Federal Reserve Act
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Federal Reserve Act (1913)
The question of how to regulate financial affairs was one of the earliest and most enduring problems facing the American republic. Congress formally resolved the issue only in 1913 with the passage of the Federal Reserve Act (38 Stat. 251), which created, for the first time, a permanent national central bank. The product of this act, the Federal Reserve System, was in some ways an awkward compromise among all sides of the national debate, but by the end of the twentieth century, it had become one of the most respected American public institutions. The European Union would use the Federal Reserve System as a model for its own European Central Bank.
Historical Development
From the founding of the republic to the Civil War, no national consensus existed on banking or monetary policy. Agrarian and populist interests were deeply suspicious of the concentration of wealth in Eastern financial institutions and sought regulations to constrain their power. At the same time, business and manufacturing interests sought regulations to ease commerce and expand trade.
After the Civil War, the political debate centered on the gold standard, which the United States had left in 1861. Agrarian, populist, and labor interests opposed the deflation required to resume the standard. Because of the massive expansion in incomes following the war, the gold standard was resumed with relatively little pain in 1879. Nonetheless, opposition to the gold standard continued under the free silver movement, championed by William Jennings Bryan. Indeed, the novel The Wizard of Oz by L. Frank Baum is an extended allegory favoring free silver. In the novel, as opposed to the film, the magic slippers Dorothy uses to save herself are silver, not ruby.
The period after the Civil War was also marked by successive financial panics and crises. Banks at that time were required to hold only a fraction of their deposits in reserve, that is, in the form of specie, vault cash or government securities, and could lend the remaining portion of the deposits to businesses and individuals. These loans were often illiquid, in the sense that although they were fundamentally sound investments in the long run, in the short run they could only be converted into cash for a fraction of their value. Such a system is prone to bank runs, in which a bank's depositors literally race each other to the bank to withdraw their deposits. Following the Panic of 1907, all political parties agreed that a mechanism had to be found to supply banks with short–term liquidity (known as an "elastic currency" at the time).
Congressional Passage and Early Implementation
Congress passed the Aldrich-Vreeland Act in 1908 in reaction to the Panic of1907. The act provided for a system of temporary liquidity for banks (slated to expire in 1914), and it also created a National Monetary Commission chaired by Senator Nelson Aldrich to find a permanent solution to the problem of bank runs. The Aldrich Commission's report was submitted to Congress in 1912. Although Woodrow Wilson, a Democrat, won the 1912 election, the Republican Aldrich's plan shaped the extensive debate that followed. A Democrat, Carter Glass of Virginia, shepherded the Federal Reserve Act through the Congress, and on Dec. 23, 1913, Congress adopted the Federal Reserve Act, also known as the Owens-Carter Act. Although Glass went to some lengths to distinguish the Federal Reserve Act from the Aldrich Commission's plan, the two acts had quite a bit in common.
The Federal Reserve Act provided for the creation of between eight and twelve Reserve Banks in cities throughout the United States. These institutions were to be capitalized by the member banks within each Reserve District; the member banks would control the board of directors of each Reserve Bank and appoint its president and chairman. The entire system was to be overseen by an appointed Federal Reserve Board, based in Washington, D.C. By 1914 a full complement of twelve Federal Reserve Banks had been established in Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, Kansas City, Dallas, and San Francisco.
In keeping with the act's central requirement that the Federal Reserve System provide an "elastic" currency (that is, one whose quantity could grow or shrink as required by economic policy), the system required its member banks to keep a certain fraction of their assets on deposit with the Reserve Banks as Federal Funds. In addition, the system issued Federal Reserve notes, the immediate ancestors of the familiar paper banknotes used today. The founders of the system hoped to prevent further banking panics by providing their member banks with ready and immediate access to liquidity via the discount window at which member banks could borrow at a published discount rate. Finally, as the United States was still on the gold standard in 1914, all Federal Reserve notes and deposits were backed by gold.
