Saturday, August 13, 2011

The Federal Reserve System

While most Americans are likely aware of the existence of the Federal Reserve System, few can accurately describe the structure and role of this immensely powerful organization.  It is our central bank, acting as the "banks' bank."  It determines our monetary policy.  It even issues our currency that we carry in our wallet.  The power that this organization wields leads many to believe that it is part of a master conspiracy, evil in design, and a detriment to our society.  In reality, the Federal Reserve System is a complex entity composed of public and private interests and decentralized throughout the country.  The specific structure and design of the Federal Reserve System is worth exploring, as it is uniquely American and exceedingly socially capitalistic. 

The Federal Reserve System is not America's first central bank.  In fact, it's not even the second.  Agrarian interests and a national fear of centralized power brought to an end our first two central banking systems.  The Federal Reserve Act of 1913 created the Federal Reserve System as we know it, and the tensions of American politics left clear fingerprints on the design.  Because Americans have typically feared large, centralized institutions removed from much of the nation by thousands of miles, the Federal Reserve Act created twelve regional banks to decentralize the power of the central bank and to ensure a distribution of oversight across regional lines.  Additionally, these banks were established as quasi-public institutions.  Thus, ownership of the banks is shared between the federal government and the private commercial member banks in each district.  By dividing the bank into twelve regional banks that are mutually owned by the government and private banks, power was divided between the public and private sector and further distributed throughout the country.

It would have been possible to stop with the regional distribution of the banks and the quasi-public ownership to ensure a reasonable distribution of power, but the Federal Reserve Act went further.  A Board of Governors was established to oversee the activities of the banks.  The Board is composed of seven members appointed by the President and confirmed by the Senate.  However, once appointed, the Board of Governors has tremendous autonomy from the government as they are appointed to long fourteen year terms.  The appointment by the President reflects the public need for input into the leadership of the bank.  The fourteen year terms, however, insulate the Board from political pressure and allow for long-term decision making.

For each regional bank, another layer of hybrid oversight was established.  The twelve regional banks each are headed by nine directors.  Six of these directors are elected by the (private) member banks of the Federal Reserve System.  The remaining three directors are appointed by the Board of Governors.  Of these nine directors, there are three categories of directors:  A, B, and C.  The three A directors are professional bankers and are elected by the member banks.  The three B directors, also elected by the member banks, are chosen from private industry, labor, agriculture, or consumer organizations.  The three C directors are the appointees from the Board of Governors, and they are prohibited from being an officer, employee, or stockholder of any bank.  The nine directors determine the president and officers of each bank.  This complex mix of public and private election and appointment that mixes bankers, industrialists, and public advocates adds one more layer to the checks and balances of the entire Federal Reserve System.

Although the Federal Reserve System created twelve banks, there is still a need for a centralized component of the system that handles specific monetary policy decisions.  Therefore, the Federal Reserve System also has the Federal Open Market Committee (FOMC).  When you read about actions of the "Fed" in the news, it is likely that you are reading about the specific actions of the FOMC.  The FOMC makes decisions that influence interest rates and the money supply, so their decisions receive much more attention than the actions of the individual regional banks.  The FOMC includes the seven members of the Board of Governors, as well as five presidents of the regional banks.  The president of the New York Federal Reserve Bank is always a voting member of the FOMC to reflect New York's unique position in the financial industry.  The remaining four presidents are determined on a rotating basis among the remaining eleven regional banks.  However, when the FOMC meets, all regional presidents attend.  Only the current voting members have voting rights on decisions.  This allows for input from all regional members, but restricts final decisions to a limited body.

Contemplate for a moment the complex consideration of various interests that went into the design of our central bank.  Regional distribution provides decentralized control.  The Board of Governors are appointed by the President, but still insulated from politics due to their long appointments.  The directors of each regional bank are composed of bankers, leaders of industry, and public advocates to distribute power among the finance sector, non-finance sectors, and the general public.  Finally, the FOMC represents both the public appointees of the Board of Governors as well as regional presidents appointed by the nine directors of each bank.  The alchemical mix of capitalism and social protection expressed in this uniquely American institution is truly marvelous in design and execution. 

The individuals that serve in the various roles of the Federal Reserve System are still fallible.  Improvements to the structure of the system will likely occur over time.  However, the values expressed in the design of our central bank are clear.  Our preeminent capitalist institution shows a careful weighing of regional and social values.  There is no clearer proof that we are, in fact, a social capitalist nation.

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