““Whoever controls the volume of money in any country is absolute master of all industry and commerce.”
-James A. Garfield, 20th President of the United States
Table of Contents
II. History and Creation of the Federal Reserve
III. Structure of the Federal Reserve System
A. The Fed’s Chain of Command
IV. Federal Open Market Committee
V. Federal Reserve Advisory Bodies
VI. The 12 Private Banks That Form the Federal Reserve
A. The New York Fed
B. The Other Federal Reserve District Banks
C. How Banks Become a Member
D. Rights and Powers of Members
VII. The 12 Private Banks That Form the Federal Reserve
A. Appointments of Board Members
B. Roles and Responsibilities of Board Members
IX. About Us
March 30, 2018
The Federal Reserve is one of the most influential organizations in the U.S. when it comes to economic policy. It is also one of the least well understood elements of the government–especially in that it is not really truly a government organization. Its top level officials are a government agency of the Executive branch. However, the Federal Reserve, and especially its 12 Federal Reserve District Banks, occupy a strange twilight zone between government agency and private banking organization.
This status has come up in court cases, where the district banks of the Federal Reserve have argued successfully that they are not a government agency–instead being classified as “federally created instrumentalities” (Scott v. Federal Reserve Bank of Kansas City, No. 04-2357 (8th Circ. Ct of App, 2005) (available at http://media.ca8.uscourts.gov/opndir/05/04/042357P.pdf)). A cynical person might say that they are part of the Federal government where advantageous and separate when it is not. However, it is enough to say that the Federal Reserve has a complex, hybrid structure to it.
The Federal Reserve itself has quite a bit of involvement in creating the monetary policy of the U.S. The most commonly discussed ways it influences the economy include acting as a last resort lender to member banks, regulating private banking, and–perhaps above all–setting the discount rate on loans to solve temporary liquidity issues for private banks across the county.
As the bank of the U.S. Federal Government, there is obviously great concern and interest in the financial goings on of the Federal Reserve. This has led to multiple attempts to audit the Federal Reserve–usually with Congress turning to the Government Accountability Office (GAO). The GAO is a Congressional agency which investigates federal spending. As we’ve discussed in previous articles, these duties are accomplished with varying levels of success by topic. (See The U.S. Statutes Creating Modern Constitutional Financial Management and Reporting Requirements and the Government’s Failure to Follow Them, available at https://constitution.solari.com/the-u-s-statutes-creating-modern-constitutional-financial-management-and-reporting-requirements-and-the-governments-failure-to-follow-them/.) Congress has requested studies as to the lengths to which the GAO can investigate the financial goings on of the Federal Reserve. (See e.g., Federal Reserve System Audits: Restrictions of GAO’s Access, available at https://www.gao.gov/products/T-GGD-94-44.) In 1978, the Federal Banking Agency Audit Act placed the Federal Reserve under the audit authority of the GAO–reversing the 1933 Banking Act provisions that originally removed this authority (31 USCA §714, available at http://www4.law.cornell.edu/uscode/31/714.html). Since this change, there have been dozens of GAO audits of the Federal Reserve. These audits have led to suggestions from the GAO on everything from check clearing policies to larger regulatory reforms (see id.). This being said, there are some notable exceptions to the areas the GAO can look into, including:
“(1) transactions for or with a foreign central bank, government of a foreign country, or nonprivate international financing organization; (2) deliberations, decisions, or actions on monetary policy matters, including discount window operations, reserves of member banks, securities credit, interest on deposits, open market operations; (3) transactions made under the direction of the Federal Open Market Committee; or (4) a part of a discussion or communication among or between members of the Board of Governors and officers and employees of the Federal Reserve System related to items” (id.).
These are substantial exemptions. In order to understand just how substantial, it’s necessary to more fully understand the structure and role of the Federal Reserve. It’s worth noting that there have been multiple attempts in Congress to implement a more thorough audit nearly every year–including last year. (See e.g., H.R. 24, Federal Reserve Transparency Act of 2017, available at https://www.congress.gov/bill/115th-congress/house-bill/24?q=%7B%22search%22%3A%5B%22Federal+Reserve+Transparency+Act+of+2017%22%5D%7D&r=4.) These attempts have never succeeded. In past articles, we have discussed the problematic lack of transparency in government spending–especially in certain executive agencies. The Department of Defense and the Department of Housing and Urban Development have over $21T unaccounted for–approximately the same amount as our current national debt. (See e.g., The Missing Money, available at http://missingmoney.solari.com.) There is an obvious need for greater financial transparency and regulatory compliance in the government.
In order to understand the role and issues of the Federal Reserve System, this series intends to take a look at the inner workings and functions of the Federal Reserve. To do a true deep dive on this issue can and has taken volumes to properly explore every avenue. Our goal with this series is to instead give a strong overview of the Federal Reserve, its functions, and its issues. Later articles will discuss the Federal Reserve Act in more depth (as well as the twilight-zone legal classification of a “federally created instrumentality”), the lending practices of the Federal Reserve, and some of the problems inherent to the most powerful banking organization in the U.S. and potentially the world.
The Federal Reserve handles the government’s accounts, funds, and security transactions, and implements monetary policy (mainly through the New York Federal Reserve Bank, discussed below). However, in order to give the best understanding of the Federal Reserve itself, we will start by looking at the history and structure of the Federal Reserve–the what and why of the United States’ most powerful bank.
II. History and Creation of the Federal Reserve
The Federal Reserve was first signed into existence by then-President Woodrow Wilson over a century ago on December 23, 1913. (See Federal Reserve Act, Ch. 6, 38 Stat. 251, enacted December 23, 1913, 12 U.S.C. §§ 221 to 522, available at http://legisworks.org/sal/38/stats/STATUTE-38-Pg251a.pdf.) The Federal Reserve Act created the Federal Reserve System and a centralized banking system for the U.S. It also granted this newly minted Federal Reserve System, among many other things we will discuss below, the power to issue Federal Reserve Notes (see id.).
