When reading news on the current and potential future state of the U.S. economy, you're probably going to notice that the Federal Reserve comes up a lot.
Understanding the Federal Reserve, its purpose and its history over the past century will help you understand the current economy and economic system in this country. What is the Federal Reserve, what does it do and why was it established?
What Is the Federal Reserve?
The U.S. Federal Reserve, also known as the Fed, is the central bank for the nation. The Fed also performs critical tasks in helping shape economic policy in the U.S., especially in establishing benchmark interest rates that banks, lenders, businesses, and individuals use to engage in commerce, and borrow and lend money. Most recently, the Fed made a decision to cut its benchmark lending rate by 50 basis points to counter the economic impact of the coronavirus outbreak.
The Federal Reserve was created in 1913 as part of the Federal Reserve Act, which was signed into law by President Woodrow Wilson.
What Does the Federal Reserve Do?
The Act has several key components and responsibilities that drive the Fed forward, including:
Steering the U.S. economy
According to the Federal Reserve's web site, the Fed does so "by influencing money and credit conditions in the economy in pursuit of full employment and stable prices."
The Fed is also tasked with injecting stability into the often unstable worlds of politics and commerce, and is especially focused on assessing potential economic risk in U.S. and global financial markets.
The Federal Reserve also regulates and oversees U.S. financial institutions (especially banks) to help provide clear, efficient and ethical channels between customers and the financial services industry. A high priority is protecting consumers from financial institutions that may try and take advantage of them.
Acting as the Government's Bank
The Federal Reserve also provides specific financial services to the federal government, and to U.S. and international financial institutions, while also steering the U.S. payments systems.
Why Was the Federal Reserve Created?
Before the Federal Reserve Act was signed into law in 1913, the U.S. had experienced a rash of financial crises and subsequent panic among the public worried over the safety of their bank and investment deposits. If one bank or lender collapsed, it would trigger a domino effect where other banks would fail, too, leading directly to the need by the federal government to have a steady hand at the wheel during a financial crisis. Upon its enactment, the Federal Reserve was immediately thrust into action in providing emergency loans to banks and financial institutions that needed them to stay afloat.
If there is a genesis or starting point for the Fed, it may well have occurred in 1907 when an especially rough economic patch took many banks out of business, and sent many more to the precipice. Financial institutions lobbied politicians heavily to step in and offer some much-needed support, particularly in the form of a central bank, leading to the drafting of the 1913 Federal Reserve Act.
Who Owns the Federal Reserve?
Nobody actually owns the Federal Reserve, just as nobody actually owns the U.S. Congress or the U.S. Department of Justice.
The Federal Reserve was created to serve the public interest, as its functioning Federal Reserve Board of Governors reports to and is accountable to Congress, which acts on behalf of the U.S. public.
To delve deeper into the ownership issue, it's worth taking a look at how the Federal Reserve is created - it shows an independent, public and private institution that's charter is to both help steer U.S. economic policy, provide financial services to the federal government, and to serve the interests of the American people.
Structurally, the Fed has three key pillars:
- A central governing board, also known as the Federal Reserve Board of Governors
- A decentralized operating structure involving all 12 Federal Reserve Banks
- A balance of public and private operating characteristics
Under this quasi-balanced approach, the Federal Reserve remains independent, and is not funded by Congress - its 12 separate Federal Reserve Bank are responsible for their own income, each with their own board of directors, and their own separately incorporated status.
Consequently, the Federal Reserve Banks do not operate with the goal of making a profit, relying on a system of interest earned on U.S. government securities it owns through everyday market transactions, and by stock owned by commercial banks to fund its operations. Any profits the Fed does earn are turned over to the U.S. Treasury, after paying for expenses incurred by the Fed in its day-to-to-day operations. The Fed also makes dividend payments to stock owners, and is allowed to have a moderate surplus fund on hand as part of its charter.
That all said, while the Federal Reserve isn't actually "owned" by anyone, the Fed is accountable to Congress and to the U.S. public, and regularly issues reports, statements, and notes on its operations, and on its view of the economy and on lending and credit conditions, to provide transparency.
Where are the 12 Federal Reserve Banks?
While the primary hub of the Federal Reserve is in the nation's capital - Washington, D.C., the Fed has 12 operating arms spread out in official districts across the U.S.
Each Federal Reserve Bank has the same charter - to provide services to financial institutions and the federal government, hold cash in reserve, provide loans and credit, and provide basic back-office functions like handling checks and managing currency movements, while acting as the fiscal agent for Uncle Sam.
