Like an umpire in baseball or the referee in football, Federal Reserve Chairman Jerome Powell strode to the podium and recited the "rules to this game." He does this every time he gives a press conference or speech.

"My colleagues and I are squarely focused on achieving our dual mandate goals of maximum employment and stable prices for the benefit of the American people."

Educated as a lawyer, Powell says, " See, we did what you asked us to do."

But this time, the words seemed to ring hollow, creating confusion and perplexity among the analysts on Wall Street. The analyst's reasoning went like this: if the Fed's goals are stable prices (with an inflation goal of 2%) and steady employment, then why isn't the Fed fighting higher prices (inflation)? Fighting inflation would mean that the Fed would look to raise interest rates, not lower them.

Currently, inflation, as measured by its most widely followed indicator, the Consumer Price Index (CPI), is rising, not falling. In November's reading, the CPI was up 2.7% after reaching a cycle low of just 2.4% in September.

Underscoring this rise in inflation, Powell goes on to say that core PCE Prices (the Fed's preferred measure of inflation) are rising at 2.8%, even higher than the CPI level.

At this point, we're all on the same page: Inflation is the problem, and the Fed ought to fight it.

It's then that Powell pulls the rug out from under us:

At today's meeting, the Committee decided to lower the target range for the federal funds rate by 1/4 percentage point to 4-1/4 to 4-1/2 percent.

Wait just a minute! As any first-year econ student knows, lowering interest rates contributes to inflation; it doesn't curtain it. This move is inexplicable; it makes no sense in a world where inflation is rising.

Wall Street was gobsmacked, the bond market went into a tizzy, and market commentators wrote long screeds about Powell's misreading the financial markets.

However, like most things in Washington, Powell's move had less to do with finance and economics than politics. And to appreciate that, you have to go back to the origin of Powell's "Rules of the Game." Where did the twin mandate come from? And why are the Fed's chief goals "full employment and stable prices?"

To understand the Twin Mandate, we have to go back nearly half a century to the time of one of the cleverest politicians of that era, Hubert Horatio Humphrey. Humphrey was a self-styled "man of the people." A populist from Minneapolis, Humphrey did not trust the "North East Bankers."

He felt that the brokers and bankers from New York and Boston had too much influence over our economy to the detriment of everyday people. At this time, the nation was suffering from the twin ills of high inflation and high unemployment. Humphrey thought it was time to put the nation's central Bank, the Federal Reserve, on the task of addressing those two problems.

So, he, along with his colleague in the House, Augustus Hawkins, wrote the Humphrey Hawkins Bill, which was later passed into law. This was the law that "mandated" the Fed's twin goals: full employment and stable prices.

The new law also cleverly removed the federal government's primary responsibility for full employment, which it had been for 32 years (under the Employment Act of 1946), and now placed the goal squarely on the shoulders of the Federal Reserve while adding "stable prices" (I.e., Fighting inflation).

What a remarkable tour de force! Humphrey could remove himself and his fellow legislators from the responsibility for full employment and hand it over to the Bankers, the very ones he did not trust.

The new law also very subtly set a trap for the Federal Reserve, one that Jerome Powell stepped into this week.

Ask any banker before the Humphrey Hawkins Bill (now called the "Full Employment And Balanced Growth Act), what the primary function of the Central Bank should be? And they'd no doubt answer: maintain a sound banking system. That is, ensure the nation's banks are healthy and strong.

Unfortunately, today, we find ourselves in an environment where fighting inflation conflicts with the Bank's balance sheet.

Banks, broker-dealers, Insurance Companies, and other financial institutions are required to maintain certain minimum levels of (net) capital. I'm most familiar with Broker-Dealer Capital Requirements, but the principle behind all of these computations is the same (although the specific regulations differ between industries).

Most banks hold their capital in US Treasuries, the highest-rated of all available investment options. A look at the capital account of most banks will reveal a number of US Treasury Bills, Notes, and Bonds. Generally, the Bank will calculate its current capital position by adding up the current quote of its portfolio of US Treasuries and any other capital position (like cash or corporate bonds), taking appropriate adjustments, and providing its Regulator with the current capital position of the Bank.

Here's the rub. As any bond investor knows, the past couple of years have been one of the worst bear markets in bonds. Remember, the price of bonds is INVESRSLY related to the yield. As yields rise, the price of bonds (and notes and, to some extent, Bills) falls.

So, what happened in the last couple of years that caused this bond bear market? Of course, the Federal Reserve raised interest rates -- the most in history. The Effective Fed Funds Rate went from less than 1/4% to over 5%. In Powell's pronouncement this week, the Fed reduced the rate to 4 1/4%, still substantially above the level of just a couple of years ago. It has had a devastating effect on the Bank's Capital Account.

Let's assume that your Bank purchased 5-year US Treasury Notes in January 2022, just before the Fed started raising interest rates. The Bank paid $1,000 for the Notes, and their yield was roughly $30, or 0.3%. Assuming the Bank still holds the Notes in its Capital Account (they'll mature in 2027), what's the current price of those same notes? Approximately $750, or a 25% loss.

If our imaginary Bank holds many of these Bonds or Notes, the chances are overwhelming that it is now undercapitalized. I believe that this was the real reason that Silicon Valley Bank went out of business last year.

We can see the effect that the higher rates have had on Depository Institutions (Banks and Savings and Loans Credit Unions), as the Federal Reserve publishes a monthly report on their (Capital) Reserves (net capital above requirements).

Reserves for the industry have declined from $4.1 trillion in December 2021, before the Fed raised rates, to $3.2 Trillion as of October. That's a decline of approximately $900 Billion, due almost entirely to the decline in Capital Accounts in this rising interest rate environment.

This is also why Chairman Powell was forced to reduce interest rates. Had the Fed chosen to continue raising rates, as Wall Street expected, it is likely that several major Banks and other Depository Institutions would have closed.

For now, the Fed's fight against inflation will have to take a backseat to its effort to preserve its member bank's capital accounts.

Perhaps it's time to amend the "Twin Mandate" to something that more closely replicates the reality of maintaining the Banking Industry's viability.