The Federal Reserve System's initial design, however, assured a continuing struggle between the twelve Reserve Banks and the Washington-based Federal Reserve Board. The Federal Reserve Bank of New York, in particular, had a relatively sophisticated understanding of financial markets and often advocated policies different from those pursued by the Federal Reserve Board. The tension between the Reserve Banks and the Federal Reserve Board was heightened by the fact that the Secretary of the Treasury and the Comptroller of the Currency were ex officio members of the Board.
The Federal Reserve System officially opened for business in November of 1914, shortly after the start of World War I. Conceived in peacetime to prevent banking panics, the system's first duty would be to manage the monetary dislocations of the period of American neutrality, and then to assist the Treasury in financing the war expenditures.
After the war, the United States was one of the first nations to resume the gold standard. Other nations attributed the relatively easy resumption of the gold standard in America to, in part, the newly–established Federal Reserve System. In the 1920s the system was held in high regard domestically and abroad. Indeed, the period is sometimes known as "the high tide of the Federal Reserve"
In October of 1929 the U.S. stock market crashed, losing a considerable fraction of its value. This probably would not have been enough to cause the Great Depression; however, beginning in October of 1930 a series of small Midwestern banks failed and a full-scale nationwide banking panic began. This panic was the first of three banking crises that would culminate with the long "banking holiday" of March of 1933, when the entire U.S. banking system was closed by presidential directive. The system, along with all mainstream academic and government economists, firmly believed in the "real bills doctrine," which held that providing liquidity against purely financial claims (including U.S. government bonds) was bad policy. In short, when banks came to the discount window, they were required to present as collateral claims against viable business interests, which they did not have. The Great Depression began, in essence, as a classic banking panic of the late 1800s. Because the U.S. economy had become more complex and dependent on the smooth functioning of capital markets, the damage wrought by the bank runs of the early 1930s was much greater than in previous episodes.
Reforms of the New Deal and Beyond
The Roosevelt legislative program contained several measures designed to address the problem of bank runs and general financial instability. Many of the key New Deal laws affected the functioning of the Federal Reserve System.
Among the first laws passed under the Roosevelt administration was the Banking Act of 1933, also known as the Glass-Steagall Act. This act provided the first nationally-guaranteed system of insuring bank deposits by creating the Federal Deposit Insurance Company (FDIC). Deposit insurance ended forever the problem of bank runs and banking panics (although it would open the door to the thrift crisis of the late 1980s). The Glass-Steagall Act contained several other provisions that have since been modified or superannuated, but which in their time were extremely important. These included prohibiting banks from paying interest on short-term deposits (known as "Regulation Q"); prohibiting banks from underwriting securities ("investment banking"); and prohibiting banks from engaging in many other forms of non-bank activities such as underwriting insurance.
The Banking Act of 1935 renewed and extended many of the 1933 provisions to banks outside the Federal Reserve System. However, this act is of particular note because it finally clarified several of the institutional tensions designed into the Federal Reserve System. Under the act, the Federal Reserve Board became the supreme institution; it was renamed the Board of Governors of the Federal Reserve System, and members of the Board were given the title of "Governor," the traditional title for central bankers. In addition, the act ended the ex officio membership of the Secretary of the Treasury and Comptroller of the Currency on the Board. Finally, the act formally recognized the Federal Open Market Committee (FOMC) as a separate legal entity.
The Employment Act of 1946 directed the Federal Reserve System to implement policies designed to balance the two goals of full employment and low inflation. Achieving these goals has been the guiding principle of the system, and indeed almost all modern central banks, since.
The final step in the modernization of the Federal Reserve System was the Treasury Accord of 1951. Before the accord, the system acted as a buyer of last resort for Treasury debt. If investors demanded interest rates on government bonds above a ceiling (set to 2.5 percent at the time of the accord) the system would step in to buy the residual debt. With government spending hitting new records during the Korean War, this support rule demanded an inflationary monetary policy. Under the terms of the accord, the Federal Reserve System was relieved of the responsibility of keeping interest rates low.