Each bank also oversees the health of banks and deposit institutions in its district, and helps the government establish and implement the nation's monetary policy.
To cover all that ground, there are 12 Federal Reserve Banks spread across the U.S., located in the 12 Federal Reserve Districts in the following cities and states: (data provided by the Richmond Federal Reserve.)
- Federal Reserve Bank of Boston: - 1st District. Area covered: Connecticut (excluding Fairfield County), Massachusetts, Maine, New Hampshire, Rhode Island, and Vermont
- Federal Reserve Bank of New York: (New York City) - 2nd District. Area covered: New York State, twelve counties in northern New Jersey, Fairfield County in Connecticut, Puerto Rico, and the Virgin Islands
- Federal Bank of Philadelphia: - 3rd District. Area covered: Eastern Pennsylvania, southern New Jersey, and all of Delaware
- Federal Reserve Bank of Cleveland: - 4th District. Area covered: Ohio, western Pennsylvania, eastern Kentucky, and the northern panhandle of West Virginia.
- Federal Reserve Bank of Richmond: (Richmond, Va.) - 5th District. Area covered: Maryland, Virginia, North Carolina, South Carolina, and most of West Virginia
- Federal Reserve Bank of Atlanta: - 6th District. Area covered: Alabama, Florida, Georgia, and parts of Louisiana, Mississippi, and Tennessee
- Federal Reserve Bank of Chicago: - 7th District. Area covered: Iowa and most of Illinois, Indiana, Michigan, and Wisconsin
- Federal Reserve Bank of St. Louis: - 8th District. Area covered: Arkansas and portions of six other states: Missouri, Mississippi, Tennessee, Kentucky, Indiana, and Illinois.
- Federal Reserve Bank of Minneapolis: - 9th District. Area covered: Minnesota, Montana, North Dakota, South Dakota, twenty-six counties in northwestern Wisconsin, and the Upper Peninsula of Michigan.
- Federal Reserve Bank of Kansas City: (Kansas City, Mo.) - 10th District. Area covered: Kansas City. Colorado, Kansas, Nebraska, Oklahoma, Wyoming, northern New Mexico, and Western Missouri.
- Federal Reserve Bank of Dallas: - 11th District. Area covered: Texas, northern Louisiana, and southern New Mexico.
- Federal Reserve Bank of San Francisco: - 12th District. Area covered: Alaska, Arizona, California, Hawaii, Idaho, Nevada, Oregon, Utah, and Washington, along with American Samoa, Guam, and the Northern Mariana Islands.
Pros and Cons of the Federal Reserve
Few mainstream financial observers would argue with the merit and need of a U.S. central bank - a role the Federal Reserve has played on a global stage for over 100 years.
That said, there are fair points to make on a "pro" and con basis with the Federal Reserve, especially on its unique role as both a financial services provider to the federal government, and its substantial role in shaping U.S. economic policy.
Let's look at both sides of the issue:
Pros of the Federal Reserve
- Stability. The Federal Reserve can provide a calm, helpful hand to financial institutions and their depositors in times of severe economic strife.
- United behind a single currency. Before the ascent of the Federal Reserve, the U.S had literally hundreds - even thousands - of currencies rolling through the economy. With its power granted by Congress and the executive branch, the Fed was instrumental in uniting the nation behind a single currency - the U.S. dollar.
- It's a good risk containment system. The Federal Reserve regularly checks the nation's banks and financial institutions, running "stress tests" and reviewing financial statements to ensure that the public is dealing with institutions in good financial standing, and not overly-loaded with risk and liabilities.
Cons of the Federal Reserve
- Limits on accountability. As a privately-owned central bank, the Federal Reserve, as an institution, has powers that exceed the powers of dutifully elected U.S. politicians, including the president and Congress.
- Lack of true transparency. While the Federal Reserve does issue regular reports and its senior staff, including speeches and reports from the Fed chairperson and the 12 bank presidents, critics accuse the Fed of operating in secrecy, while Congress seems powerless to provide genuine oversight.
- Its bailouts of big banks left a stain on the Fed that hasn't disappeared. In what many say was a big policy error by the Federal Reserve, the central bank issued bailouts to not only U.S. banking giants at significant risk, but to overseas banks, too. The bailouts amounted to trillions of dollars, and kept big banks - the real culprits of the near collapse of the nation's financial system in 2008 and the resulting "Great Recession" - out of harm's way while millions of Americans lost their jobs and their homes in the crisis.
Certainly, the Federal Reserve plays a powerful and needed role in measuring and actively steering the U.S. economy on a regular basis - a fact that isn't going to change anytime soon.