The History and Organization of the Federal Reserve: The What and Why of the United States’ Most Powerful Banking Organization
The History and Organization of the Federal Reserve: The What and Why of the United States’ Most Powerful Banking Organization Posted by SOLARI STAFF
“Whoever controls the volume of money in any country is absolute master of all industry and commerce.”
-James A. Garfield, 20th President of the United States
The Federal Reserve is one of the most influential organizations in the U.S. when it comes to economic policy. It is also one of the least well understood elements of the government–especially in that it is not really truly a government organization. Its top level officials are a government agency of the Executive branch. However the Federal Reserve, and especially its 12 Federal Reserve District Banks, occupy a strange twilight zone between government agency and private banking organization.
This status has come up in court cases, where the district banks of the Federal Reserve have argued successfully that that they are not a government agency–instead being classified as “federally created instrumentalities.” (Scott v. Federal Reserve Bank of Kansas City, No. 04-2357 (8th Circ. Ct of App, 2005)(available at http://media.ca8.uscourts.gov/opndir/05/04/042357P.pdf)). A cynical person might say that they are part of the Federal government where advantageous and separate when it is not. However, it is enough to say that the Federal Reserve has an complex, hybrid structure to it.
The Federal Reserve itself has quite a bit of involvement in creating the monetary policy of the U.S. The most commonly discussed ways it influences the economy include acting as a last resort lender to member banks, regulating private banking, and–perhaps above all–setting the discount rate on loans to solve temporary liquidity issues for private banks across the county.
As the bank of the U.S. Federal Government, there is obviously great concern and interest in the financial goings on of the Federal Reserve. This has led to multiple attempts to audit the Federal Reserve–usually with Congress turning to the Government Accountability Office (GAO). The GAO is a Congressional agency which investigates federal spending. As we’ve discussed in previous articles, these duties are accomplished with varying levels of success by topic. ( see The U.S. Statutes Creating Modern Constitutional Financial Management and Reporting Requirements and the Government’s Failure to Follow Them, available at https://constitution.solari.com/the-u-s-statutes-creating-modern-constitutional-financial-management-and-reporting-requirements-and-the-governments-failure-to-follow-them/) Congress has requested studies as to the lengths to which the GAO can investigate the financial goings on of the Federal Reserve. (see eg. Federal Reserve System Audits: Restrictions of GAO’s Access, available at https://www.gao.gov/products/T-GGD-94-44). In 1978, the Federal Banking Agency Audit Act placed the Federal Reserve under the audit authority of the GAO–reversing the 1933 Banking Act provisions that originally removed this authority. (31 USCA §714, available at http://www4.law.cornell.edu/uscode/31/714.html).. Since this change, there have been dozens of GAO audits of the Federal Reserve. These audits have led to suggestions from the GAO on everything from check clearing policies to larger regulatory reforms. (see id.) This being said, there are some notable exceptions to the areas the GAO can look into, including:
(1) transactions for or with a foreign central bank, government of a foreign country, or nonprivate international financing organization; (2) deliberations, decisions, or actions on monetary policy matters, including discount window operations, reserves of member banks, securities credit, interest on deposits, open market operations;(3) transactions made under the direction of the Federal Open Market Committee; or (4) a part of a discussion or communication among or between members of the Board of Governors and officers and employees of the Federal Reserve System related to items.” (id.)
These are substantial exemptions. In order to understand just how substantial, it’s necessary to more fully understand the structure and role of the Federal Reserve. It’s worth noting that there have been multiple attempts in Congress to implement a more thorough audit nearly every year–including last year. (see eg. H.R. 24, Federal Reserve Transparency Act of 2017, available at https://www.congress.gov/bill/115th-congress/house-bill/24?q=%7B%22search%22%3A%5B%22Federal+Reserve+Transparency+Act+of+2017%22%5D%7D&r=4). These attempts have never succeeded. In past articles, we have discussed the problematic lack of transparency in government spending–especially in certain executive agencies. The Department of Defense and the Department of Housing and Urban Development have over $21T unaccounted for–approximately the same amount as our current national debt. (see eg. The Missing Money, available at http://missingmoney.solari.com). There is an obvious need for greater financial transparency and regulatory compliance in the government, and the Federal Reserve handles the government’s accounts, funds, security transactions, and implements monetary policy (mainly through the New York Federal Reserve Bank, discussed below).