The Modern Federal Reserve System
The formal laws governing the conduct of monetary policy have remained largely unchanged since the 1950s. Monetary policy decisions are largely made by the Federal Open Market Committee (FOMC). The FOMC is a separately-recognized legal entity made up of the seven Governors in Washington, D.C., the president of the Federal Reserve Bank of New York, and the presidents of four of the remaining eleven Reserve Banks (chosen on a rotating basis). It typically meets eight times a year. The FOMC dictates the conduct of open market operations, the technical means by which the Federal Reserve System affects short term interest rates.
The Full Employment and Balanced Growth Act of 1978, also known as the Humphrey-Hawkins Act, amended the Federal Reserve Act to require that the Board of Governors submit reports on the state of the U.S. economy and the conduct of monetary policy twice a year (typically in February and July). In addition, the chairman typically testifies before the relevant House and Senate Committees as part of the report. This appearance, referred to as the Humphrey-Hawkins testimony, has become a closely-watched event.
Several of the financial regulatory reforms of the 1980s and 1990s involved the Federal Reserve System to some extent, either in its role as a bank regulator or by amending the Federal Reserve Act directly. The most important of these include the Depository Institutions Deregulation and Monetary Control Act of 1980, the Financial Institutions Reform, Recovery, and Enforcement Act of 1989, and the Gramm-Leach-Bliley Act.
Finally, several consumer protection and anti-discrimination laws also involve the Federal Reserve System. Among of the most important of these are the Home Mortgage Disclosure Act of 1975 and the Community Reinvestment Act of 1977.
Bibliography
Board of Governors of the Federal Reserve System. Federal Reserve Act and OtherStatutory Provisions Affecting the Federal Reserve System (As Amended Through October 1998). Washington, DC, 1998.
Federal Reserve Bank of Kansas City. Fed 101.
Federal Reserve Bank of Richmond. The Fiftieth Anniversary of the Treasury–FederalReserve Accord. 2001.
Friedman, M. and A. J. Schwartz. A Monetary History of the United States, 1867-1960. Princeton, NJ: Princeton University Press, 1963.
Friedman, M. and A. J. Schwartz. Monetary Trends in the United States and the UnitedKingdom. Chicago: University of Chicago Press, 1982.
Hamilton, J. D. "The daily market for Federal Funds." 1 Journal of Political Economy 104 (1996): 26–56.
Rockoff, H. "'The Wizard of Oz' as a Monetary Allegory." 4 Journal of Political Economy 98 (1990): 739–760.
Wikipedia on Answers.com:
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Federal Reserve Act
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| Full title | An Act To provide for the establishment of Federal reserve banks, to furnish an elastic currency, to afford means of rediscounting commercial paper, to establish a more effective supervision of banking in the United States, and for other purposes. |
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| Enacted by the | 63rd United States Congress |
| Citations | |
| Public Law | Pub.L. 63-43 |
| Stat. | ch. 6, 38 Stat. 251 |
| Legislative history | |
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The Federal Reserve Act (ch. 6, 38 Stat. 251, enacted December 23, 1913, 12 U.S.C. ch.3) is an Act of Congress that created and set up the Federal Reserve System, the central banking system of the United States of America, and granted it the legal authority to issue Federal Reserve Notes (now commonly known as the U.S. Dollar) and Federal Reserve Bank Notes as legal tender. The Act was signed into law by President Woodrow Wilson.
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Background
For nearly eighty years, the U.S. was without a central bank after the charter for the Second Bank of the United States was allowed to expire. After various financial panics, particularly a severe one in 1907, some Americans became persuaded that the country needed some sort of banking and currency reform that would,[1] when threatened by financial panics, provide a ready reserve of liquid assets, and furthermore allow for currency and credit to expand and contract seasonally within the U.S. economy.
Some of this was chronicled in the reports of the National Monetary Commission (1909–1912), which was created by the Aldrich–Vreeland Act in 1908. Included in a report of the Commission, submitted to Congress on January 9, 1912, were recommendations and draft legislation with 59 sections, for proposed changes in U.S. banking and currency laws.[2] The proposed legislation was known as the Aldrich Plan, named after the chairman of the Commission, Republican Senator Nelson W. Aldrich of Rhode Island.