The stated goal of President Wilson and Congress was to promote economic stability through the uniformity and certainty of a central banking system which would promote and handle much of the monetary policy of the U.S. The move was almost without question the most substantial reform in U.S. financial law in the history of the country. (see 1913 Federal Reserve Act, available at https://www.investopedia.com/terms/f/1913-federal-reserve-act.asp)
The enormous financial reform bill came to President Wilson with the support of many Democrats of the time and the respective chairmen of the House and Senate Banking and Currency committees (see id.). However, the law was not prepared to make such a titanic change permanent just yet. The initial 1913 act limited the grant of power to twenty years, requiring renewal in or before 1933. (See The Federal Reserve Act, 12 U.S.C. §§ 221 to 522.) However, Congress moved to renew the Act and make it permanent well before this deadline. In February of 1927 the Act was amended to perpetuate the Federal Reserve “until dissolved by Act of Congress or until forfeiture of franchise for violation of law” (see 44 Stat. 1234). This move to make the Federal Reserve System permanent by renewing the Federal Reserve Act was far from a certainty during this time period. History buffs out there will certainly have noticed something about the timing of this renewal–it falls just before the beginning of the Great Depression. (See 1913 Federal Reserve Act, available at https://www.investopedia.com/terms/f/1913-federal-reserve-act.asp.) The Federal Reserve, and most financial institutions of the time, were not particularly popular with the public. As the years progressed, and the Great Depression deepened, this opinion would only get worse. It’s also worth mentioning that the Bureau of Internal Revenue (later the IRS) was formed at the same time as the Federal Reserve in 1913. This came shortly after the 16th Amendment allowed for constitutional federal income tax after 50 years of creating and repealing income tax as a concept. During World War I the income tax spiked substantially–as high as 77%–it only came back down to around 24% by 1929 but continued to rise throughout the Great Depression. (See Brief History of the IRS, available at https://www.irs.gov/about-irs/brief-history-of-irs.) This just exacerbated the extremely poor public opinion of financial institutions at the time. It’s very possible that had the renewal come in 1933 as planned there might be no Federal Reserve system today. (See 1913 Federal Reserve Act, available at https://www.investopedia.com/terms/f/1913-federal-reserve-act.asp.)
However, even in the throes of the Great Depression, the recently strengthened Federal Reserve saw some changes to its structure and purpose. The Banking Act of 1933 further amended the Federal Reserve Act in a number of ways. (See Pub. L. 73-66 available at https://fraser.stlouisfed.org/scribd/?title_id=991&filepath=/docs/historical/congressional/1933_bankingact_publiclaw66.pdf.) The Banking Act of 1933 created the Federal Open Market Committee (FOMC)–a 12 member committee of top level officials from the Federal Reserve which we will discuss at length later in this article. This created a committee that remains one of the most powerful and influential arbiters of financial policy decisions in the U.S. to this day. The Act gave the FOMC power over essentially all open-market operations of the member banks of the Federal Reserve (see id.). It additionally added a requirement that the FOMC meet at least four times per year (see Pub. L. 73-66). Today, they generally meet double that number, about eight times in a year. (See 1913 Federal Reserve Act, available at https://www.investopedia.com/terms/f/1913-federal-reserve-act.asp.)
However, as we will discuss in a later article, these meetings are not open to the public, although they do publish edited and redacted meeting minutes and transcripts.
Since the creation of the FOMC, the Federal Reserve Act has seen well over 200 amendments (see id.). However, it continues to be at the center of U.S. financial policy. As of November 16, 1977, the Federal Reserve Act was amended to provide the FOMC and the Federal Reserve a clear goal: “to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates” (The Federal Reserve Act, Section 2A, available at https://www.federalreserve.gov/aboutthefed/section2a.htm). This amendment also required the FOMC Chairman to appear before Congress at semi-annual hearings and report on their current and future steps toward achieving these goals. Congress wanted testimony to make sure the Federal Reserve was operating as intended.
III. Structure of the Federal Reserve System
In order to understand the function and faults of the operations of the Federal Reserve, and most importantly whether and how they work to achieve their stated goals, it is important to first understand the structure of the Federal Reserve itself. While linked to the federal government, much of the Federal Reserve essentially operates as a private corporation would. They do not even receive funding appropriated by Congress. They would hardly need it with approximately $100B in profits in 2015 alone, of which $97.7B went to the U.S. Treasury. The Federal Reserve is required to turn over all money it makes in excess of its costs to the U.S Treasury every year. The Federal Reserve derives its income for operations and salaries from “the interest on government securities that it has acquired through open market operations…the interest on foreign currency investments held by the Federal Reserve System; fees received for services provided to depository institutions, such as check clearing, funds transfers…automated clearing house operations; and interest on loans to depository institutions” (How is the Federal Reserve System Structured, available at https://www.richmondfed.org/faqs/frs).
The Federal Reserve’s chief governing body–the Board of Governors–is an executive agency with the salaries of the individual members set by the federal government. This means the top levels of the Federal Reserve have direct ties to and report to the federal government. However, from there the organization’s connection to the government becomes much looser–with other elements of the Federal Reserve connected to the government essentially only by oversight from the Board of Governors. In a lot of ways, the Federal Reserve essentially runs itself as a private business that hands over the money it doesn’t pay itself to the U.S. Treasury (see id.).
