The Federal Reserve is the central bank of the
United States. It, like all central banks, is
charged with maintaining internal economic stability
through control of exchange rates, interest rates,
and money supply. It is the arbiter and implementer
of American monetary policy. Hated
by conspiracy theorists, gold standard true believers,
and anti-globalization forces alike the Fed is one
of the most powerful organizations in the world. It is
a pity, then, that so few understand what it does or why.
In 1907 the United States experienced its fourth banking
panic in 35 years. Liquidity dried up as depositors
withdrew funds and interest rates shot sharply upward as
banks scrambled for cash to cover the withdrawals. Institutions
that still had cash on hand stopped lending, preferring to
hoard their cash in case of another run on deposits. The
sudden withdrawal of credit forced more businesses to make
large cash withdrawals to meet operational costs and debt
repayments. Lacking any mechanism to influence liquidity the federal
government was forced to sit idly by as thousands of businesses
failed, drowning in a horrific financial whirlpool created by the
vicious cycle of simultaneous cash and credit crunches.
The need for reform was clear, but the political will was severely
lacking and efforts stalled. Bills sponsored by senators from
New England failed to win widespread support, those that did
pass didn't go far enough. People in the south and fast-growing west were
unwilling to accept legislation pushed by people viewed as being in the
pocket of large eastern banks and corporations (think JP Morgan,
Standard Oil, and the like). Opposition arising from Americans'
instinctive distrust of any centralized power was more widespread.
The first attempt was the Aldrich-Vreeland Act, enacted in the spring
of 1908. This provided emergency currency to help the still fragile
financial system recover from the panic of 1907. It also formed the
National Monetary Commission and charged it with creating a plan
for the reform of the banking system. The bill also generated intense
opposition for perceived pandering and cronyism. The lead sponsor,
Nelson Aldrich of Rhode Island, had numerous apparent conflicts of interest,
he was a close friend to J.P. Morgan and his daughter was married to
a junior Rockefeller.
Opposition didn't come only from those worried about the scope of government
or threatened by pork-barrel politics--bankers and businessmen
were against the idea of any reform at all if it
would increase their cost of business. Still, over the next 4 years
and after much compromise and the spending of much political capital
the commission came back with a recommendation. Named the Alrdrich
Plan, it called for the creation of a privately held central bank
backed by commercial assets, The Federal Reserve.
The election of 1912 changed that. Woodrow Wilson swept in and
with him came a Democrat majority Senate to go along with the
Democrat majority House. The Aldrich plan was a good plan, though,
not designed to benefit the rich Northerners at everyone elses expense.
His main concern when drafting it had been to adequately check the
powers of elected officials over the economy while still retaining
government oversight and accountability. In this he succeeded,
and the final Federal Reserve Act, passed in 1913, ended up, in the words of
President Wilson, "70% faithful" to the original Aldrich Plan.
The structure of the Federal Reserve
70% Aldrich it may have been, but the man most associated with the
creation of the Fed was Georgian Carter Glass. An antebellum
Southern gentleman, Glass believed absolutely in the supremacy
of the white male property owner. A politician of the Jeffersonian
flavor, he was staunchly opposed to the centralization of power
and it is in this respect that the most important 30% of the Aldrich
Plan was gutted.
The original plan called for the creation of a single central bank
with power of the currency of the United States. Glass changed
this to a system consisting of several independent central banks,
each with responsibility for a certain geographic area. These banks
would be operated by professional bankers and would not be wholly owned (in the sense
that they were not wholly originally capitalized) by the Federal Government.
Initial capital for each branch would come from the banks in its region,
for which each Reserve branch would conduct the routine business of a
central bank--settlement and clearing, interbank loans, and the like--for
member banks in its region.
Overseeing these banks would be the Federal Reserve Board of Governors,
a seven member committee appointed by the President and confirmed by
the Senate. This Board, plus five of the governors of the regional
branches, would constitute the Federal Open Market Committee which would
be vested with control over monetary policy. Both Aldrich and Glass
had recognized the importance of checking the private bankers natural
inclination to push policy beneficial to them or their industry with
publicly accountable officers while at the same time ensuring that
partisan politicians couldn't hijack the economy.
This plan passed as the Federal Reserve Act of 1913. Today, the Fed is organized
along these broad lines. The members of the Board of Governors are appointed to
14 year terms with a term expiring every two years. To avoid regional bias,
no Fed district can have more than person on the Board at a time.
The mission of the Fed
The Fed sees its mission as fourfold:
- Conduct the monetary policy of the United States
- Supervise and regulate the American banking system
- Maintain the stability of the financial system
- Provide banking services to member banks and the federal government
As the designer of monetary policy the Fed engages all of the traditional
powers of the central bank--the ability to set interest rates,
control over the money supply, and control over the nation's foreign reserves.
It uses these powers to implement and maintain a set of policies collectively
known as the Golden Straitjacket.
As supervisor of the banking system the Fed is responsible for setting
capitalization requirements for banks, overseeing the credit processes,
and enforcing other banking regulations.
As a lender of last resort the Fed has the power to preserve the stability
of the financial system by providing emergency cash infusions to institutions
facing severe cash problems. Banks on the verge of bankruptcy can be
rescued while an orderly dispersal of assets or management restructuring
Finally, the Fed provides clearing and settlement services to its
member banks and to the federal government. Its settlement service
processes more than one-third of all checks written in the United States,
$12 trillion annually. It handles more than $200 trillion annually
if purely electronic transactions are factored in.
Federal Reserve Banks
- Boston, Massachusetts, District 1
- New York, New York, District 2
- Philadelphia, Pennsylvania, District 3
- Cleveland, Ohio, District 4
- Richmond, Virginia, District 5
- Atlanta, Georgia, District 6
- Chicago, Illinois, District 7
- St. Louis, Missouri, District 8
- Minneapolis, Minnesota, District 9
- Kansas City, Missouri, District 10
- Dallas, Texas, District 11
- San Francisco, California, District 12