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Tuesday, April 1, 2008

You, the Fed Gov, & the Fed

Today's papers are filled with stories about the Bush Administration's proposal to cede more power over the nation's economy to the Federal Reserve System.

But before considering the merits or demerits of that proposal, take a few minutes to read this overview of the Federal Reserve and its functions. Given that this material was prepared and placed on the Web by the Federal Reserve Bank of Cleveland, a member institution of the Federal Reserve itself, you might want to pay attention when they say:
...The Federal Reserve System is independent within the government. Although its decisions are not ratified by the President or by the executive branch of government, the entire System is subject to congressional oversight. For instance, Federal Reserve Governors periodically report to Congress. So, the Federal Reserve operates independently within a framework of economic and financial policy objectives established by the government...(emphasis added)

Walk with me now as we ask a few questions of the Federal Reserve system, in interview form:

WRSA: So let me get this straight - the Fed's decisions are independent of POTUS and his Cabinet, including the Secretary of the Treasury, right?

System: Yup.

WRSA: Then what is the Federal Reserve System?

The Federal Reserve System is made up of 12 Federal Reserve Districts, or service areas. A major financial center in each district is home to a Federal Reserve Bank. Most of the Reserve Banks also have branch offices in their district. There are 25 branch offices nationwide.

Each of the 12 Federal Reserve Banks is separately incorporated, and each has its own president and board of directors. The Reserve Bank presidents are appointed to five-year terms by the bank's board of directors. Each branch of a Reserve Bank also has its own board of directors.

The directors on each Reserve Bank board serve three-year terms and represent the various sectors of the economy, including business and industry, agriculture, finance, labor, and consumers...

WRSA: Anything else we should know about the Fed's structure?


The Board of Governors in Washington, D.C., provides general oversight of the Reserve Banks. The Board is composed of seven members who are appointed by the President and confirmed by the Senate to serve 14-year terms. These terms are staggered so that one expires every two years.

The President of the United States designates one member of the Board as chairman and another as vice chairman, both of whom serve four-year terms. The chairman of the Board of Governors is Ben Bernanke, and Donald L. Kohn is the vice chairman...

WRSA: Well, does that "congressional oversight" referenced in the first paragraph above mean that Congress has authority and control over the Fed's budget?

System: Not according to the same source:

...Although the Reserve Banks were created by a legislative act, they receive no budget appropriations from Congress. Each Reserve Bank is self sufficient, earning income from interest on holdings of U.S. Treasury securities, from interest on loans to depository financial institutions, and from fees for the services provided to those institutions.

The stock of Reserve Banks is owned entirely by the commercial banks that are members of the Federal Reserve System. Dividends are paid semiannually to stockholders at a fixed rate of 6 percent. At the end of each year, Reserve Banks return to the U.S. Treasury all earnings in excess of expenses necessary for operations...(emphasis added)

WRSA: So let me see if I understand so far - the Federal Reserve has its own budget with no Congressional oversight, does not answer to the President of the United States or his Cabinet, and merely "periodically reports" to Congress?

System: That's correct.

WRSA: But isn't the Federal Reserve the only entity in this country which can increase or decrease the supply of money?

System: Actually, the Fed does conduct monetary policy as follows:

The Federal Reserve System has three main tools for conducting its monetary policy:

Open market operations:
The most powerful and frequently used tool to influence the amount of money and credit available in the economy is open market operations, which refers primarily to the purchase and sale of Treasury securities in the open market. The Federal Open Market Committee is responsible for carrying out open market operations.
Discount rate:
The Federal Reserve System influences the availability of money and credit by changing the discount rate-that is, the interest rate that Reserve Banks charge depository financial institutions for short-term loans of reserves. The Board of Governors sets the discount rate, based on the recommendation of the boards of directors of the 12 Reserve Banks.
Reserve requirements:
Finally, the Board of Governors may directly affect the availability of money and credit by changing the percentage of reserves which banks must hold against deposits. This tool, however, is rarely used...

But really, any bank that engages in fractional-reserve banking necessarily creates money when it lends out money in excess of its deposits:

...The fact that banks are required to keep on hand only a fraction of the funds deposited with them is a function of the banking business. Banks borrow funds from their depositors (those with savings) and in turn lend those funds to the banks’ borrowers (those in need of funds). Banks make money by charging borrowers more for a loan (a higher percentage interest rate) than is paid to depositors for use of their money. If banks did not lend out their available funds after meeting their reserve requirements, depositors might have to pay banks to provide safekeeping services for their money. For the economy and the banking system as a whole, the practice of keeping only a fraction of deposits on hand has an important cumulative effect. Referred to as the fractional reserve system, it permits the banking system to “create” money...

WRSA: Who regulates those activities by non-Fed banks?

System: We do, along with limited regulation by state governments.

WRSA: So the Fed creates money through its open market operations, discount rates, and reserve requirements?

System: That's correct, although a bit oversimplified.

WRSA: And the Fed is independent of both POTUS and Congress in doing so, right?

System: Well, we prefer the phrase "independent within government", but yes.

WRSA: And non-Fed banks also create money through fractional-reserve banking?

System: Yes, that's correct.

WRSA: The Fed is the primary regulator of those activities, right?

System: Yes.

WRSA: And the end-state of the proposal today by Secretary Paulson is to give even more regulatory authority to the Fed, isn't that right?

System: That appears to be what will happen, at least according to the executive summary of Secretary Paulson's plan.

WRSA: Thanks for your time.

So to recap:

1) As a private banking institution with its own budget outside of Congressional supervision and free from the authority of the President of the United States and his delegates, the Federal Reserve System is unaccountable today to the elected representatives of the American people;

2) The Federal Reserve controls the nation's money supply, along
with the banks it regulates; and

3) The Secretary of the Treasury (an appointee of the elected President of the United States) today proposed to give still more power to the Federal Reserve System.

Does anybody anywhere think that this situation is consistent with the growth of freedom and independence for American citizens?


Anyone at all?


Anonymous TC said...

Thanks CB, for a look into the murky waters of our Federal Reserve System. Only a combination of bankers, bureaucrats and politicians could have dreamed up this convoluted mess.

April 1, 2008 at 10:16 PM  
Blogger chris horton said...

I hope the Appleseed Program takes hold. It will be knowledge well used soon.

I also hope people took advantage of group ammo buys.

ad utrumque paratus

April 1, 2008 at 11:22 PM  

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