At the very top of the Federal Reserve System is the Board of Governors, with the FOMC and Federal Advisory Committee (FAC) directly below them as advisors to their decision making process. That being said, the majority of the FOMC is made up of the Board of Governors and has complete control over all open market operations. The Board of Governors and FOMC oversee 12 Federal Reserve district banks which each are the head of a large district of banks and have their own Boards of Directors. These district banks have no direct ties to the government. Each of these 12 district banks have a number of branches and member banks, all of which have their own Boards of Directors and also have no direct ties to the government. All of these layers have their own roles and responsibilities under the law and their own requirements for appointments to those positions (see id.).
A. The Fed’s Chain of Command
We’ve mentioned a few times already that the Federal Reserve flirts with the line between a government agency and a private sector entity. We will not fully investigate the implications and case law on that in this article. However, as we’ve mentioned, the highest level officials report directly to the government. While federal law regulates the structure and function of the Federal Reserve quite a bit, as we’ll see here and in later articles, the actual operation of the Federal Reserve runs much closer to that of a private corporation. (See Roles and Responsibilities of Federal Reserve Directors, available at https://www.federalreserve.gov/aboutthefed/directors/pdf/roles_responsibilities_FINALweb013013.pdf.)
The Federal Reserve Act provides goals for the public interest that are theoretically at the core of all moves out of the Federal Reserve–as you would expect of a government agency. However, the structure and oversight mostly comes from the Board of Governors, the FOMC, the Boards of Directors of the Federal Reserve district banks, and the FAC (see id.).
The Reserve district banks themselves are supervised by the Board of Governors. The Board of Governors itself is an agency of the federal government (see id.). Their members are appointed by the President after advice and consent from the Senate and they collaborate with Washington, D.C. on many of their responsibilities. However, while the Board of Governors has substantial impact on financial policy, the Federal Reserve district banks and branches are still by and large the majority of the Federal Reserve’s operating presence–including implementing financial policy and recommending policy to the Board of Governors (see id.).
Under the Federal Reserve Act, each district bank is supervised by a nine member Board of Directors (see id.). While there are 12 main district banks, as discussed below, most of them have at least one branch besides their head office. There are 274 existing director positions as of today–108 head office positions and 166 branch director positions (see id.). These directors are meant to act as the link between the Board of Governors and the public as well as supervising day to day functions of the district banks and their geographical districts. While we’ll get more into appointments later, these nine member boards all have 6 members appointed by the district bank itself and three members appointed by the Board of Governors (see id.).
The current Chair of the Board of Governors of the Federal Reserve is, as of February 5th 2018, Jerome Powell. He replaced Dr. Janet Yellen just recently. The Chairman is appointed by the current sitting President from among the members of the Board of Governors and has a four year term which can be renewed as the President sees fit so long as the Senate confirms them. The members themselves are appointed for staggered 14 year terms. These terms are not changed by being named chair. The theoretical stated goal behind such long terms is to avoid political pressure in financial decisions–instead allowing members to focus on their Congressionally mandated goals (see id.). As of right now, only 3 of the 7 positions are filled–Jerome Powell (R) as chair, Randall Quarles (R) as vice-chair, and Lael Brainard (D). (See Board of Governors Members, 1914-Present, available at https://www.federalreserve.gov/aboutthefed/bios/board/default.htm.)
IV. Federal Open Market Committee
Even with the Board of Governors in mind, there is an argument that it is in fact the FOMC which represents the most influential element of the Federal Reserve when it comes to planning and making financial policy changes. This is simply because they are in charge of all open market operations. (See The Federal Reserve Act, Section 12a, available at https://www.federalreserve.gov/aboutthefed/section12a.htm.)
The Federal Reserve Act created the FOMC, consisting of “the members of the Board of Governors of the Federal Reserve System and five representatives of the Federal Reserve district banks.” The bank representatives must be presidents or first vice presidents of a Federal Reserve district bank, and are elected by the Federal Reserve district banks in a somewhat lopsided manner. The Federal Reserve Bank of New York determines one of the representatives on its own. The remaining four representatives are each elected by multiple district banks: the Banks of Boston, Philadelphia, and Richmond elect one, the Banks of Cleveland and Chicago elect one, the Banks of Atlanta, Dallas, and St. Louis elect one, and the Banks of Minneapolis, Kansas City, and San Francisco elect the last. (See The Federal Reserve Act, Section 12a, available at https://www.federalreserve.gov/aboutthefed/section12a.htm.) The composition of the FOMC ends up being 12 members: “the seven members of the Board of Governors; the president of the Federal Reserve Bank of New York; and four of the remaining 11 Reserve Bank presidents . . .” although all the various Banks’ Presidents generally attend FOMC meetings (Roles and Responsibilities of Federal Reserve Directors, pg. 6 ).
The FOMC works to make “key decisions regarding the conduct of open market operations, which affect the stock of reserve balances held by depository institutions and the size and composition of the Federal Reserve’s asset holdings” (see id.). Further, the Act requires no Federal Reserve bank to “engage or decline to engage in open-market operations. . .except in accordance with the direction of and regulations adopted by the [FOMC]” (The Federal Reserve Act, Section 12a). This is an enormous amount of power, regulating the vast majority of implementation of financial policy out of the Federal Reserve.
V. Federal Reserve Advisory Bodies
While the Board of Governors has the closest link to the Federal Government within the Federal Reserve, their actions still come with a great deal of guidance from the individual member banks. Four committees directly advise the Board of Governors: The Federal Advisory Council (FAC), the Community Depository Institutions Advisory Council (CDIAC), the Division of Financial Stability, and the Community Advisory Council (CAC). They act as a sort of go between for the member banks and the Board of Governors. (See About the Fed: Advisory Councils, available at https://www.federalreserve.gov/aboutthefed/cdiac.htm.).