In order to understand the role and issues of the Federal Reserve System, this series intends to take a look at the inner workings and functions of the Federal Reserve. To do a true deep dive on this issue can and has taken volumes to properly explore every avenue. Our goal with this series is to instead give a strong overview of the Federal Reserve, its functions, and its issues. Later articles will discuss the Federal Reserve Act in more depth (as well as the twilight-zone legal classification of a “federally created instrumentality”), the lending practices of the Federal Reserve, and some of the problems inherent to the most powerful banking organization in the U.S. and potentially the world.
However, in order to give the best understanding of the Federal Reserve itself, we will start by looking at the history and structure of the Federal Reserve–the what and why of the United States’ most powerful bank.
II. History and Creation of the Federal Reserve
The Federal Reserve was first signed into existence by then-President Woodrow Wilson over a century ago on December 23, 1913. (see Federal Reserve Act, Ch. 6, 38 Stat. 251, enacted December 23, 1913, 12 U.S.C. §§ 221 to 522, available at http://legisworks.org/sal/38/stats/STATUTE-38-Pg251a.pdf). The Federal Reserve Act created the Federal Reserve System and a centralized banking system for the U.S. It also granted this newly minted Federal Reserve System, among many other things we will discuss below, the power to issue Federal Reserve Notes. (see id.)
The stated goal of President Wilson and Congress was to promote economic stability through the uniformity and certainty of a central banking system which would promote and handle much of the monetary policy of the U.S. The move was almost without question the most substantial reform in U.S. financial law in the history of the county. (see 1913 Federal Reserve Act, available at https://www.investopedia.com/terms/f/1913-federal-reserve-act.asp)
The enormous financial reform bill came to President Wilson with the support of many Democrats of the time and the respective chairmen of the House and Senate Banking and Currency committees (see id.). However, the law was not prepared to make such a titanic change permanent just yet. The initial 1913 act limited the grant of power to twenty years, requiring renewal in or before 1933. (see The Federal Reserve Act, 12 U.S.C. §§ 221 to 522). However, Congress moved to renew the Act and make it permanent well before this deadline. In February of 1927 the Act was amended to perpetuate the Federal Reserve “until dissolved by Act of Congress or until forfeiture of franchise for violation of law.” (see 44 Stat. 1234). This move to make the Federal Reserve System permanent by renewing the Federal Reserve Act was far from a certainty during this time period. History buffs out there will certainly have noticed something about the timing of this renewal–it falls just before the beginning of the Great Depression. (see 1913 Federal Reserve Act, available at https://www.investopedia.com/terms/f/1913-federal-reserve-act.asp). The Federal Reserve, and most financial institutions of the time, were not particularly popular with the public. As the years progressed, and the Great Depression deepened, this opinion would only get worse. It’s also worth mentioning that the Bureau of Internal Revenue (later the IRS) was formed at the same time as the Federal Reserve in 1913. This came shortly after the 16th Amendment allowed for constitutional federal income tax after 50 years of creating and repealing income tax as a concept. During World War I the income tax spiked substantially–as high as 77%–it only came back down to around 24% by 1929 but continued to rise throughout the Great Depression. (see Brief History of the IRS, available at https://www.irs.gov/about-irs/brief-history-of-irs. This just exacerbated the extremely poor public opinion of financial institutions at the time. It’s very possible that had the renewal come in 1933 as planned there might be no Federal Reserve system today. (see 1913 Federal Reserve Act, available at https://www.investopedia.com/terms/f/1913-federal-reserve-act.asp).
