Financial Markets and Institutions - Test

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Overview, Objectives and Readings Page ] of 1

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Overview __

The Federal Reserve System is the central bank of the United States and is of critical importance to the U.S. economy. The

Fed was established in 1913 by passage of the Federal Reserve Act in an effort to foster a sound banking system and prevent

future bank panics. Today's Fed operates under a mandate to promote economic growth commensurate with price stability.

This week we'll be gaining an understanding of the organizational structure and goals of the Fed, with a view toward next

week's discussion of monetary policy. We'll explore the many functions performed by the Fed, primarily domestically, but also

i nternationally. The roles of both the Federal Reserve District Banks and the Board of Governors will be explored, with

particular attention given to the Federal Open Market Commitee (FOMC). The FOMC is the Fed's monetary policymaking

body, arguably the single most powerful monetary authority in the world.

We'll conclude the lecture by considering the Fed's independence and accountabilty, attempting to understand why the Fed is

considered "independent within government' as opposed to being "independent of government." It will be argued that the

Federal Reserve System functions best as aquasi-governmental agency under the authority of the U.S. Congress, yet

provided with the financial and operating independence necessary to accomplish its goals.

In 1998, the U.S. experienced something of a precursor to our latest financial crisis when Long-Term Capial Management, a

highly-respected hedge fund, collapsed. The Fed and the country's major banks worked together to close down LTCM, but it

now appears that significant lessons and opportunities were missed. This week's video, Trillion Dollar Bet, gives an "insider's

perspective" on the LTCM debacle and should prove instructive regarding the troubles of today.

Objectives

After completing this module, you should be familiar

with:

• The rationale behind the Federal Reserve System, particularly the problems that passage of the Federal Reserve Act was intended to solve

• The goals and functions of the Fed, along with the mandate under which the Fed operates

• The overall structure of the Fed, including its Board of

Governors, Federal Reserve District Banks, and Federal Open Market Committee

• The Fed's independence and accountability within a

democratic society

Readings

• Read chapter 9 in Financial Markets and Intitutions, 2nd Edition by Burton, Nesiba, and Brown

• Finish reading the prologue and chapters 1 through 6 of And Then the Roof Caved In by Faber prior to taking this week's quiz.

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About the Federal Reserve System

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About the Federal Reserve System

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Lecture Overview ■ Rationale for the Federal Reserve System

■ Goals and Functions of the Fed

■ Structure of the Fed

The Board of Governors

Federal Reserve District Banks ~ .

Federal Open Market Committee (FOMC)

■ Fed Independence and Accountability

About the Federal Reserve System

Central bank of the United 1 j States J ~...

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Established December 21, 1913 by passage of the Federal Reserve Act ~;..~.

■ Preceded by: ❑ Bank of North America 1782

❑ Inflationary bank notes ❑ Lasted one year before folding

I f .

Federal Banking Before the Fed Preceded by: The First Bank of the United States

Hamilton's plan

❑ Given a 20 year charter by congress in 1791

❑ Charter not renewed by Congress in 1811

Two banks now who both preceded the current fed and were excessivei inflationary.

Federal Banking Before the Fed Preceded by: The Second Bank of the United States

❑ Chartered in 1816 after war

❑ Launched Andrew Jackson's political career

■ Attempt at early renewal of charter in" ̀ 1832 overridden by President Andrew Jackson's veto i

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.Federal Banking Before the Fed

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■ Jeffersonians ❑ Nothing in U.S. constitution permitting the fed government to establish a National Bank

■ Hamiltonians ❑ The U.S. constitution

granted "implied powers' to the fed government , which one was foundation

In 1819 Marshall court ruled in McCulloch v. Maryland that a

federally-established central bank was wnstitutional

About the Federal Reserve System

■ The Federal Reserve System was originally

not conceived of as a central bank, but as a system of banks

❑ Desired the banking system to The Public oPr~o~

be in public, not private hands

❑Wanted to avoid a concentration of wealth and power in the hands of one, single bank

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Rationale for the Federal Reserve

System

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Rationale for the Federal Reserve System ~~~ ■ Long history of agitation for ~'"1\ ~`

reforming the U.S. banking system

❑ Viewed as necessary to curb the irresponsible and inflationary practices of U.S. banking

❑ Bank panics of 1873, 1896, r ,R and 1907 served as catalysts

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Rationale for the Federal Reserve System

• Numerous monetary commissions had been exploring alternatives to the banking system

• Prior to passing the Federal Reserve Act 1913.

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Rationale for the Federal Reserve System

■ By common consensus the new banking system should:

❑Provide the reserve funds

needed to maintain the

U.S. banking system ..,,.,

❑Prevent the creation of ; , ~=' ~ '

too much currency and

credit i i

❑ Eliminate bank panics '•._____,___.

Rationale for the Federal Reserve System

Essentials of the new banking system:

Control Of ❑Creation of a single, the

federally-authorized bank note to replace all other bank

Currency notes

Single note ❑prevent currency drains in the Elastic economy Cul't'enCy ❑Protect individual banks against

insolvency

~A lender of last resort for the nation's banks

About the Federal Reserve System

Passage of the Federal Reserve Act in 1913 established:

1. Afederal system of national banks providing reserve funds to member banks

2. A federally authorized note as the sole legal tender (removed all other bank notes from circulation)

-- 3. An ultimate lender for the banking system

(lender of last resort) Y

Key Federal Reserve Acts

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Key Federal Reserve Acts

___. _ _ ■ Created the "modern" Fed _~

❑ Consolidated power in the Federal Reserve Board of ,~ Governors, which was to:

Set legal reserve requirements

Approve regional bank discount rates .

Key Federal Reserve Acts

❑ Created the Federal Open Market Committee

Official body for determining monetary policy

❑ Removed the Treasury Secretary and the Comptroller of the Currency from the Fed Board of Directors

❑ Established the selection and :, confirmation process for the Fed's Chairman and Vice-Chairman

Key Federal Reserve Acts

■ The 1951 Accord

Allowed the Fed to operate independently of the U.S. Treasury

❑The Fed was no longer required to monetize the federal debt ~ ~,,~ (by creating credit to purchase newly-issued Treasury ~~- securities) ~~~ . . Monetizing the debt had kept ~` ;

i nterest rates artificially low, •~ b ut led to high rates of price i nflation

Key Federal Reserve Acts

■ The 1978 Amendment established the

following goals for the Fed:

1. Promote stable prices

~ 2. Maximize economic output ~

3. Minimize unemployment

Mandatory Goals —Not Optional!

Key Federal Reserve Acts

■ These acts have resulted in the role of the Fed today: --

Tofoster asound banking -~s~,_, system and payments ~ ~-- "~; mechanism --._.._

To promote economic growth commensurate with ~. ~: price stability ~_ `~` ~ ~~;,:~

— Employment and GDP are key components for `. , achieving economic growth ~' n

Goals of the Federal Reserve

■ To foster a sound banking system and healthy economy

■ To pursue full employment and non- inflationary growth

❑ Humphrey-Hawkins amendment to Federal Reserve Act) 1978

■ Essentially three broad goals:

1. Promote stable prices

2. Maximize economic output

3. Minimize unemployment Y'

junctions of the Fed

~ . acts as fiscal agent for U.S. Government

2. supervises and regulates financial system

3. acilitates payments mechanism

4. 'ormulates monetary policy

J. advisor to president and congress

s. 'Yorks with other central banks

Functions of the Fed

~ , acts as fiscal agent for U.S. Government

Maintains the Treasury's transaction account

Maintains the checking account of the U.S. Treasury

All the checking and receipts on the

;~ ~ r>q-,~~ U.S. Treasury account is handled by the foil

The U.S. Government's bank Is at the fed! .. "~i

i~~ Functions of the Fed

2, supervises and regulated financial growth

Actions taken to ensure the safety and 1 soundness of the financial system

Examining national and state charter banks, BHCs, and financial holding companies

