Fed signed a memorandum of understanding that, in effect, puts the key elements of a Fed regulatory structure

implicit Fed backing for the large investment banks – into place

From the Financial Times:
on Monday, with the support of the Treasury, the Securities and Exchange Commission and the Fed signed a memorandum of understanding that, in effect, puts the key elements of a Fed regulatory structure – and implicit Fed backing for the large investment banks – into place. What this amounts to is a straightforward Fed reach for important new regulatory authority, an unprecedented step in which a weak SEC – chastened after the failure of Bear Stearns – has been complicit. It would be perfectly acceptable if the agreement covered only the emergency period the markets are now experiencing, but it has no time limit.

The agreement is very bad news for US taxpayers.

Fed involvement with the regulation of investment banks will introduce moral hazard into the securities business for the first time and pave the way for a vast new US government liability. The agreement between the Fed and the SEC will seriously compromise market discipline, which only exists when creditors and other counterparties believe that they are financially at risk. What now amounts to ongoing supervision of the financial condition of investment banks by the Fed sends an unmistakable signal to the markets that the government believes itself to be at risk. Under these circumstances, investors will be justified in believing that the US government will ultimately stand behind the large investment banks. This will irretrievably compromise market discipline, which in turn will produce the very risk-taking and subsequent losses that regulation – as recently as the savings and loan debacle – has never been able to prevent..."