banks in exchange for funding to keep them liquid. According to Reuters: "The U.S. Federal Reserve is taking a risk by opening up its own balance sheet to the same poisonous securities that have strained banks to the limit."

The agency may feel it has little choice other than to swap good money for bad securities. The problem is that, if it does not, some large financial institutions could fail. The Fed can wait to see if the value of the securities increase over time as some subprime mortgages are paid off and locked up credit markets start to trade again. But, to think that the investments will ever be worth $1 for $1 that the Fed lends out is highly unlikely.

That means that the government has gone all the way to bailing out these companies and that tax-payers will foot the bill for tens of billions of dollars of "losses" at the Fed.

But, even if the tax-payer is asked whether he would like to pay a few more dollars to help big financial institutions stay in business or lose his job in a huge recession, he is likely to vote for paying the extra money.

Douglas A. McIntyre is an editor at 247wallst.com.

Reuters reports that Carlyle Capital -- an affiliate of Carlyle Group that counts former President George H. W. Bush among its advisers -- can't pay back the $16.6 billion it owes banks. So its lenders are taking possession of its assets to try to recoup some of the money they lent. Interestingly, it said that the only assets held in its portfolio as of Wednesday were U.S. government agency AAA-rated residential mortgage-backed securities (MBSs). If these securities are indeed worth their AAA rating, I wonder how much of a "haircut" those lenders will take.

This latest collapse is evidence of two viciously destructive cycles in the global credit markets which government policy decisions are making even worse. The first cycle is driving down the stock market, setting inflation on fire, and hammering the dollar -- which is down 68% since 1/19/01 -- as the economy slows. The second cycle is reinforcing a chest-clutching decline in the value of the $6.1 trillion MBS market:

• The Bernanke call. As I've posted, this means that Federal Reserve Chairman Ben Bernanke's moves mark a ceiling below which the market keeps falling. The basic idea is that when the stock market falls, the Fed responds by flooding the market with money -- interest rates have fallen from 5.25% to 3% and are likely to hit 1% and then there's the "Term Auction Facilities" like this week's $200 billion month long swap of government securities for MBSs. The lower rates and added money spur inflation -- oil (+357% since 1/19/01), food prices rise (e.g., milk prices +12% in 2007) and gold futures hit $1,000 -- but do nothing to solve the basic problem -- which is to recapitalize banks. The market falls on the announcement of a new credit market problem, such as Carlyle's default, and the cycle begins anew.