The Federal Reserve Act created the Federal Advisory Council, consisting of “as many members as there are Federal reserve districts” (The Federal Reserve Act, Section 12, https://www.federalreserve.gov/aboutthefed/section12.htm). Each year, each member bank selects one member of the FAC. The FAC then meets at least four times a year in Washington, D.C., in order:
“(1) to confer directly with the Board of Governors . . . on general business conditions; (2) to make. . . representations concerning matters within the jurisdiction of said board; (3) to call for information and to make recommendations in regard to discount rates, rediscount business, note issues, reserve conditions in the various districts, the purchase and sale of gold or securities by reserve banks, open-market operations by said banks, and the general affairs of the reserve banking system.” (The Federal Reserve Act, Section 12, available at https://www.federalreserve.gov/aboutthefed/section12.htm)
The CDIAC, on the other hand, is not a statutory body. It was formed by the Board of Governors in 2010 to provide input on issues of interest to community depository institutions. (See About the Fed: Advisory Councils, available at https://www.federalreserve.gov/aboutthefed/cdiac.htm.) It selects one member from each Federal district bank, and meets twice a year to discuss “the economy, lending conditions, and other issues of interest to community depository institutions” (see id).
In November of 2010, the Federal Reserve’s Board of Governors also established the Office of Financial Stability Policy and Research, which was renamed the Division of Financial Stability and made a division of the Board itself in 2016 (Federal Reserve Press Release, May 11, 2016, available at https://www.federalreserve.gov/newsevents/pressreleases/other20160511a.htm). The Division is the research and monitoring organization responsible for coordinating with other Board divisions and the various Reserve banks in order to find structural risks to financial stability and formulate policy responses to said risks.
More recently, in 2015, The CAC was formed by the Board of Governors to complement the FAC and CDIAC. (see About the Fed: Advisory Councils, available at https://www.federalreserve.gov/aboutthefed/cac.htm) Its purpose is to focus on the “needs of consumers and communities, with a particular focus on the concerns of low- and moderate-income populations” (see id.). The committee currently has 15 members and meets semi-annually (see id.).
VI. The 12 Private Banks That Form the Federal Reserve
The Board of Governors may sit atop the Federal Reserve, working closely with the federal government as an executive agency. However, an enormous number of duties, powers, and day to day activities are squarely in the hands of the 12 Federal Reserve district banks–all private banks with minimal connection to the federal government. These 12 banks each head one of the 12 Federal Reserve System districts, often with multiple branch offices. They are responsible for managing commercial banking in their districts (including the various Federal Reserve member banks), storing currency, processing payments, and generally acting as “bankers’ banks” by providing banking services to other commercial banks in their districts. (See The Structure and Functions of the Federal Reserve, available at https://www.federalreserveeducation.org/about-the-fed/structure-and-functions.)
These districts are also, somewhat counterintuitively, not limited by State borders. Instead, the Federal Reserve Act mandated that they “shall be apportioned with due regard to the convenience and customary course of business and shall not necessarily be coterminous with any State or States” (The Federal Reserve Act, Section 2, available at https://www.federalreserve.gov/aboutthefed/section2.htm). They are all privately owned by members. However, there are no laws (that we found) requiring disclosure or confidentiality of the ownership interests, and finding that information is an opaque process at best.
A. The New York Fed
The Federal Reserve Bank of New York is the largest of the district banks, at least in regards to the assets held and volume of financial activity. The activities they conduct, their location in New York City, and the assets they hold combine to entrench the New York Fed into a (if we’re putting it nicely) “first among equals” position among the 12 districts.
The New York Fed has a leading role in the Federal Open Market Committee (discussed in further detail below) and tends to be the main force implementing the monetary policy decided in D.C. The president of the New York Fed is a permanent voting member of the FOMC, and the FOMC uses the New York Fed to buy and sell a portfolio of U.S. government securities1 as part of the FOMC’s open market operations (The New York Fed: Who We Are and What We Do, available at https://www.newyorkfed.org/aboutthefed/fedpoint/fed13.html), (Domestic Open Market Operations During 2016, pp. 14-15, available at https://www.newyorkfed.org/medialibrary/media/markets/omo/omo2016-pdf.pdf).
The New York Fed also carries out national exchange rate policy for the Treasury Department, the Federal Reserve System, and some foreign banks and international organizations (The New York Fed: Who We Are and What We Do). One of the ways they accomplish this is by acting as fiscal agent of the Treasury Department by managing the Exchange Stabilization Fund2 (ESF) (Fedpoint: Exchange Stabilization Fund, available at https://www.newyorkfed.org/aboutthefed/fedpoint/fed14.html). They also “maintain reciprocal currency arrangements with the Bank of Canada and the Bank of Mexico in the maximum amounts of $2 billion and $3 billion, respectively,” and warehouse up to $5 billion in foreign currencies (Domestic Open Market Operations During 2016, p. 15). The New York Fed also holds foreign official gold reserves, due to “the convenience of centralizing gold holdings in a place where international payments can be made quickly” (The New York Fed: Who We Are and What We Do). What’s more, they offer a list of primary dealers–banks and firms allowed to directly purchase government securities with the intent of reselling them (see Federal Reserve of New York: Primary Dealers, available at https://www.newyorkfed.org/markets/primarydealers.html). These primary dealers work directly with the New York Fed to create markets for such securities (see id.). The New York Fed also provides information on the history of such sales (Federal Reserve of New York: Primary Dealers Statistics, available at https://www.newyorkfed.org/markets/gsds/search.html).
Finally, the New York Fed also acts as the depository of the U.S. government. All the Federal Reserve District Banks have the duty of being fiscal agent and bank of the U.S. government. However, the New York Fed handles the lion’s share of this–maintaining accounts, processing government checks, collecting federal tax deposits, etc. (Federal Reserve Education: Financial Services, available at https://www.federalreserveeducation.org/about-the-fed/structure-and-functions/financial-services.) This also means that the New York Fed holds a substantial portion of the gold of the U.S. government in their vaults–along with the gold of several other banks and a few foreign governments. They don’t own this gold; however, it represents the largest known depository of monetary gold in the world. The New York Fed receives a handling fee for the gold they store (Federal Reserve Bank of New York: Gold Vault, available at https://www.newyorkfed.org/aboutthefed/goldvault.html). This role as the bankers of the U.S. government also presumably provides the New York Fed, and really all the Federal Reserve District Banks, with an enormous amount of financial data on which they can operate.