However, even in the throes of the Great Depression, the recently strengthened Federal Reserve saw some changes to its structure and purpose. The Banking Act of 1933 further amended the Federal Reserve Act in a number of ways. (see Pub. L. 73-66 available at https://fraser.stlouisfed.org/scribd/?title_id=991&filepath=/docs/historical/congressional/1933_bankingact_publiclaw66.pdf). The Banking Act of 1933 created the Federal Open Market Committee (or “FOMC”) — a 12 member committee of top level officials from the Federal Reserve which we will discuss at length later in this article. This created a committee remains one of the most powerful and influential arbiters of financial policy decisions in the U.S. to this day. The Act gave the FOMC power over essentially all open-market operations of the member banks of the Federal Reserve. (see id.). It additionally added a requirement that the FOMC meet at least four times per year. (see Pub. L. 73-66.) Today, they generally meet double that number, about eight times in a year. (see 1913 Federal Reserve Act, available at https://www.investopedia.com/terms/f/1913-federal-reserve-act.asp).
However, as we will discuss in a later article, these meetings are not open to the public, although they do publish edited and redacted meeting minutes and transcripts.
Since the creation of the FOMC, the Federal Reserve Act has seen well over 200 amendments. (see id.) However, it continues to be at the center of U.S. financial policy. As of November 16, 1977, the Federal Reserve Act was amended to provide the FOMC and the Federal Reserve a clear goal: “to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.” (The Federal Reserve Act, Section 2A, available at https://www.federalreserve.gov/aboutthefed/section2a.htm). This amendment also required the FOMC Chairman to appear before Congress at semi-annual hearings and report on their current and future steps towards achieving these goals. Congress wanted testimony to make sure the Federal Reserve was operating as intended.
III. Structure of the Federal Reserve System
In order to understand the function and faults of the operations of the Federal Reserve, and most importantly whether and how they work to achieve their stated goals, it is important to first understand the structure of the Federal Reserve itself. While linked to the federal government, much of the Federal Reserve essentially operates as a private corporation would. They do not even receive funding appropriated by Congress. They would hardly need it with approximately $100B in profits in 2015 alone, of which $97.7B went to the U.S. Treasury. The Federal Reserve is required to turn over all money it makes in excess of its costs to the U.S Treasury every year. The Federal Reserve derives its income for operations and salaries from “the interest on government securities that it has acquired through open market operations…the interest on foreign currency investments held by the Federal Reserve System; fees received for services provided to depository institutions, such as check clearing, funds transfers…automated clearing house operations; and interest on loans to depository institutions. (How is the Federal Reserve System Structured, available at https://www.richmondfed.org/faqs/frs.)
The Federal Reserve’s chief governing body–the Board of Governors–is an executive agency with the salaries of the individual members set by the federal government. This means the top levels of the Federal Reserve have direct ties to and report to the federal government. However, from there the organizations connection to the government becomes much looser–with other elements of the Federal Reserve connected to the government essentially only by oversight from the Board of Governors. In a lot of ways, the Federal Reserve essentially runs itself as a private business that hands over the money it doesn’t pay itself to the U.S. Treasury. (see id.)
At the very top of the Federal Reserve System is the Board of Governors, with the FOMC and Federal Advisory Committee (FAC) directly below them as advisors to their decision making process. That being said, the majority of the FOMC is made up of the Board of Governors and has complete control over all open market operations. The Board of Governors and FOMC oversee 12 Federal Reserve district banks which each are the head of a large district of banks and have their own Boards of Directors. These district banks have no direct ties to the government. Each of these 12 district banks have a number of branches and member banks, all of which have their own Boards of Directors and also have no direct ties to the government. All of these layers have their own roles and responsibilities under the law and their own requirements for appointments to those positions. (see id.)