'. Ensuring that depository institutions are meeting their reserve requirements and

- ~ - ~ ~ maintaining sufficient

Functions of the Fed

3, acilitates payment mechanism

( Actions taken to ensure the safe and efficient transfer of funds— clearing checks and providing currency and coin

Processes checks and cash settlements

~" Works to ensure that the payment

~ ~ system is operating effectively,. ti

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_.. ~

Functions of the Fed

Q, ormulates monetary policy

Action taken to improve the health of the economy

Accomplish its goals of price stability, maximize GDP, minimize unemployment

Managing the money supply

i ~~' Functions of the Fed

5. ,dvisor to president and congress

Provides economic analysis and advice to the president and congress

Analysis regarding banking monetary policies, financial

., ~,~ ~ :~ ~ ~ markets, and the economy

Functions of the Fed

6, Vorks with other central banks

Discusses and coordinates international banking and monetary issues with other central banks

~I Meets annually to direct the ~'` affairs of an international

.̀'~ ~ financial institution known as the bank for international settlements

Federal Reserve Membership and District Banks

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Federal Reserve Membership

■ Nationally-chartered banks are required to be members of the Federal Reserve System

■ State-chartered banks that qualify for membership may elect to become members

■ Member banks are required to maintain reserve deposits and purchase stock in their respective district banks

Federal Reserve Membership

Only member banks had to maintain reserve accounts at the Fed

■ Since 1980 non-member banks have been granted direct borrowing privileges ❑ All banks must now maintain reserve accounts at the Fed

■ All banks must: ❑ Meet reserve requirements established by the Fed

❑ Maintain adequate FDIC coverage

Federal Reserve District Banks

■ The Federal Reserve System is composed of:

12 Federal Reserve Banks

Reserve Banks District Banks

Separate districts were established to allow regional economies to have specific needs monitored and met

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Federal Reserve Districts include:

1. Boston

2. New York >~

3. Philadelphia

4. Cleveland

5. Richmond

6. Atlanta

7. Chicago

District Banks

ven

8. St. Louis "e

9. Minneapolis " ~"w ;<en` 6u~~w~~coann

10. Kansas City

1 1. Dallas

12. San Francisco

Federal Reserve District Banks

■ Some districts have Districts include: ~ No N Branch Banks

no branch banks, ~ 2.

Boston ' — New Yc

No Branch Bank

One Branch Bank

while others have 3. Philade ~ No Branch Bank multiple branches 4. Cleve~ano TvroBranchBanks

5. Richmond Tvro Branch Banks ❑ There are no branch 6. Atlanta Five Branch Banks banks in the 1 S' and 7. Chicago o„e e~an~n ea~k 3'" districts 8. SI. Louis Three Branch Banks

9. Minneapolis One Branch bank ❑ There are five branch banks in the 6'h district

~0. ~ 7,

Kansas Cily

Dallas

Three Branch Banks

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❑ The single branch ~z. se"Fri""s`°

bank in the 7"'district To~aior r 25 branch

is located in Detroit hanks in

Federal Reserve District Banks

~ • lonitoring respective districts economy

2, ending funds to depository institutions

$, roposing and administering discount rates

4. upplying currency and coins to the district

5. dministering funds transfers (including check -ocessing and clearing)

s, Reporting economic conditions to the public

District Bank Boards

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Federal Reserve Beige Book

Provides anecdotal ~ I ~ information on economic

conditions as reported ~ f '"`m'""'""" by each of the 12 federal { '~~ - :reserve district banks ~

■ OI ommentary on Ci iic Conditions but is 'red to as The beige Bi

■ Pu„~~~~~~„~~y~~.,~mesperyearand read by economists, bankers, and business leaders to better understand their districts economic , s,ỳ.~a. condition

Federal Reserve Beige Book

■ Information typically considers:

❑ Consumer spending

❑ Business spending

❑ Tourism and travel

❑ Manufacturing activity

❑ Service activity

❑ Construction and real estate

❑ Banking and lending activity

❑ Prices, wages, and employment ~ `

❑ Agriculture and natural resources

District Bank Boards

Each district bank is directed ~ .,

by anine-member board of ~ directors

■ District bank directors serve - --. on a part-time basis

■ Three classes of directors district bank boards

~. Class A directors: Bankers

z. Class B directors: Non- Bankers

s. Class C directors: Fed Appointees

District Bank Boards

'' Each district board appoints a district bank ; t

', president

❑Approval required from Federal Reserve Board of Governors

■ District bank presidents are

economists and serve five

District Bank Boards

• Recall: Class C directors Fed Appointees

❑ A district bank president approval required from Federal Reserve Board of Governors

■ District bank presidents are suggested by the Board of Governors

Class A

Class B Directors

~i ~ District Bank Boards and The Federal Advisory Committee Each district board chooses a member to serve on the Federal Advisory Council /_ _. ~

■ A1112 members must be '` ~ - ~~ bankers and each serves a one-year term

` The FAC provides advice to' the Federal Reserve Board j of Governors %

❑ Meets four Umes per year

❑ Cannot issue public statemern

Federal Reserve Board of Governors

~ _~ i ~ i Federal Reserve Board of Governors

Directs all activities of the Federal Reserve S' ,.~oor~:riv~k.9 -

HQ in Washington D.C.

h: Seven members

Q'~'•`'~t ~E'.`~y~'~. Typically professional economists

Appointed by the U.S. President

Confirmed by senate

Similarto appointing a Supreme Court Justice

Federal Reserve Board of Governors

'.c=aao~~~~~FRti,4. 14-year term of office

• b r ~ Reappointment not permitted :~ s: ~, ~ ;~,~ Replacements may serve out predecessor's ~T,~ ~' '~."~R,,~ Rest°:~' Then can be appointed to their own term

Replaced predecessor

Appointed to own term

A ointed for fife AWn Greenspan -

Chalrman 1987-2006

FA~p!-.ai Reserve Board of Governors

~s ; Terms are staggered

F ~ One member replaced every two years .F .A ~' a~~'R.1L RES~Q••••

~q~ Two appointments per Presidential term s A o 'Max of four appointments for a President

~i , a~' Most members do not serve the full termt35, y,~~

Federal Reserve Board of Governors

p n( GfJVF Rr,or~ ~,~ , Wh not serve the full term.

e s •. ~: - Have a high market value in private sector

• ~F, ~ ~ ~ -Pay potential much larger in private sector .e'•'

"~.°~'k,~. w~s~"`~' -Large opportunity cost to serve

The Chairman of the Federal Reserve Board of Governors

Appoinledforfour ~ ~'ro~,..F ~ 0

ear term ~` ~~~ ~ ;.,

May be reappointed Y

sen S. aemanke until the term on BOG ~~i:9s, ,~ y{

Chairman expires --- ~---~

■ Chairman is one of the principal economic advisors to the President and Con ress

Allen Greenspan Chairman

1987 - 2006

L ::i

~ ~ The Chairman of the Federal Reserve Board of Governors

Humphrey-Hawkins act of 1978

Twice)

Ben S. Bernanke Chairman

■ Chairman's views are scrutinized by "Fed watchers"very carefully

~_I Federal Open Market Committee

(FMOC)

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Federal Open Market Committee (FOMC)

. ra~~~~~ ̀ ~"+~ Monetary policymaking body 1

;, , Established by the Federal ~a~t4 ~ ~,,:~"~ Reserve Act of 1936

Most powerful monetary authority in the world

Meets eight times annually

Discusses policy issues

--~ v

--- - € —

Members stay in _. Fed chairman may contact between ~ I change interest rates meetings I between meetings

FOMC Membership

12 members: ~ ~

7 members of BOG President of the 4 of the 11 district NY District Bank L bank presidents

----- Most important T job at the Fed ~`~ Serving in one

Year rotations ~,...,. .

