An Exploration of the Federal Reserve (System)

….AKA the FED

You might have an idea of what the Fed is, and what it does. Most people think it’s a government organization – but that’s not entirely true.

The Federal Reserve is kind of like a Toyota Prius…..it’s a hybrid!!!

Actually, the Federal Reserve occupies a unique space, in that it has a hybrid structure. It’s both public and private, like that lower back tattoo you accidentally got in Tijuana last spring break.

What is the Federal Reserve?

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The first misconception most people hold is that there is one single entity known as the Federal Reserve. Actually, the Federal Reserve is a system of twelve Federal Reserve banks littered around the country, as well as other privately-owned banks and advisory councils. The Federal Reserve is like the Wayans family of central banking, you thought you knew how many there were, but new ones keep popping up and surprising you.

via GIPHY

The Fed is essentially the central banking system of the United States. It was created way back in 1913 after a series of financial panics.

The need for a system like the Federal Reserve was highlighted during the Panic of 1907, where a number bank runs occurred. What is a BANK RUN you ask? A bank run is when everyone tries to get their money out of the bank at the same time. The scenes at a bank run are similar to those outside your local Walmart on Black Friday, except more rage and despair instead of consumerist-driven mania.

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Source:Vivify

Banks don’t typically hold all the money their customers leave them, instead they hold just a fraction and use the rest to fund their bank-like activities, such as making loans. Small banks will work with bigger reserve banks to provide them with liquidity (cash) if there’s an unusual situation. Unfortunatly, during a bank run these reserve banks often forget to pick up the phone and the banks are left with nothing to give their panicking customers!

Never fear the FED is here!!!!

That’s where the Federal Reserve comes to the party. They’re able to act as a “lender” in these times of crises. Like the wealthy dad of a spoiled teenager, the Fed is always there to provide cash – even when no one else can or will.

What is the FEDS role?

Aside from bailing out the banks, the Fed’s role has expanded over the years.

They are responsible for:

  1. Regulating banks
  2. Ensuring the stability of the financial system
  3. Setting monetary policy and the fed funds rate.

The fed fund rate is the interest rate at which the Federal Reserve banks lend money out to other banks. By manipulating the fed funds rate, the Fed is able to control the liquidity in the banking system. Increase the interest rate, and it becomes expensive to borrow money, drying up liquidity.

In order to ensure the stability of the financial system, the Fed also has control over the money supply. They are able to create or destroy money with the click of a mouse. This is done through something called “open market operations”.  Basically if the Fed wants to create money they simply purchase government bonds. The money is created by adding 1s and 0s to the Fed balance sheet.

Its real money by the way, they earn interest on these bonds – which is how they make a profit, i.e. $101.5 billion in 2014.

Who owns the FED?

Another misconception a lot of us have about the Fed is that it is owned by the Federal government. It’s not hard to see why. It’s called the Federal Reserve after all.

In reality, the Federal Reserve is a weird public/private structure – having a foot in both worlds.

Here’s what we mean.

Commercial banks are required to hold stock in the Federal Bank in their region. So the Fed is technically a private institution whose shareholders are other banks.

So it’s private?

Yes….

EXCEPT the shareholders aren’t allowed to buy or sell their shares and are required to invest 3% of their capital in the Federal Reserve System. Additionally, the members and chair of the Federal Reserve Board are both appointed by and have their salaries paid for by the government.

Ok, so it’s public?

EXCEPT its monetary policy decisions don’t have to be approved by the President or anyone else in government.

Private?

Yes….

EXCEPT they can be questioned by Congress over their actions. Not to mention that the U.S. government takes pretty much all the Fed’s profits every year.

HYBRID!!!

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The fact is that the Fed exists to serve both national and commercial banks.  It works to serve its shareholders – which could explain why their policies lean towards benefiting the banking industry. They don’t receive funding from the government, making it more like an independent agency that pays tribute to the government in the form of a corporate dividend.

To Conclude….

There have been other central banks – simplified versions of the system we have today. Fear over a central bank consolidating too much power eventually meant that these early versions were scrapped. For a time the country operated without a central bank, from 1836 onwards.

Eventually financial panic and bank collapses in 1873, 1893 and 1907 spurred the creation of the new central bank. At the time, between 1907 to its creation, there were two camps. The first favored a privately run central bank and the other camp wanted a public, government-run organization.

The debates from that period shaped the Federal System we have today. A hybrid, not-quite public, not-quite private decentralized central bank that exists within the government and outside of it at the same time.

Glad we cleared that up.

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