B. The Other Federal Reserve District Banks
The Reserve Banks of the other 11 districts tend to have a less exaggerated role in U.S. financial policy. However, as discussed above, they perform a variety of financial functions for their districts and produce a great deal of financial research, although the size and scope of their activities vary.
The Federal Reserve District Banks of San Francisco, Minneapolis, and Kansas City vote together to determine one of the voting members of the FOMC. The San Francisco Fed (About the 12th District, available at https://www.frbsf.org/our-district/about/) covers the Twelfth District including Alaska, Arizona, California, Hawaii, Idaho, Nevada, Oregon, Utah, and Washington, and the territories of the Northern Mariana Islands, American Samoa, and Guam. The San Francisco Fed covers the largest area and population of the member bank Districts and is second to the New York Fed in assets held (see id). It is also “the headquarters for the Federal Reserve’s Cash Product Office, which oversees and supports the entire system’s cash distribution process” (see id.). However, despite its size, the San Francisco Fed still pales in comparison to the fairly well entrenched authority of the New York Fed. The Federal Reserve Bank of Minneapolis (The Ninth District, available at https://minneapolisfed.org/about/more-about-the-fed/the-ninth-district) covers the Ninth District of the Federal Reserve, including Minnesota, Montana, North and South Dakota, and parts of Wisconsin, and Michigan. The Federal Reserve District Bank of Kansas City (The Federal Reserve Bank of Kansas City Information, available at https://www.kansascityfed.org/aboutus/kcfedinformation) covers the Tenth District of the Federal Reserve, including Colorado, Kansas, Nebraska, Oklahoma, Wyoming, and parts of Missouri and New Mexico.
The Federal Reserve District Banks of Atlanta, Dallas, and St. Louis vote together to determine another FOMC voting member. The Dallas Fed (About the Dallas Fed, available at https://www.dallasfed.org/fed) covers the Eleventh Federal Reserve District, including Texas and parts of Louisiana and New Mexico. The Dallas Fed is an authority in the energy industry, on U.S.-Mexico border economics, and operates the U.S. Electronic Payment Solution Center which processes federal benefit payments (Dallas Fed: Year in Review, 2016, available at https://www.dallasfed.org/fed/annual/2016/yir.aspx). The Federal Reserve District Bank of Atlanta (The Atlanta Fed, available at https://www.frbatlanta.org/about/atlantafed.aspx) covers the Sixth District which includes Alabama, Florida, Georgia, and parts of Tennessee, Louisiana, and Mississippi. The Federal Reserve District Bank of St. Louis (About the St. Louis Fed, available at https://www.stlouisfed.org/about-us) covers the Eighth Federal Reserve District, including Arkansas and parts of Illinois, Indiana, Kentucky, Mississippi, Missouri, and Tennessee.
The Federal Reserve District Banks of Philadelphia, Boston, and Richmond choose one voting seat on the FOMC. The Philadelphia Fed (Who We Are, What We Do: An Overview, available at https://www.philadelphiafed.org/about-the-fed/who-we-are) covers the Third District of the Federal Reserve, which includes parts of Pennsylvania, New Jersey, and Delaware. It conducts research on the economy, and its regional manufacturing index is considered a fairly accurate proxy for nationwide manufacturing conditions (Manufacturing Business Outlook Survey, available at https://www.philadelphiafed.org/research-and-data/regional-economy/business-outlook-survey). The Federal Reserve Bank of Boston (Maps of the Federal Reserve System, available at https://www.federalreserve.gov/boarddocs/rptcongress/annual07/pdf/maps.pdf) covers the First District of the Federal Reserve, including New England, Maine, Massachusetts, New Hampshire, Rhode Island, Vermont, and most of Connecticut. The Federal Reserve District Bank of Richmond (About the Richmond Fed, available at https://www.richmondfed.org/-/media/richmondfedorg/about_us/who_we_are/pdf/richmondfed_q_and_a.pdf) covers the Fifth District of the Federal Reserve, including the District of Columbia, Maryland, North Carolina, South Carolina, Virginia, and most of West Virginia.
The Federal Reserve District Banks of Cleveland and Chicago determine one voting seat on the FOMC. The Chicago Fed (Overview of the Seventh District Economy, available at https://www.chicagofed.org/utilities/about-us/seventh-district-economy) covers the Seventh Federal Reserve District, including Iowa and parts of Illinois, Indiana, Wisconsin, and Michigan. The Federal Reserve District Bank of Cleveland (The Cleveland Fed at a Glance, available at https://www.clevelandfed.org/en/about-us/at-a-glance.aspx) covers the Federal Reserve System’s Fourth District, including Ohio and parts of Pennsylvania, Kentucky, and West Virginia.
C. How Banks Become a Member
Essentially any private bank–state or national–can apply to become a member bank which is part of the Federal Reserve. So long as the bank is incorporated under the laws of its state and the laws of the United States, any bank can go through the process set forth in the Federal Reserve Act to become a member bank (The Federal Reserve Act, Section 9, available at https://www.federalreserve.gov/aboutthefed/section9.htm). The process requires an application to the Board of Governors, requesting stock in the Federal Reserve. All national banks are required to become member banks, and many state-chartered banks do so as well. Out of the commercial banks in the United States, 38 percent are member banks of the Federal Reserve System (The Structure and Function of the Federal Reserve, available at https://www.federalreserveeducation.org/about-the-fed/structure-and-functions).