All district ba nts participate

Only r an vote ++~!

FOMC Membership

President of the NY District Bank

'"°' Implements monetary policye directives of the FOMC

Ben S. BemankeWiiliam C. Dudley "' ~ Chaittnan Virg-Chairman ~~ ~ y ~ ~ ~~

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First amongequals ~~

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Independence and

Accountability

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Independence and Accountability

Independent within government

~~~f; ~'`~ Under the authority of the

t~.~n, U.S. Congress

:~:. , . -- ~' Subject to congressional laws, oversight, and review

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Independence and Accountability

/I i~, quasi-government agency t

~ I.~~~ Doesn't depend on funding from Congress

Exempt from many provisions of Freedom of Information Act 1966 and "government i n the sunshine' legislation

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i ~ i i ..l ~i ec=~,~. `~:

Independence and Accountability

Quasi-government agency

Doesn't take orders concerning monetary policy;' from anyone in the federal government •~ i

„ ~ a

The presides ~f the federal reserve boar :hat the chairman set a particu policy

Independence and Accountability

Too autonomous?

I'm frustrated with the economy, inter st srgl rates, and inflation! ~ r, ̀ `sjr.~ .►

o v 1f tiu, ~•~y 9 q~~

Interest rates

q{ t Independence and Accountability

Financial and operating independence is necessary.

a:~-1, ~ ~ -~;- . ~,.-.~--

Congres t~ Fed ~̀ ~ Independence;j

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Independence and Accountability

Restricted by congressional laws and oversight

d~ ~~~ TAlF . ~ ~,~ Autonomy only maintained i( Fed operates

o \4~~~ W within politically acceptable bounds

q~ ~~ ~~' Congress can change laws without Fed9fSE¢ approval

r ` ,

( • Independence and Accountability

:hanging the status of Reserve Bank residents on the FOMC to non-voters

-~ ~ nF GOI~I.'R;Y

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Independence and Accountability

1 ~ Changing the status of Reserve Bankpresidents on the FOMC to non-voters 2~ Broadening the authority of the GAO

GAO Accountability +Integrity • Feliabflity

~4 ;~

Indeaendence and Accountability

'~ ~ Changing the status of Reserve Bank presidents on the FOMC to non-voters

2. Broadening the authority of the GAO

3, Disclosure of monetary policies and discussions

~li Independence and Accountability

1 Changing the status of Reserve Bank ~ presidents on the FOMC to non-voters

2. Broadening the authority of the GAO

3, Disclosure of monetary policies and discussions

4, Setting a mandatory " inflation target ~ '

I ndependence and Accountability

The Fed has adopted reporting practices leading to more openness. !

• Issues policy statements on present and likely future interest rates

• Makes minutes of FOMC meeting available to the public after three weeks

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Board of Governors of the Federal Reserve System

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Answers to Review Questions

Discuss each of the four major functions of the Fed. Which do you believe requires Fed autonomy? Why?

The primary responsibility of the Fed is the formulation and implementation of the nation's monetary policy. The conduct of monetary policy has two objectives. First, to ensure that

sufficient money and credit are available to allow the economy to expand along its long-run

potential growth trend under conditions of relatively little or no inflation. Second, in the short run, to minimize tl~e fluctuations—recessions or inflationary booms—around the long-term

trend.

Along with other government agencies, the Fed is responsible for the supervision and regulation of the financial system. In general, supervisory activities are directed at promoting

the safety and soundness of depository institutions by making sure that banks are operated prudently and according to standing statutes and regulations.

The third main responsibility of the Fed is to help maintain an easy-running payments mechanism. The Fed's main activities in this area involve the provision of currency and coin and the clearing of checks.

The final main responsibility of the Fed is to serve as the fiscal agent for the government. The Fed furnishes banking services to the government in a manner similar to the way private banks furnish banking services to their customers. The Fed also clears Treasury checks, issues and redeems government securities, and provides other financial services.

2. Give the major responsibilities of each of the following:

a. The Board of Governors b. The 12 Reserve Banks c. The Federal Open Market Committee

a. The Fed's Board of Governors' responsibilities are the following: 1. Sets reserve requirements and approves discount rates as part of monetary policy 2. Supervises and regulates member banks and bank holding companies 3. Establishes and administers protective regulations in consumer finance 4. Oversees Federal Reserve Banks

b. The following are the Federal Reserve Banks' responsibilities: 1. Propose discount rates 2. Lend funds to depository institutions (discount policy) 3. Furnish currency 4. Collect and clear checks, and transfer funds for depository institutions 5. Handle U.S. government debt and cash balances

c. The Federal Open Market Committee directs open market operations (buying and selling of

U.S. government securities), which are the primary instrument of monetary policy.

3. Why was the Fed created? What effect should the existence of the Fed have on financial crises?

Following the banking crises of 1907, lawmakers were convinced that a central bank was necessary. The central bank (the Fed) would serve as a bank for banks, which could lend funds

to commercial banks during emergencies and thus provide banks with the funds necessary to

avoid insolvency and bankruptcy. Having the Fed should avoid, or at least minimize, financial

Tl~e Overseer: Tl~e Federal Reserve System

crises because it is prepared to be a lender of last resort. Tl~e creation of the Fed was also motivated by a desire to preserve the public's confidence in the safety and soundness of tl~e financial system.

4. Why did Congress create 12 Federal Reserve l3anlcs rather than one central bank?

The reason why the original Federal Reserve Act created twelve Reserve Banks was to decentralize policymaking authority. There was considerable antifederalist sentiment in Congress at the time. Overtime, despite the existence of l2 Federal Reserve Banks, policymaking authority has been concentrated in Washington.

5. What features of the Fed's structure serve to make it fairly autonomous? Is Congress able to wield any control over the Fed?

The Federal Reserve was established by Congress as an independent agency to give it a certain amount of isolation from the political process. It is allegedly independent because of tl~e way it is structured. Each member of the Board is appointed to a fourteen-year- term, so that once appointed, a member of the Board does not have to defend his or her actions to Congress, the President, or the public. Also, the Fed does not need or get an appropriation from Congress. The Fed obtains funds from the interest income it earns ou loans to depository institutions and its holding of government securities. Last, the Fed is exempt from many provisions of the Freedom of Information Act and "government in the sunshine° legislation which calls for government policy to be made in meetings open to the public. As a result, Fed policy makers usually meet in secret to formulate policy. Nevertheless, the Fed is not completely outside the government. It is firmly embedded in our political system. In the short run, however, .the Fed does not take orders from anyone in the executive or legislative branch'of government. Its decisions regarding monetary policy are, in theory, not constrained by the whims of the President or Congress or by any partisan politics. In the long run, however, Congress can pass laws that the Fed must obey. Congress could even abolish the Fed.

6. Why have the responsibilities of the Fed increased since its inception?

The responsibilities of the Fed have increased over time, particularly since the 1930s, when it became clear that the limited powers and scope of the Fed were not up to handling the financial havoc of the Great Depression. At this time, new legislation charged the Fed with contributing to the attainment of the nation's economic and financial goals. Not only was the Fed to supervise and regulate the financial system, but it was also to influence the availability and cost of money and credit in order to affect the overall health and stability of the economy.

In many cases, the Fed argued that it needed more powers to accomplish its existing responsibilities or that taking on additional responsibilities was a natural adjunct to what it was already doing. Congress often responded favorably to the Fed's arguments or simply let the Fed decide on its own if it would be the best agency to handle certain economic issues.

7. Discuss the major policy tools that the Fed can use to promote the overall health of the economy. What is the most widely used tool?

To promote the overall health of the economy, the Fed can utilize open market operations, changes in the primary credit (discount) and secondary credit rates, and/or changes in the required reserve ratio.

