Organization of the Federal Reserve System
The Federal Reserve System is sometimes described as a quasi-government
agency because it contains elements of both the private sector and
of government control. The System has three organization levels:
member banks, Federal Reserve Banks, and the Board of Governors. Let's
examine each briefly.
Member banks are at the bottom of the organization chart. These
are commercial banks and S&Ls who have joined the Federal Reserve
System (FRS). By law, all nationally chartered banks must join,
and any state chartered bank has the option to join (12
USCA §282). By joining the FRS a member bank is becoming
a shareholder -- an owner -- in its regional Federal Reserve Bank. For
example, suppose you and I open a new nationally chartered bank in
Charlotte, North Carolina. According to the district
map, we see that Charlotte is in the Richmond Federal Reserve
district, so our new bank will have to become a member of the Richmond
Federal Reserve Bank. So, the claim that the "Fed is privately
owned" is correct -- each Federal Reserve Bank is owned by private
for-profit commercial banks and S&Ls.
Why are member banks -- the owners -- at the bottom of the organization
chart? They are at the bottom because unlike the shareholders
of a typical corporation such as IBM, member banks have very little
power over how their regional Federal Reserve Bank is run. And
they have no control at all over monetary policy. Shareholders
of IBM elect the company's board of directors who in turn choose
the firm's CEO, so they have a collective say on the company's operations. Member
banks also get to select 6 of the 9 directors of their regional Federal
Reserve Bank, but these directors control only the Bank's daily operations,
not monetary policy which is the most important function of the Federal
Reserve System (12
USCA §301 and 12
USCA §302).
At the middle level in the organization chart are the 12 regional
Federal Reserve Banks. They have a variety of powers and duties,
some of which are:
- Buy and sell government bonds in the secondary markets (open
market operations)
- Lend reserves to member banks
- Offer check-clearing services to member and non-member banks
- Issue Federal Reserve Notes and collect worn-out ones for destruction
- Enforce reserve requirements and other regulations of the member
banks
- Monitor banking and economic activity within their respective
district
In terms of monetary policy, the most important power is the first
one -- open market operations. Buying government bonds in the
secondary markets increases the amount of reserves in the banking system,
puts downward pressure on interest rates, and tends to expand the money
supply. Selling government bonds does the opposite. This
is the monetary policy function that is most often associated with
the Fed (What
is monetary policy?). However, a Federal Reserve Bank can
only employ open market operations with the explicit approval of the
Board of Governors (12
USCA §355).
Finally, at the top of the structure chart is the Board
of Governors. The Board is a 7-member panel who is appointed
by the President of the United States and confirmed by the Senate (12
USCA §241). The Board's current Chair is Alan
Greenspan. Among its responsibilities:
- Determine open market policies
- Set the required reserve ratio for member banks
- Set the Discount Rate
- Deciding how much new currency to print
- Monitor the health of the U.S. economy
- Report to Congress periodically on the state of the U.S. economy
It's single most important duty is deciding its open market policy, that is,
whether it should order the Federal Reserve Banks to buy or sell government
bonds, and if so, how much. This decision is made in conjunction with
the Federal
Open Market Committee. The FOMC is a 12-member panel can consists
of all the Board members, the president of the New York Federal Reserve Bank,
and 4 presidents from the other Federal Reserve Banks on a rotating basis. The
presidents are appointed by each Bank's board of directors, pending approval
from the Board of Governors (12
USCA §341).
Thus, all the key monetary policy decisions -- the ones that affect interest
rates -- are made by a government agency whose members are selected by the
President of the United States. The Fed may be privately owned, but
it is controlled by the government.
The Fed and Taxpayers
The second part of this myth is that the Fed is a drain on the Treasury,
and therefore a drain on taxpayers. This is untrue. The Federal
Reserve Banks are entirely self-financing institutions; they do not receive
any tax dollars allocated to them from the federal budget. Let's take
a look at the table below to see exactly where they get their money and how
they spend it:
1999 Combined Statements of Income of the Federal Reserve Banks (in millions)
Interest income Interest on U.S. government securities $28,216 Interest
on foreign securities 225 Interest
on loans to depository institutions 11
Other income 688 ------- Total
operating income 29,140
Operating expenses Salaries and benefits 1,446 Occupancy
expense 189 Assessments
by Board of Governors 699 Equipment
expense 242 Other 302 ------- Total
operating expenses 2,878
Net Income Prior to Distribution $26,262
Distribution of Net Income Dividends paid to member banks 374 Transferred
to surplus 479 Payments
to U.S. Treasury 25,409 ------- Total
distribution 26,262
Source: 86th
Annual Report of the Board of Governors, p.335.
We can see from the top of the table that the Fed's primary source of income
is interest from government bonds. This money is paid to the Fed by
the U.S. Treasury. Is this not de facto evidence the Fed is leaching
off the taxpayers? No, it is not. The Treasury is obligated to
pay interest to whomever owns those bonds. If the Fed did not own them,
then the interest would have been paid to someone else. In fact, from
the Treasury's perspective, it is a good thing the Fed holds those bonds. At
the bottom of the table, we see the Fed makes a substantial annual payment
to the Treasury. The higher the Fed's net income is, the larger the
payment to the Treasury. In other words, the Treasury gets back a significant
amount of the interest paid to the Fed. Thus, government bonds held
by the Fed are essentially interest-free loans to the government.
Conclusion
The regional Federal Reserve Banks are private owned, but they are controlled
by the Board of Governors -- a federal agency whose members are appointed
by the President and confirmed by the Senate. The Board sets monetary
policy and the Federal Reserve Banks execute it. In addition, the Fed
does not use any taxpayer money to fund its operations. While the Fed
does collect interest on government bonds, the Treasury would have had to
make such payment even if they Fed did not hold any bonds. Moreover,
the Fed rebates a significant share of its net income to the Treasury each
year, revenues the government would not have at all if the Fed owned no government
bonds.