The application process for state and national banks is basically exactly the same (The Federal Reserve Act, Section 9). In fact, a state bank can even convert into a national bank under the Federal Reserve Act by having enough unimpaired capital (generally a minimum of $4M) and a simple majority vote of shareholders where at least 51% of shareholders vote (The Federal Reserve Act, Section 8, available at https://www.federalreserve.gov/aboutthefed/section8.htm). The only exceptions are where such a conversion would in some way violate another existing law. The actual organization and structure of a bank after such a conversion changes very little, except for a few required amendments to articles of association–hardly a laborious change if there is already director and shareholder approval (see id.). Banks are barred from making the conversion if they’re facing down a cease and desist order from their State or the Fed, or if they face a ruling against them from a State Attorney General (see id.).
The actual application process requires the purchase of stock in the Federal Reserve (The Federal Reserve Act, Section 9, available at https://www.federalreserve.gov/aboutthefed/section9.htm). The application is considered by the Board of Governors and accepted, at least under the Federal Reserve Act, where the bank is in an acceptable financial condition and its leadership and corporate culture don’t act against the Congressionally mandated goals of the Federal Reserve (see id.). After the application is accepted, the bank in question is issued stock and required to pay a stock subscription upon the call of the Board of Governors (see id.). This stock is not voting stock unless it is held by a member bank, and no member can hold more than $25,000 worth of stock in the Federal Reserve (The Federal Reserve Act, Section 2, available at https://www.federalreserve.gov/aboutthefed/section2.htm). These banks also become subject to inspection by the Board of Governors or their representatives at any time. The Board of Governors can also cause a bank to forfeit its membership and revoke their stock at any time if they feel they have not complied with the goals of the Federal Reserve or failed to comply with the provisions of the Federal Reserve Act and related laws such as the National Banking Act (The Federal Reserve Act, Section 9). Banks can voluntarily withdraw from the Federal Reserve System with 6 months of notice to the Board of Governors (see id.).
D. Rights and Powers of Members
In addition to the activities most banks undertake, member banks of the Federal Reserve have a few special powers they use in the course of business. A lot of these powers are too complicated to fully explore in this article–or even in a textbook for that matter. With this in mind we’ll only be giving a general discussion of them here. However, look for a future article where we will take a deeper dive on these powers.
For instance, as mentioned in the introduction, the Federal Reserve banks often offer loans at a discounted rate to provide temporary liquidity to banks and stabilize financial markets (Policy Tools: Discount Rate, available at https://www.federalreserve.gov/monetarypolicy/discountrate.htm). While historically, these discounted loans were given to other depository institutions, the 2007-2009 financial crises saw the use of an old 1932 authorization to lend to other businesses (Federal Reserve Credit Programs During the Meltdown, available at https://www.federalreservehistory.org/essays/fed_credit_programs).
The 1932 amendment allowed for discounts for individuals, partnerships, and corporations in “unusual and exigent circumstances” (The Federal Reserve Act, Section 13, available at https://www.federalreserve.gov/aboutthefed/section13.htm). This form of discounting requires both authorization from the Board of Governors and evidence the recipient of the discount “is unable to secure adequate credit accommodations from other banking institutions. . .” (id.). The Board is also required to put policies and procedures in place to avoid aiding failing and insolvent financial companies, to terminate discount programs in a timely fashion, and secure satisfactory collateral for discounted loans (see id.). Any discount programs also require the prior approval of the Secretary of the Treasury. Further, after any such loans are authorized, the Board is required to make reports to the Senate’s committees on Banking, Housing, and Urban Affairs, and the House of Representatives’ Committee on Financial Services (see id.).
The member banks are also authorized to purchase bankers’ acceptances as part of their market operations. Bankers’ acceptances are a form of short term loan used to finance trade. Used as a sort of advance on payment when goods were shipped long distance, bankers’ advances tended to be low risk short term investments (The Tools and Transmission of Federal Reserve Monetary Policy in the 1920s, https://www.federalreserve.gov/econresdata/notes/feds-notes/2016/tools-and-transmission-of-federal-reserve-monetary-policy-in-the-1920s-20161122.html). The member banks were authorized to accept bankers’ acceptances growing out of importation, exportation, or domestic shopping of goods. ([Formerly 12 USC 372, as amended by act of March 3, 1915 (38 Stat. 958); by act of Sept. 7, 1916 (39 Stat. 752), which completely revised this section; and by acts of June 21, 1917 (40 Stat. 235) and Oct. 8, 1982 (96 Stat. 1239). Omitted from the U.S. Code.]) Member banks were also authorized to use those acceptances for “the purpose of furnishing dollar exchange as required by the usages of trade” (id.).
Federal Reserve banks may also make short term advances (no longer than 15 or 90 days, depending on the type of note) on secured promissory notes to their member banks (12 USC 347). The rates of these advances are determined by each Federal Reserve bank, subject to review by the Board of Governors. Similar advances can be provided to individuals, partnerships, and corporations on promissory notes “secured by direct obligations of the United States or . . . fully guaranteed as to principal and interest by, any agency of the United States” (12 USC 347c).
The member banks are also permitted to act as insurance agents in locations with a population of 5000 or less (see Insurance Activities: Comptroller’s Handbook, June 2002, available at https://www.occ.treas.gov/publications/publications-by-type/comptrollers-handbook/insurance-activities/pub-ch-insurance-activities.pdf p2; 12 USC 92). However, that authorization is somewhat obsolete, as national banks can also conduct insurance activities regardless of population under 12 USC 24(Seventh). (See Insurance Activities: Comptroller’s Handbookat p. 2.)