Open market operations are the most widely used tool by the Fed. These operations, which are executed by the Federal Reserve Bank of New York, involve the buying or selling of U.S. Government securities by the Fed. They affect the amount of cash assets available for reserves

The Overseer: The Federal Reserve System 24

in tl~e banking system. When tl~e Fed wants to speed up tl~e economy, reserves are pumped into

the system and vice versa.

The primary credit (discount) and secondary rates are the interest rates the Fed charges

depository institutions that borrow reserves directly from the Fed. The financially healthiest

institutions are charged the primary credit rate while less healthy institutions are charged the

secondary credit rate. When the rate is lowered, depository institutions are encouraged to make

more loans, because if they are caught short of reserves, it will not cost them as much to

borrow reserves from the Fed. Likewise when the rate is increased, depository institutions are

discouraged fi-oin lending because, if caught short of reserves, borrowing reserves from the Fed

would be more costly.

The Fed requires depository institutions to Fold required reserves assets equal to a proportion

of checkable deposit liabilities. This proportion is the required reserve ratio. This is not a

widely used tool. However, lowering of the required reserve ratio would free up additional

reserves so that depository institutions could make more loans and extend credit.

8. What are the primary and secondary credit rates? When do they change? How often

does the Fed change the required reserve ratio? How often does the Fed engage in

open market operations?

The primary credit (discount) rate is the interest rate that the healthiest depository institutions

are charged to borrow reserves from the Fed. The secondary credit rate is the rate that weaker

banks are charged to borrow reserves from the Fed. The Board of Governors ultimately has

responsibility for setting the primary and secondary credit rates. At the present time, the

primary credit (discount) rate is set one percent above the fed funds rate (another key short-

term interest rate that the Fed in#]uences) and the secondary credit rate is set one and a half

percent above the fed finds rate.

Despite its power, the Fed does not change the required reserve ratio very much. When it does

choose to use this tool, the Fed is more likely to lower the ratio than to increase it. In

December of 1990 and again in December of 1992, the required reserve ratio was lowered in an

effort to stimulate the economy.

Unlike the required reserve ratio, open market operations have been the major instrument used

to implement monetary policy. Open market operations are executed by the New York Fed on a

daily basis in accordance with the Policy Directive of the FOMC.

9. What are the arguments for increasing the autonomy of the Fed? The arguments for

increasing the accountability of the Fed?

Proponents of continuing the Fed's independence argue that politicians are interested in getting

elected and reelected, and this means they are short-run maximizers. They (politicians) do not

take the long view, which could be disastrous if the long-run impacts of policy are different

from the short-run impacts. For instance, to please the electorate, politicians might pursue a

stimulative monetary policy resulting in an expansion of economic activity, even though the

more long-run impact of the policy might accelerate inflation. In other words, incumbent

politicians may have an incentive to use monetary policy to stimulate the economy before an

election even though it would lead to inflation and tightening of policy after the election.

Proponents for increasing the accountability of the Fed argue that the Reserve Bank presidents

represent the interests of the banking community since they are elected by the Reserve Bank

directors, two-thirds of whom, in turn, are elected by the member banks. Proponents for more

The Overseer: Tl~e Federal Reserve System 25

accountability of the Fed also argue that the General Accounting Office should be able to audit all aspects of the Fed.

10. Suppose that the Fed were less independent. How could this affect monetary policy? Suppose that the Fed were more independent..How could this affect monetary policy?

The less independent the Fed is, the more vulnerable it is to political pressure. Monetary policy could become directed toward ever-changing short-term political goals instead of long-term economic goals.

The more independent tl~e central bank, the less likely it will be to tailor monetary policy to the whims of politicians.

11. Why is the president of the New York Fed a permanent member of the FOMC?

New York is the center of the financial system of the United States. More importantly, the New York Fed implements open market operations on a daily basis in accordance with the FOMC's Policy Directive. Therefore, it is logical that the president of the New York Fed be a permanent member of the FOMC.

12. Is the Fed more accountable to Congress or to the president? Why? Who created the Fed? Who appoints the Fed chair?

The Fed is more accountable to Congress than to the President because in tl~e long run, Congress can pass laws that the Fed must obey. Congress could even abolish the Fed altogether.

Congress created the Federal Reserve System in 1913. The U.S. president appoints, with the advice and consent of the Senate, one of the seven Fed Board members as the Fed Chairperson for afour-year term.

13. How does each of the following affect the money supply?

a. The Fed lowers the required reserve ratio. b. The Fed buys government securities.

a. If the Fed lowered the required reserve ratio, the money supply would increase. b. If the Fed bought government securities, the money supply would increase.

14. What are sweep accounts? How do sweep accounts affect required reserves? Are balances in sweep accounts subject to reserve requirements?

Sweep accounts are a financial innovation that allows depository institutions to shift customers' funds out of checkable accounts that are subject to reserve requirements and into highly liquid money market deposit accounts that are not. Sweep accounts reduce the amount of required reserves since balances in sweep accounts are not subject to reserve requirements.

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PBSt ISSu@S A timeline of banking legislation and regulation The Case for More Capital. Continued

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1900 Analvzina the Influence of Occupational Licensing Duration and Grandfatherinq

• Capital requirements are eased forsmall-town national Sta%RerMrtrketOutcomes

banks.

• The United States adopts the gold standard. connect MinneapolisFed on Twitter

1907 Minneapolis Fed on Facebook RSS Feeds

• Banking panic—leads to congressionally appointed National

Monetary Commission (Aldrich Commission) in 1908 to study

the nation's banking system.

1913

• President Woodrow Wilson signs Federal Reserve Act on

Dec. 23.

1927

• The McFaddden Act prohibits interstate banking.

1929

• Stock Market crashes on Oct. 24—known as Black Thursday.

1930-33

• Nearly 10,000 banks fail nationally.

1932

• Federal Home Loan Bank Board is created to help

homeowners affected by the Great Depression. Membership

is limited to savings and loan associations, savings banks

and insurance companies if they meet certain qualifications,

including making home mortgage loans.

1933

• Bottom of Great Depression.

• Congress passes the Glass-Steagall Act that separates

commercial and investment banking and permits use of U.S.

government securities as collateral for Federal Reserve

notes. Also known as the Banking Act of 1933, it establishes

https://www.minneapolisfed.org/publications/the-region century-of-change 11 /7/2017

Century of Change ~ Federal Reserve Bank of~ Minneapolis

the Federal Deposit Insurance Corp.; places control of open

market operations under the Fed.

• United States ends domestic gold standard.

1934

• Securities and Exchange Act provides for minimum margins

on purchases of securities on credit; regulated by the Fed.

• Sen. Carter Glass pushes for the repeal of Glass- Steagall,

arguing that the law has gone too far in prohibiting national

bank branching.

• Title IV of the National Housing Act creates the Federal

Savings and Loan Insurance Corp.

1935

• Banking Act of 1935 creates Federal Open Market

Committee; Federal Reserve Board becomes Board of

Governors, membership on the Board re-established and

terms set at 14 years.

1946

• Employment Act establishes goals for national economic

policy, including monetary policy.

1956

• Bank Holding Company Act names the Fed the regulator of

companies owning two or more banks. Also allows holding

companies with only one bank to escape federal supervision

and expand into nonbank activities, such as insurance-and

prohibits multibank holding companies from entering into

bank/insurance combinations.

1966

• Financial Institutions Supervisory Act strengthens powers of

bank supervisors—the Comptroller of the Currency (OCC),

the Federal Reserve Board, the Federal Deposit Insurance

Corp. and the Federal Home Loan Bank Board.

1970

• Amendments to the Bank Holding Company Act of 1956

extend the Fed's regulatory powers to one-bank holding

