SUNNY SIDE OF THE STREET: ANALYSIS OF THE FINANCIAL SYSTEM & THE ECONOMY (part 6)

The Overseer: The Federal Reserve System

by

Charles Lamson

Speak softly and carry a big stick.

     ---Theodore Roosevelt

Organizational Structure of the System

The Federal Reserve System was created by Congress in 1913. Experience in the United States and abroad had finally convinced lawmakers that such an institution was needed to avoid the banking crises that had periodically plagued the economy, most recently in 1907. The main purpose of the Federal Reserve Act was simple. It created a central bank---a kind of bank for banks---that could lend funds to commercial banks during emergencies and thus provide these banks with the funds necessary to avoid insolvency and bankruptcy. An example of such an emergency is a major crop failure that makes it impossible for farmers to pay off their bank loans. The 1913 legislation referred to this role of the Fed as providing an "elastic currency," and it is often today referred to as "the lender of last resort" function.

Over time, the responsibilities of the Federal Reserve have been expanded. In the midst of the Great Depression, it was clear that the limited scope and powers of the Federal Reserve System were not up to handling the nearly 8,000 bank failures that occurred during the 1930-1933 period. In the Banking Reform Acts of 1933 and 1935, Congress provided many of the additional policy tools and regulations that the Fed needed.

The core of the Federal Reserve System is the Board of Governors located in Washington D.C. The Board consists of seven members appointed by the president with the advice and consent of the U.S. Senate. The full term of a board member is 14 years, and the terms are arranged so that one term expires every two years. The long tenure and staggered terms were designed to insulate the board from day-to-day political pressures, and encourage the members to exercise the same independent judgment that Supreme Court justices employ. In theory, a president would be able to appoint only two of the seven members on the board during a four-year term. In actuality, deaths and early resignations of board members have permitted recent presidents to name more than two more board members during a four-year term. We might also note that although board members cannot be reappointed if they serve a full term, they may be reappointed if the initial appointment was to fill an unexpired term do to an early resignation or death. Board members can be removed from office only under extraordinary circumstances. It has never happened.

Federal Reserve Banks

The original Federal Reserve Act divided the nation into 10 districts. Each Federal Reserve Bank district is served by a Reserve Bank located in a large city in the district. We have the Federal Reserve Bank of Boston, the Federal Reserve Bank of New York, and of Philadelphia, Richmond, Cleveland, Atlanta, Chicago, Dallas, Kansas City, St. Louis, Minneapolis, and San Francisco, respectively. The three largest are the Reserve banks of New York, Chicago, and San Francisco, which account for more than 50 percent of Fed assets. The Federal Reserve Banks have a total of 26 branches located in major cities in the respective districts. For example, the St. Louis Fed has branches in Memphis, Tennessee, and Little Rock, Arkansas, while the Dallas Fed has branches in Houston, San Antonio, and El Paso, Texas. All commercial banks that are federally chartered national banks must join the Federal Reserve System. State-chartered banks may join, or not, as they choose. The member banks within a Reserve Bank District (say, the Boston district) elect six of the nine directors of that Reserve Bank and the Board of Governors appoints the other three. These directors, in turn, appoint the president and other officials of that Reserve Bank.

Federal Open Market Committee (FOMC)

The Federal Open Market Committee (FOMC) is the principal policy-making body within the Federal Reserve System. The FOMC formulates monetary policy and oversees its implementation. The committee has 12 members, including all 7 members of the board and 5 of the 12 Federal Reserve Bank presidents. The FOMC meets in closed meetings in Washington eight times a year (about every six weeks or so). 

1. The Organizational Structure of the Federal Reserve System

LOOKING BACK

Early Attempts at Establishing a Central Bank

The creation of the Fed in 1913 was not the first attempt to establish a central bank in the United States. The first effort occurred back in 1791 when the Bank of the United States was given a 20-year charter, with the government providing one-fifth of the start up capital. The fledgling bank had elements of both a private and a central bank. Like other private banks, it made loans to businesses and individuals. Like a central bank, the new bank issued banknotes backed by gold, attempted to control the issuance of state banknotes, acted as fiscal agent for the government, and was responsible for the aggregate quantity of money and credit supplied in the economy. However, the bank was not without its detractors who alleged that the bank represented big city "moneyed" interests. Fear and distrust, the unpopularity of centralized power, and questions about the bank's constitutionality all contributed to pressures to dissolve the bank. Its charter was allowed to run out in 1811.

The War of 1812 brought renewed pressures for a central bank that could oversee the financing of the war. Congress chartered the Second Bank of the United States in 1816. This bank also acted as fiscal agent for the U.S. government and issued banknotes redeemable in gold. Friction persisted between those who wanted a strong central bank (Federalists) and those who supported a more decentralized system (anti-Federalists). After substantially reducing the bank's powers in the early 1830s. President Andrew Jackson vetoed the rechartering of the bank, and it went out of existence in 1836.

The National Banking Acts of 1863 and 1864 succeeded in establishing a uniform national currency, but the lack of a central bank meant that there was no easy way to regulate the amount of currency in circulation. Consequently, the country experienced periodic shortages that often led to financial crises. Such crises occurred in 1873, 1884, 1893, and 1907. Nevertheless, attempts at creating a central bank that could regulate the amount of currency in circulation were not successful until 1913 when the Fed was established.

Recap

The Federal Reserve System was created in 1913. It consists of 12 reserve banks. The Fed is governed by the Board of Governors, whose seven members are appointed by the president to 14-year terms. The board chair is appointed for a four-year term. The FOMC is the major policy-making body. It includes the seven Fed governors, plus five Reserve Bank presidents. The president of the New York Reserve Bank is a permanent member of the FOMC, and the other four slots rotate yearly among the remaining 11 Reserve Bank presidents.

*SOURCE: THE FINANCIAL SYSTEM & THE ECONOMY, 3RD ED., 2003,  MAUREEN BURTON & RAY LOMBRA, PGS. 82-87*

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