Finally, the Fed, under direction of the FOMC, can also exercise its powers simply by purchasing assets from its member banks, in a process called Quantitative Easing (QE). QE (colloquially called “printing money”) involves a central bank, like the Fed, purchasing securities from banks in order give those banks more liquid funds to (hopefully) spend and stimulate the economy. It’s sometimes referred to as printing money because the securities are usually bought by issuing credit to banks, essentially out of thin air. (See What Is Quantitative Easing, available at https://www.thebalance.com/what-is-quantitative-easing-definition-and-explanation-3305881.) For instance, the Fed did this between 2008-2013 to combat the financial crises, by buying bank debt, U.S. Treasury notes, and mortgage-backed securities (yes, including the toxic subprime mortgages that caused the whole mess) through the New York Fed’s trading desk.
VII. The Boards That Oversee the Banks (Board of Governors and Board(s) of Directors)
All the Federal District Banks, branches, and member banks have their own Boards of Directors associated with them–much like most corporations do. As opposed to the political appoints of the Board of Governors–appointed by the President and confirmed by the Senate–these Boards of Directors are voted in primarily by the private banks themselves. This being said, these Boards’ work is a little different than the usual corporate Board of Directors due to requirements of the Federal Reserve Act. They also have roles and responsibilities created by the Act which go beyond the usual role one would expect from your average private corporation’s Board of Directors.
A. Appointments of Board Members
The individual nine person Boards of Directors all have their own rules and limitations for who can be appointed and how. The Board of Governors has some more vague positional requirements for directors on these boards, asking that they be familiar with the economic conditions and business community of the region they are selected for. (See Roles and Responsibilities of Federal Reserve Directors at p. 21.) However, these are not legal requirements so much as stated preferences (see id.). This being said, the Federal Reserve Act offers quite a bit of structure into how these directors are appointed (The Federal Reserve Act, Section 4, available at https://www.federalreserve.gov/aboutthefed/section4.htm). The result of all these rules is a Board of Directors halfway between what you’d expect of a private corporation and a government run entity ostensibly for the public interest.
As we’ve mentioned, there is a nine member Board of Directors running each member bank of the Federal Reserve. There is no age requirement or limitation for these positions, or even a requirement that you still work at the bank as retired individuals are occasionally given the positions. (See Roles and Responsibilities of Federal Reserve Directors at p. 21.) The business affiliations of directors are considered in the selection process as part of achieving the Federal Reserve Act’s goal of diversity of perspective. However, in theory, the directors are not supposed to be an advocate for any particular interest group besides the public’s best interest (see id.). For instance, elected officials and Administration appointees are not allowed on the Board.
This being said, looking at the appointment process of these directors provides a pretty clear idea of their goals and structure. The nine directors are broken down into three “classes”–Class A, B, and C (The Federal Reserve Act, Section 4). Each of these classes has three members. Class A is appointed by the district bank itself and represents district member banks. Class B is also appointed by the district bank but theoretically represents the public at large. Finally, Class C is appointed by the Board of Governors and also theoretically represents the public (see id.). The Board of Governors also appoints the chair and deputy chair of every Board of Directors from the three Class C directors (see id.). Each of these classes has their own eligibility requirements.
It is worth noting that the branches of the Federal Reserve as a whole also have their own Board of Directors of five to seven members each. The majority of these directors are appointed by a Reserve district bank with the rest appointed by the Board of Governors. There are no classes to Branch Directors; however, directors appointed by the Reserve banks generally need to fulfill the same eligibility requirements of Class A or B directors while those appointed by the Board of Governors must fulfill Class B requirements (see id.).
The eligibility requirements for each class of directors are set by the Federal Reserve Act (see id.). For all of the classes, no Senator or Representative in Congress can sit as a director–or on the Board of Governors for that matter (see id.). Once somebody is an officer (president, vice president, etc.) or director at one bank, they’re not allowed to be a Class A director at another bank unless the nomination comes from the bank having the largest aggregate resources of any of those of which that person is an officer or director. In Class B, the nominees outright cannot be an officer, director, or employee of any bank. Class C shares the same limitations, but also bars stockholders of any bank (see id.). These limitations on Class B and C are intended to help ensure these directors serve the interests of the public.
Each class carries a legal requirement that members be appointed without discrimination on the basis of race, creed, color, sex, or national origin. Class B carries a certain amount of consideration for the interests of agriculture, commerce, industry, services, labor, and consumers. In fact, the Federal Reserve Act requires such consideration in appointments–although it also requires that these interests not be the only consideration. Similar rules are in place for the election of Class C directors by the Board of Governors (see id.).
The actual election and appointment of Class A and B directors works as follows. Each member bank nominates one potential director each for Class A and Class B–sending these nominations to the chairman of the Board of Directors for their district. All these nominations are compiled by this chairman and sent to each member bank within 15 days of the completion of the list. After this, each member bank individually votes on their preferences for each position and the nominee receiving a majority of the highest preference level (generally tiered one to three) is appointed. If there’s no majority at the highest preference level, the lower tier preferences are tallied and counted in deciding who to appoint (see id.).
For Class C, the appointments are a little simpler but have a few more requirements. The Board of Governors outright appoints these directors, so the appointment process is quite straightforward. However, those appointed to Class C must have lived in the district they are appointed in for at least two years and have “tested banking experience.” This latter requirement is fairly ill defined but generally requires some previous work in the industry. Once appointed, Class C directors serve as Federal Reserve agents–essentially an agent of an Executive Agency–reporting to the Board of Governors. As mentioned before, the chairman of each board is appointed from among these three directors (see id.).
The duration of appointments is staggered between the directors. For this reason, at the first meeting of any Board of Directors for a Federal Reserve bank they have the odd duty of deciding the order in which they will go. Each class–A, B, and C–has to designate one member who will have a one year term, one for a two year term, and one for a three year term. After this, each director appointed has a three year term. If there is an unexpected vacancy on a board, the successor stays an additional period equal to their predecessor’s term. This prevents the logistical nightmare of potentially replacing nine directors at once (see id.).