companies, but also gives holding companies more powers.

1977

• Congress passes the Community Reinvestment Act (CRA) to

encourage financial institutions to help meet their

communities' needs-through safe and sound lending

practices and by providing retail banking and community

development services.

1978

• Financial Institutions Regulatory Interest Rates Control Act

substantially increases regulation of insider trading and

changes some Regulation Q ceilings on interest rates.

1980

Page 2 of 5

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Centwy of Change ~ Federal Reserve Bank of Minneapolis

• Depository Institutions Deregulation and Monetary Control

Act of 1980 requires the Fed to price its financial services

available to all depository institutions and establishes reserve

requirements for ali eligible financial institutions.

• Banks, with the blessing of the Fed and the OCC, begin

testing discount stock brokerage. The Merrill Lynch Cash

Management Account and NOW accounts, offering interest

on checking account balances, are created.

1982

• Depository Institutions Act, also known as the Garn-St

Germain Act, deregulates some activities of banks and

nonbank banks while prohibiting insurance activities of banks.

• New money market deposit accounts are permitted.

• The Fed allows "toe-hold" investments by banking companies

i n banks across •state lines. Regional compacts begin

occurring.

1983

• ICI v. Conover cases result in ruling that commingled funds

for IRAs are not mutual funds and thus do not violate Glass-

Steagall.

1984

• Citicorp requests the Fed's permission to establish a holding

company subsidiary to underwrite and deal in bank-eligible

securities. The request is rejected but results in the first

approvals of Section 20 subsidiaries, that is subsidiaries of

bank holding companies defined in Glass-Steagall, three

years later.

• A Glass-Steagall reform bill passes the U.S. Senate;

however, the House fails to act on the bill.

• The U.S. Supreme Court upholds regional interstate

compacts.

Mid-1980s

• Nonbanking companies like Sears charter "nonbank

banks"-the unitary thrifts of the 1980s.

1986

• The OCC allows national banks to sell insurance nationwide

from bank branches in towns with a population of 5,000 or

less, developing a loophole in the banking/insurance wall.

The OCC claimed these activities were permissible under a

1916 amendment to the National Banking Act.

• Official end ofdeposit-interest rate controls.

1987

• Competitive Equality Banking Act and Expedited Funds

Availability Act redefines nonbank banks, expands some

bank powers and sets cone-year moratorium on bank

powers expansions by federal regulators.

Page 3 of 5

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Century of Change ~ Federal Reserve Bank of Minneapolis

• The Fed allows bank holding companies to underwrite

securities through Glass-Steagall's Section 20 subsidiaries,

but such underwriting may account for only 5 percent of the

subsidiary's revenues.

1988

• Risk-based capital guidelines are established that link a

bank's capital requirements to the riskiness of its on-and off-

balance sheet assets.

• The moratorium on expanded bank powers ends.

1989

• Commercial banks are allowed to join the Federal Home

Loan Bank System.

• The Financial Institutions Reform, Recovery, and

Enforcement Act of 1989 kills the FSLIC and creates the

Savings Association Insurance Fund (SAIF).

• The Office of Thrift Supervision (OTS) is created under the

Treasury, which will charter a wave of unitary thrifts in the

1990s.

• The revenue limit of 5 percent on underwriting securities is

raised to 10 percent for Section 20 subsidiaries.

1991

• The Federal Deposit Insurance Corp. Improvement Act gives

regulatory agencies more authority to establish and enforce

capital standards and requires them to establish standards on

nearly all areas of a bank's business. The Act also creates

Truth in Savings.

• An early version of FDICIA contained provisions that would

permit activities prohibited under Glass-Steagall, but those

provisions were stripped from the bill.

1992

• The OTS allows thrifts to branch where they choose.

1994

• Riegle-Neal Interstate Banking and Branching Efficiency Act

sanctions interstate banking and loosens interstate

branching.

1995

• Republican Banking Committee leaders introduce banking

modernization bills.

• The U.S. Supreme Court rules that banks can sell annuities,

previously considered insurance and allowed to be sold only

by insurance companies. In the same case the Court rules

that the OCC could grant bank subsidiaries powers

"incidental to banking."

1996

• The Fed loosens restrictions on Section 20 subsidiaries of

banks and allows mergers of banks and large securities

companies. Some banks immediately take advantage of the

Page 4 of 5

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Century of Change ~ Federal IZesci•ve Balik of~ Minneapolis

ruling to acquire securities firms. The Fed also raises the

Section 20 revenue limit from 10 percent to 25 percent.

• Financial modernization bill goes nowhere due to opposition

from insurance industry.

1997

• The insurance industry drops opposition to financial

modernization.

• The OCC's "First Union letter" further opens national bank

insurance powers.

• Fed eliminates Section 20 firewalls.

• House and Senate Banking Committee chairmen introduce

financial modernization bills, but while the House bill passes

in 1998, the Senate version dies. This effort sets the stage for

the '99 bill, however. Important compromises are reached

regarding the regulation of bank insurance powers and

prohibiting a mix of banking and commerce. The Senate got

stuck on CRA provisions and the lack of a solution to the "op

sub" question, that is whether the new activities would be

conducted through a subsidiary or affiliate of the bank.

1999

• The Gramm-Leach-Bliley Act is signed into law and overturns

the Glass-Steagall Act of 1933, thus removing many

prohibitions on bank activities.

2000

• Regulators rush to meet the March enactment date for

provisions of the Financial Services Modernization Law.

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Past issues A timeline of banking legislation and regulation

Research Digest Index „ , _ ,,,,_ _ _______. Published March 1, 2000 ~ March 2000 issue

Interview Index TWEET SHARE POST EMAIL PRINT

1900

• Capital requirements are eased for small-town national

banks.

• The United States adopts the gold standard.

1907

• Banking panic—leads to congressionally appointed National

Monetary Commission (Aldrich Commission) in 1908 to study

the nation's banking system.

1913

• President Woodrow Wilson signs Federal Reserve Act on

Dec. 23.

1927

• The McFaddden Act prohibits interstate banking.

1929

• Stock Market crashes on Oct. 24—known as Black Thursday.

1930-33

• Nearly 10,000 banks fail nationally.

1932

• Federal Home Loan Bank Board is created to help

homeowners affected by the Great Depression. Membership

is limited to savings and loan associations, savings banks

and insurance companies if they meet certain qualifications,

including making home mortgage loans.

1933

• Bottom of Great Depression.

• Congress passes the Glass-Steagall Act that separates

commercial and investment banking and permits use of U.S.

government securities as collateral for Federal Reserve

notes. Also known as the Banking Act of 1933, it establishes

https://www.minneapol isfed.org/publications/the-region/century-of-change

MOST POPULAR

Stephen Hawking says A.I. could be 'worst event in the

https://www.cnbc.com/id/43752521 l l /7/2017

Andrew Hamer Bloomberg ~ Getty Images

The Marriner S. Eccles Federal Reserve Building in Washington.

The Tedecal Reserve: CNBC Explains Page 2 of 6

Besides being the nation's central bank, the Fed studies economic ~`''~~ hiStoYy of our

trends and makes policy decisions on how to make the economy "run civilization'

better." 3 sunny places to

The Fed is an independent agency—which means it can make decisions 2' retire — on just your

on its own, without needing approval from any other branch of ~ _~_~. Social Security Check

government. However, it is subject to questions from Congress over its ~ ~ `C~

actions. The Federal Reserve chairman regularly testifies to both the ~~

Senate and the House. ,~ 3, The surprising trait

But while the Fed has to explain itself, it is theoretically free from ~ ~ Jeff Bezos looks for

political pressure. One caveat on this freedom'—Fed board members '`--- -~ ~n successful

are nominated by the President and must be approved by the Senate. ~y '' employees

What does the Federal Reserve System do? Forbes says

=:" Commerce Secretary The Fed's mandate is "to promote sustainable growth, high levels of ~>

employment, stability of prices to help preserve the purchasing power Wilbur Ross lied

of the dollar and moderate long-term interest rates," according to the about being a billionaire

Federal Reserve's web site.

What does that mean? The Fed has to make sure the U.S. has a sound The bicyclist who

banking system and a healthy economy. flipped off the

-~ President's motorcade has been

To do that~e Fed makes decisions over monetary policy to help fired, but has no maintain e ployment, keep prices stable, and keep interest rates at a regrets level that f~ej~s the economy. It also supervises and regulates banks to

make sure i~ey are safe places for people to keep their money, and to

protect co~~mers' credit rights.

But there'~mQre. CJ

The Fed pl a major role in clearing checks, processing electronic

payments, distributing coin and paper money to the nation's

banks, credit unions, savings and loan associations. For example, when

you cash a check or have money electronically transferred, there is a

good chance that a Fed Bank will handle the transfer of money from

one bank to another.

The Federal Reserve System also conducts research on the U.S. and

regional economies and distributes information about the economy to

the public through published articles, speeches by board members,

seminars and web sites.

This information is released to the public as part of the Fed's mandate

to study the economy.

Two important outlets for this information are:

• The Beige Book—named this way because of the reports tan cover.

I t's a report published eight times per year. Each Federal Reserve

bank gathers anecdotal information on current economic conditions

in its district. The beige book generally consists of reports from bank

and branch directors and interviews with key business contacts,

economists, market experts, and other sources.

• Fed Minutes—these are notes from discussions the Federal Open

Market Committee has over economic policy. They are released

https://www.cnbc.com/id/43752521 11 /7/2017

The Federal Reserve: C:NBC Explains

eight times a year, after each meeting. They often detail

disagreements between members over what policy to follow.

These two reports are followed very closely—by the stock market and

economists in general— to gauge how the economy is doing and what

the Federal Reserve board is thinking.

When was the Federal Reserve created and why?

The U.S. Congress created the Federal Reserve System on December

23,1913, with the signing of the Federal Reserve Act by then-President

Woodrow Wilson.

Before then, the U.S. has had two major periods of central

banks—which could be considered an over-simplified form of the

Federal Reserve—one starting in 1791 and the other in 1816. Each was an

attempt to create a disciplined banking policy and help avoid economic

collapses.

However, fears of a central bank being too powerful insetting financial

policy brought about their ends. Congress failed to renew the first

national bank's charter in 1811.

The 1816 central bank period ended in 1836 when then President

Andrew Jackson refused to renew its charter—claiming the bank would

be run, in hi~words, by "Eastern Elites."

However, a~`ries of U.S. bank collapses in 1873, 1893 and especially in

1907, pushed many in Congress to call once again for a centralized

banking sy~1~m.

I n 1907, th~was a massive run on the banks—people demanding their

money—anr~d the banks started recalling all of their loans to pay off

customersL2b~is was started after large blocks of fraudulent stocks and

bonds were sold to corner the market on one firm—the United Copper

Company.

The scheme failed and banks who were part of the effort went

bankrupt—and that spread to other banks across the country.

The bank panic of 1907 resulted in a congressional investigation that

concluded: "a central bank was necessary so that these kinds of panics

would never happen again."

However, it wasn't until 1913 before a law was actually passed—when

Congress was able to work out a compromise on the Fed's mandate.

What is monetary policy?

We've mentioned that the Fed makes decisions over monetary policy.

So what is that? It's the regulation of interest rates and the availability

of money in order to provide economic growth and prevent downturns.

This is the nuts and bolts of what the Fed does.

If the economy needs to grow faster and create more jobs, the Fed can

supply more credit to banks for lending.

Page 3 of 6

https://www.cnbc.com/id/43752521 I 1 /7/2017

The Federal Reserve: CNBC Explains

I t can also lower interest rates that banks use to borrow money from

the Fed, making it cheaper for banks to lend. This is referred to as the

Discount Rate—the interest rate that an eligible depository institution

is charged to borrow short-term funds directly from a Federal Reserve

Bank.

The Fed can also lower banks' reserves—meaning banks would need to

carry less money on their books—and can lend more to businesses and

consumers as well as to other banks. This tactic increases the money

supply in the economy.

Another way the Fed increases the money supply is by buying

government securities, like treasury bonds, from the public. This is a

form of whaYs called quantitative easing .Buying government

securities makes more money available with the aim of increasing

consumer spending and boosting the economy.

Now, if the Fed believes the economy is growing too fast and needs to

slow down and avoid inflation—the increased costs of goods and

services—iYs going to do the opposite of what we've just mentioned.

To put some brakes on the economy, the Fed will increase interest

rates for borrowing, make banks hold on to more of their money and

therefore decrease lending. It will also stop buying securities, a

strategy th~F in turn cuts down on the amount of money thaYs in the

economy. T

What is th~OMC?

This is the ~up within the Fedthat makes the decisions we just

mentionec~EQMC stands for the Federal Open Market Committee. L ~̀1

The FOMC~~i ets eight times per year to set key interest rates and to

decide wh~kler to increase or decrease the money supply—which the

Fed does by buying and selling government securities.

The FOMC consists of 12 members—the seven members of the Board of

Governors, the president of the Federal Reserve Bank of New York, and

four of the other 11 Reserve Bank presidents.

Read More > Video: How do Fed Open Market operations work?

The four Reserve Bank presidents serve one-year terms on a rotating

basis. Non-voting Reserve Bank presidents attend the meetings of the

Committee, participate in discussions, and contribute information

about economic conditions in their District.

Where does the Fed get its money?

The Federal Reserve makes money—lots of it. The Fed had over $4.5

trillion in assets, as of March 12, 2015. The majority of revenue comes

from open market operations—specifically the interest on the Fed's

portfolio of Treasury securities as well as the money that comes from

the buying/selling of the securities and their derivatives.

Other Fed revenue come from sales of financial services like check and

electronic payment processing and discount loans to banks. There's

also interest on foreign deposits within the Federal Banking system.

Page 4 of 6

https://www.cnbc.com/id/43752521 11/7/2017

"I'he Federal Reserve: CNBC Explains

However, the Fed doesn't really keep the money. The government

receives all of the system's annual profits—after certain expenses. In

2014, the Fed sent $98.7 billion of its $101.5 billion total net income in

2014 to the U.S. Treasury.

How does the Fed affect U.S. citizens?

I t has a major impact on daily lives of nearly every American. As we

mentioned above, the Fed can raise interest rates to slow down the

economy. That means buying a home or a car can be more expensive if

you have to pay more interest on a Ioan. Credit card interest rates can

also go up.

An even greater impact could be fewer jobs as business costs to

borrow money go up—those interest rates again—and firms may want

to lay off people instead of hiring them.

And if the Fed cuts back on buying securities (quantitative easing) it is

lowering the amount of money circulating in the economy—and

creating less consumer spending.

Of course, the opposite is true. If the Fed lowers interest rates and

borrowing costs, that makes a home or car purchase cheaper. And that

could also mean businesses would borrow money at a cheaper rate and

think aboutpiring if the economy picks up steam and consumers are

spending. t

How is the~derai Reserve System made up?

Under the ~~leral Reserve System, the United States is divided into 12

districts. Each district has an actual bank, called a reserve bank, serving

it. But iYs the type of bank where the average citizen deposits

money. Ra~r, it hold the funds of the Fed, which we'll describe below.

The 12 Reserve Banks are named after the city in which they are

located. Those are Boston, New York, San Francisco, Philadelphia,

Cleveland, Chicago, Richmond, St. Louis, Minneapolis, Atlanta, Kansas

City, and Dallas.

Each reserve bank is run by a staff headed by a president or chairman,

who also help make up the very important Federal Open Market

Committee.

What is the Board of Governors?

The Board of Governors oversees the Fed. It is made up of seven

members who, as we mentioned above, are appointed by the President

and confirmed by the Senate. The full term of a Board member is 14

years, and the appointments are staggered so that one term expires on

each even-numbered year.

The board members can come from within the Fed—many Federal

Reserve bank presidents have gone from the banks to the board—or

they can come from academia and other places. The President can

appoint anyone he believes is qualified to serve.

Page 5 of 6

1lttps://www.cnbc.com/id/43752521 11 /7/2017

The Federal Reserve: CNBC Explains

A Chairman and Vice Chairman lead the Board. They too, are appointed