This leaves an odd situation for most Boards of Directors. For an organization that most believe to be very closely tied to the government, the majority of every Board of Directors is appointed by private banks. This is slightly offset by a couple of things. First, the Board of Governors appoints the head of every Board of Directors. Second, the Class B directors at least theoretically represent the public. However, in reality most Boards of Directors operate very similarly to a private corporation with the exception of reporting to the Board of Governors.
B. Roles and Responsibilities of Board Members
We’ve seen that there are a number of different boards and director roles–Board of Directors, Branch Directors, Board of Governors, and the FOMC. Each of these roles has their own duties set forth by the Federal Reserve Act and the Board of Governors (see Roles and Responsibilities of Federal Reserve Directors).
The Directors are generally intended to be more in touch with the industries and economy of their immediate area and make monetary policy suggestions in line with the needs of that area. This comes in a lot of forms but–above all–it comes in a biweekly recommendation from each Reserve Bank Board as to the appropriate action to take in regards to discount rates (see id. at 32). Directors theoretically act as the link between the Federal Reserve and the public, giving the Board of Governors and the Federal Reserve recommendations from smaller economic climates across the nation (see id.).
While directors are involved in general functions of the Federal Reserve, they are not supposed to be making specific supervisory decisions for the banks they are associated with. They do implement some internal audit procedures and the like under the Federal Reserve Act. However, they are largely not involved with day to day functions (see id. at 2).
This being said, the Boards of Directors do have a substantial impact on these day to day functions by appointing the executives of the bank they are associated with. They have the power under the Federal Reserve Act to appoint a president, vice president, and such other officers as necessary to handle day to day duties. The president is appointed by the Class B and C directors, with approval of the Board of Governors, for a term of 5 years. All other executives simply report to this president, although the first time a vice president is appointed, the same procedure is followed as for the appointment of a president. The Boards of Directors also have the power to set the duties of these officers and dismiss them as they please (see id. at 35).
The Board of Governors and the FOMC have a larger decision making role within the Federal Reserve. They receive the reports from all the different Boards of Directors and from the 12 Reserve district banks and use them to make and implement broader monetary policy decisions. These decisions, along with the recommendations and information from the individual Boards of Directors, are shared with the public two weeks before FOMC meetings in something known as the Beige Book (Beige Book: Summary of Commentary on Current Economic Conditions by Federal Reserve District available at https://www.federalreserve.gov/monetarypolicy/beige-book-default.htm).
Additionally, Directors “act as a link between the Federal Reserve and the private sector, with information flowing in both directions” (Roles and Responsibilities of Federal Reserve Directors). While doing this, directors are required to keep confidential information they receive from the public, and cannot disclose monetary policy action until it has officially been disclosed (How is the Federal Reserve Structured? available at https://www.richmondfed.org/faqs/frs). This, among other transparency issues, has led to some criticism of the Federal Reserve System.
The Federal Reserve System is much less federal than the name would have you believe. There is a fair bit of government guidance from the Board of Governors, as well as from the directors the Board of Governors gets to choose. However, the actual system itself is primarily made up of private banks with a majority of privately appointed directors running the show at individual member banks and offering advice on monetary policy changes. While the upper levels of the organization are a government agency, this leaves much of the daily goings-on of the Federal Reserve in individual banks inaccessible to the public.
The goal of President Wilson and Congress in creating the Federal Reserve System was to promote economic stability through the uniformity and certainty of a central banking system which would promote and handle much of the monetary policy of the U.S. More recently, Congress expanded this aim, “[promoting] effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.” The idea behind a centralized banking system is that it protects consumers from individual banks taking advantage of them as well as providing stability to the banking system.
However, the banking system in recent years has not really been known for its stability. As it stands, the Federal Reserve Act and associated law puts a lot of power to fulfill ostensibly government functions in entirely or partially private elements of the Federal Reserve. For example, the New York Fed–a private bank with government guidance–has a tremendous amount of power and influence over the financial state and policy of the U.S. The FOMC likewise has an enormous amount of power for a committee that is nearly half composed of what are, at the end of the day, private banking interests.
This state of affairs, coupled with the rocky trajectory of the banking industry over the last several decades, has led to quite a bit of criticism directed at the Federal Reserve. Critics have targeted everything from the structure of the Federal Reserve System, to its very efficacy in achieving its stated goals. This is an extremely complicated discussion. Look to future articles which will look more at the powers granted by the Federal Reserve Act, the loaning practices of the Federal Reserve, and some of these criticisms.
There is certainly a very credible argument that placing substantial control over monetary policy in the hands of private organizations which could profit from those policies is not ideal to say the least. This being said, the power split between public and private within the Federal Reserve System is complicated to unpack. However, it is plain to see that while the function and goals of the Federal Reserve are simple to recite, they are much more difficult to achieve in practice. The question of whether the current structure of the Federal Reserve is the best means of achieving those goals is similarly difficult to parse.
IX. About Us
This article was written and edited by Michele Ferri and Jonathan Lurie of The Law Offices of Lurie and Ferri for use by The Solari Report. Michele Ferri and Jonathan Lurie are both practicing attorneys out of California. The Law Offices of Lurie and Ferri focus on working with start-up businesses as well as on intellectual property and business law issues. They can be found at http://www.lflawoffices.com/ or contacted at firstname.lastname@example.org.
i. These include Treasury securities, government-sponsored enterprise debt securities, and federal agency and government-sponsored enterprise mortgage-backed securities.
ii. The Solari Report has discussed the ESF at length previously.
See The Exchange Stabilization Fund with Rob Kirby, available at https://home.solari.com/the-exchange-stabilization-fund-with-rob-kirby/