by the President and confirmed by the Senate. But the nominees to

these posts must already be members of the existing board.

The terms for these two top positions are four years, but the Chairman

and Vice Chairman may be reappointed for additional four-year

terms—as long as their term as Board member is active.

How Has the Fed Changed Over the Years?

Various changes over the years have given the Fed more power and

responsibilities. Before 1937 for example, there was no FOMC issuing

economic policy statements.

I n the 1940s, the Fed and the banking industry developed the routing

numbers that you see at the bottom of your checks—to identify the

bank and account from which the check is written. This move led to the

automation of check processing.

I n response to banking and other financial problems that developed in

the 1980s, the Fed Board adopted a policy in 1985 requiring the

Reserve Banks to inspect once a year the various holding companies of

the nation's larger banks. This is to make sure the banks themselves

have enough reserve funds.

I n 1991, the'~ight to Truth in Savings Act empowered the Fed to require

that banks disclose account information to consumers, including the

annual per~itage yield; regulated advertising of savings accounts;

and prohibjted certain methods of calculating interest.

~n As a result of the Recession of 2007-2009, the Fed will oversee the

Bureau of ~sumer Financial Protection (CFPB)—an independent

bureau witp'i~r the Fed to help give consumers the information they

need to m~~financial decisions.

Janet L. Yellen is the current Fed chairperson. Yellen was appointed

Chair of the Board of Governors of the Federal Reserve System on

February 3, 2014, for afour-year term ending February 3, 2018. Yellen

also serves as Chairman of the Federal Open Market Committee, the

system's principal monetary policy-making body.

Mark Koba ~~,`~,~ Senior Editor, CNBC t.

Page 6 of 6

https://www.cnbc.com/id/43752521 11 /7/2017

"I~IIe I~ ed -Structure o~1~ the E~ ederal Reserve System

Structure of the Federal Reserve System

Page 1 of 6

Purposes and Functions

About the Federal Reserve System

The Federal Reserve System is the central bank of the United States.

It performs five general functions to promote the effective operation of the U.S. economy and, more

generally, the public interest. The Federal Reserve

• conducts the nation's monetary policy to promote maximum employment, stable

prices, and moderate long-term interest rates in the U.S. economy;

• promotes the stability of the financial system and seeks to minimize and contain

systemic risks through active monitoring and engagement in the U.S. and abroad;

• promotes the safety and soundness of individual financial institutions and

monitors their impact on the financial system as a whole;

• fosters payment and settlement system safety and efficiency through services to

the banking industry and the U.S. government that facilitate U.S.-dollar transactions and

payments; and

• promotes consumer protection and community development through consumer-

focused supervision and examination, research and analysis of emerging consumer

issues and trends, community economic development activities, and the administration

of consumer laws and regulations.

Read more in the 10th edition of Federal Reserve System Purposes &Functions.

U_~_ Central Bank

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12 Feder Federal Reserve Open ~rlcet Banks Committee

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The Fed -Structure of the Federal Reserve System Page 2 of 6

E~~y~ Function

The Decentralized System Structure and Its Philosophy

I n establishing the Federal Reserve System, the United States was divided geographically into 12

Districts, each with a separately incorporated Reserve Bank. District boundaries were based on

prevailing trade regions that existed in 1913 and related economic considerations, so they do not

necessarily coincide with state lines.

Twelve Federal Reserve Districts operate independently but with supervision

Federal Reserve District boundaries are based on economic considerations; the Districts

operate independently but under the supervision of the Federal Reserve Board of Governors.

Federal Reserve Banks

01-Boston

02-New York

03-Philadelphia

04-Cleveland

05-Richmond

06-Atlanta

07-Chicago

08-St. Louis

https://www.federalreserve.gov/aboutthefed/structure-federal-reserve-system.htm 11 /7/2017

The Fed -Structure ol~the Federal IZeserve System

09-Minneapolis

10-Kansas City

1 1-Dallas

12-San Francisco

Board

The Federal Reserve officially identifies Districts by number and Reserve Bank city.

Page 3 of 6

I n the 12th District, the Seattle Branch serves Alaska, and the San Francisco Bank serves Hawaii. The System

serves commonwealths and territories as follows: the New York Bank serves the Commonwealth of Puerto Rico and

the U.S. Virgin Islands; the San Francisco Bank serves American Samoa, Guam, and the Commonwealth of the

Northern Mariana Islands. The Board of Governors revised the branch boundaries of the System in February 1996.

As originally envisioned, each of the 12 Reserve Banks was intended to operate independently from

the other Reserve Banks. Variation was expected in discount rates--the interest rate that commercial

banks were charged for borrowing funds from a Reserve Bank. The setting of a separately

determined discount rate appropriate to each District was considered the most important tool of

monetary policy at that time. The concept of national economic policymaking was not well developed,

and the impact of open market operations--purchases and sales of U.S. government securities--on

policymaking was less significant.

As the nation's economy became more integrated and more complex, through advances in

technology, communications, transportation, and financial services, the effective conduct of monetary

policy began to require increased collaboration and coordination throughout the System. This was

accomplished in part through revisions to the Federal Reserve Act in 1933 and 1935 that together

created the modern-day Federal Open Market Committee (FOMC).

The Depository Institutions Deregulation and Monetary Control Act of 1980 (Monetary Control Act)

introduced an even greater degree of coordination among Reserve Banks with respect to the pricing

of financial services offered to depository institutions. There has also been a trend among Reserve

Banks to centralize or consolidate many of their financial services and support functions and to

standardize others. Reserve Banks have become more efficient by entering into intra-System service

agreements that allocate responsibilities for services and functions that are national in scope among

each of the 12 Reserve Banks.

The U.S. Approach to Central Banking

The framers of the Federal Reserve Act purposely rejected the concept of a single central bank.

I nstead, they provided for a central banking "system" with three salient features: (1) a central

governing Board, (2) a decentralized operating structure of 12 Reserve Banks, and (3) a combination

of public and private characteristics.

Although parts of the Federal Reserve System share some characteristics with private-sector entities,

the Federal Reserve was established to serve the public interest.

There are three key entities in the Federal Reserve System: the Board of Governors, the Federal

Reserve Banks (Reserve Banks), and the Federal Open Market Committee (FOMC). The Board of

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Governors, an agency of the federal government that reports to and is directly accountable to

Congress, provides general guidance for the System and oversees the 12 Reserve Banks.

Within the System, certain responsibilities are shared between the Board of Governors in

Washington, D.C., whose members are appointed by the President with the advice and consent of

the Senate, and the Federal Reserve Banks and Branches, which constitute the System's operating

presence around the country. While the Federal Reserve has frequent communication with executive

branch and congressional officials, its decisions are made independently.

The Three Key Federal Reserve Entities

The Federal Reserve Board of Governors (Board of Governors), the Federal Reserve Banks

(Reserve Banks), and the Federal Open Market Committee (FOMC) make decisions that help

promote the health of the U.S. economy and the stability of the U.S. financial system.

Three key entities, serving the public interest

The framers of the Federal Reserve Act developed a central banking system that would broadly

represent the public interest.

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BOARD Q~ G4VERNdRS Governors and Peserve Bank presidents. are the operating arms of the

The Chair o~ the Board is the is an independent agency of the Federal Reserve System and are FO~~C Chair.

federal government. supervised by the Board of Governors.

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Other Significant Entities Contributing to Federal Reserve Functions

Two other groups play important roles in the Federal Reserve System's core functions:

1. depository institutions--banks, thrifts, and credit unions; and

2. Federal Reserve System advisory committees, which make recommendations to the Board of

Governors and to the Reserve Banks regarding the System's responsibilities.

Depository Institutions

Depository institutions offer transaction, or checking, accounts to the public, and may maintain

accounts of their own at their local Federal Reserve Banks. Depository institutions are required to

meet reserve requirements--that is, to keep a certain amount of cash on hand or in an account at a

Reserve Bank based on the total balances in the checking accounts they hold.

Depository institutions that have higher balances in their Reserve Bank account than they need to

meet reserve requirements may lend to other depository institutions that need those funds to satisfy

their own reserve requirements. This rate influences interest rates, asset prices and wealth,

exchange rates, and thereby, aggregate demand in the economy. The FOMC sets a target for the

federal funds rate at its meetings and authorizes actions called open market operations to achieve

that target.

Advisory Councils

Four advisory councils assist and advise the Board on matters of public policy.

Federal Advisory Council (FAC). This council, established by the Federal Reserve Act,

comprises 12 representatives of the banking industry. The FAC ordinarily meets with the Board

four times a year, as required by law. Annually, each Reserve Bank chooses one person to

represent its District on the FAC. FAC members customarily serve three one-year terms and

elect their own officers.

2. Community Depository Institutions Advisory Council (CDIAC). The CDIAC was originally

established by the Board of Governors to obtain information and views from thrift institutions

(savings and loan institutions and mutual savings banks) and credit unions. More recently, its

membership has expanded to include community banks. Like the FAC, the CDIAC provides

the Board of Governors with firsthand insight and information about the economy, lending

conditions, and other issues.

3. Model Validation Council. This council was established by the Board of Governors in 2012 to

provide expert and independent advice on its process to rigorously assess the models used in

stress tests of banking institutions. Stress tests are required under the Dodd-Frank Wall Street

Reform and Consumer Protection Act. The council is intended to improve the quality of stress

tests and thereby strengthen confidence in the stress-testing program.

4. Community Advisory Council (CAC). This council was formed by the Federal Reserve Board

in 2015 to offer diverse perspectives on the economic circumstances and financial services

needs of consumers and communities, with a particular focus on the concerns of low- and

moderate-income populations. The CAC complements the FAC and CDIAC, whose members

represent depository institutions. The CAC meets semiannually with members of the Board of

Governors. The 15 CAC members serve staggered three-year terms and are selected by the

Board through a public nomination process.

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Federal Reserve Banks also have their own advisory committees. Perhaps the most important of

these are committees that advise the Banks on agricultural, small business, and labor matters. The

Federal Reserve Board solicits the views of each of these committees biannually.

Last Update: March o3, 201

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Lecture

The Dodd Frank Act

Content Author: Steve Sholty

The Dodd Frank Wall Street Reform and Consumer Protection Act was signed into law by President Barack Obama on July 21, 2010. Financial Services Committee Chairman Barney Frank introduced a version of the bill into the House of Representatives and Senator Chris Dodd did the same in the Senate Banking Committee in December, 2009. The aim of the legislation is to improve the financial stability of the United States through greater accountability and transparency in the financial system.

Bank Regulation

Page 1 of 3

Banks are subject to increased regulation. The Financial Stability Oversight Council (FSOC) was created to monitor risks that may affect the entire financial system. The FSOC is chaired by the US Department of Treasury Secretary, and has nine members including the Federal Reserve, the Securities and Exchange Commission (SEC) and the new Consumer Financial Protection Bureau (CFPA). The Federal Reserve is given new authority to monitor large bank holding companies and significant non-bank financial firms like hedge funds and take direct control of financially troubled companies if they are considered to be systemically significant.

The Office of Thrift Supervision is eliminated, and savings and loan holding companies fall under Federal Reserve supervision while federally- chartered S&Ls become the responsibility of the Office of the Comptroller of the Currency (OCC). State-chartered S&Ls are to be regulated by the Federal Deposit Insurance Corporation (FDIC). The Federal Reserve will continue to regulate state member banks and the OCC will continue to be responsible for national banks.

The Office of Financial Research (OFR) is created within the US Department of Treasury to provide data collection and research services to support the Financial Stability Oversight Council.

Volcker Rule

The Volcker Rule prohibits banks from engaging in proprietary trading for their own profit subject to certain exceptions. For

example, banks are permitted to trade currencies to offset their own holdings in a foreign currency. Banks are prohibited from

owning, investing, or sponsoring hedge funds or private equity funds. However, banks can keep any funds that are less than

three percent of their revenue (Note that the Volker rule was not implemented until July 2015.)

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Lecture

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Derivatives

The Securities Exchange Commission and the Commodity Futures Trading Commission (CFTC) are responsible for regulating derivatives. The CFTC is charged with creating a platform to trade standardized derivatives and to regulate and supervise swap dealers. The SEC is responsible for oversight of security-based swap dealers and major security-based swap participants although some energy companies, hedge funds and banks are exempt from derivative oversight. In addition, the Federal Reserve is prohibited from providing any federal assistance to any swap dealer or major swap participant with respect to any swap activity.

Consumers

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The Consumer Financial Protection Bureau (CFPB) was created to protect consumers from 'unscrupulous business' practices by banks. The CFPB consolidated a number of existing consumer protection responsibilities in other government agencies. The CFPB is an independent entity within the Federal Reserve that assumes responsibility for most consumer protection laws and will have broad authority to curb practices it finds to be unfair. The CFPB also oversees credit reporting agencies, credit and debit cards, payday and consumer loans— but not auto loans from dealers.

Mortgage originators are required to retain a certain amount of risk when securitizing their assets. Also, they must act in the best interests of a consumer and seek to ensure that a consumer will have the capacity to repay the loan.

The SEC was given the authority to -but is not required to - adopt a uniform fiduciary standard of conduct for both broker- dealers (BDs) and registered investment advisers (RIAs) when providing financial advice to retail customers. At present, RIAs have a fiduciary responsibility to their clients (i.e. always act in their clients best interest) however broker dealers are held to a "fair dealing standard" and "suitability" standard but not the fiduciary standard.

The Dodd Frank Act continues to be a work in progress since it was signed into law in 2010. As of December 2015, the status of current implementation is:

Page 2 of 3

Insurance Companies

The Federal Insurance Office was established within the US Department of Treasury to provide expertise and advice regarding insurance matters of companies that my carry a systemic risk to the financial system. The new FIO will also gather information about the insurance industry and make sure affordable insurance is available to minorities.

Credit Rating Agencies

The Office of Credit Rating (OCR) was created within the Securities and Exchange Commission (SEC) to enhance the regulation, accountability and transparency of "nationally recognized statistical rating organizations" or "NRSROs. As part of the new rules, the SEC can require agencies to submit their rating systems for review, and can de-certify an agency that gives misleading ratings

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Lecture Page 3 of 3

• 68.46% or 267 of the 390 total required rulemakings have been met with finalized rules and rules have been proposed

that would meet 40 (10.26%) more. Rules have not yet been proposed to meet 83 (21.28%) rulemaking requirements.

• For a recent update please see the following link:

http://www..davis _olk_com/Dod_d-Frank-Rulemaking~Progress-Re ~ort/

• For further information about the implementation of Dodd Frank please see the following link at the SEC website:

htt~,//www_sec.,~ov/spotl.i,~ hUdod d,-fra n k. shtm

I mage Source: ://www.huffington~ostcom/eileen,-Appelbaum/doddfrank-at-fv_e-.~riv_ate b 7835748,.html_

http://www.consumerfinance.gov/newsroom/

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