The Plan called for the establishment of a National Reserve Association with 15 regional district branches and 46 geographically dispersed directors primarily from the banking profession. The Reserve Association would make emergency loans to member banks, print money, and act as the fiscal agent for the U.S. government. State and nationally chartered banks would have the option of subscribing to specified stock in their local association branch.[2] It is generally believed that the outline of the Plan had been formulated in a secret meeting on Jekyll Island in November 1910, which Aldrich and other well connected financiers attended.[3]
Since the Aldrich Plan essentially gave full control of this system to private bankers, there was strong opposition to it from rural and western states because of fears that it would become a tool of certain rich and powerful financiers in New York City, referred to as the "Money Trust".[4] Indeed, from May 1912 through January 1913 the Pujo Committee, a subcommittee of the House Committee on Banking and Currency, held investigative hearings on the alleged Money Trust and its interlocking directorates. These hearings were chaired by Rep. Arsene Pujo, a Democratic representative from Louisiana.[5]
In the election of 1912, the Democratic Party won control of the White House and both chambers of Congress. The party's platform stated strong opposition "to the so called Aldrich bill for the establishment of a central bank." However, the platform also called for a systematic revision of banking laws in ways that would provide relief from financial panics, unemployment and business depression, and would protect the public from the "domination by what is known as the Money Trust."[6]
Legislative history
The banking and currency reform plan advocated by President Wilson in 1913 was sponsored by the chairmen of the House and Senate Banking and Currency committees, Representative Carter Glass, a Democrat of Virginia and Senator Robert Latham Owen, a Democrat of Oklahoma. According to the House committee report accompanying the Currency bill (H.R. 7837) or the Glass-Owen bill, as it was often called during the time, the legislation was drafted from ideas taken from various proposals, including the Aldrich bill.[6] However, unlike the Aldrich plan, which gave controlling interest to private bankers with only a small public presence, the new plan gave an important role to a public entity, the Federal Reserve Board, while establishing a substantial measure of autonomy for the (regional) Reserve Banks which, at that time, were allowed to set their own discount rates. Also, instead of the proposed currency being an obligation of the private banks, the new Federal Reserve note was to be an obligation of the U.S. Treasury. In addition, unlike the Aldrich plan, membership by nationally chartered banks was mandatory, not optional. The changes were significant enough that the earlier opposition to the proposed reserve system from Progressive Democrats was largely assuaged; instead, opposition to the bill came largely from the more business-friendly Republicans instead of from the Democrats.[1]
After months of hearings, debates, votes and amendments, the proposed legislation, with 30 sections, was enacted as the Federal Reserve Act. The House, on December 22, 1913,[7] agreed to the conference report on the Federal Reserve Act bill by a vote of 298 yeas to 60 nays, with 76 not voting. The Senate, on December 23, 1913, agreed to it by a vote of 43 yeas to 25 nays with 27 not voting. The record shows that there were no Democrats voting "nay" in the Senate and only two in the House. The record also shows that almost all of those not voting for the bill had previously declared their intentions and were paired with members of opposite intentions.[8]
The Act
The plan adopted in the original Federal Reserve Act called for the creation of a System that contained both private and public entities. There were to be at least eight, and no more than 12, private regional Federal reserve banks (12 were established) each with its own branches, board of directors and district boundaries (Sections 2, 3, and 4) and the System was to be headed by a seven member Federal Reserve Board made up of public officials appointed by the President and confirmed by the Senate (strengthened and renamed in 1935 as the Board of Governors of the Federal Reserve System with the Secretary of the Treasury and the Comptroller of the Currency dropped from the Board - Section 10). Also created as part of the Federal Reserve System was a 12 member Federal Advisory Committee (Section 12) and a single new United States currency, the Federal Reserve Note (Section 16).
Congress decided in the Federal Reserve Act that all nationally chartered banks were required to become members of the Federal Reserve System. It required them to purchase specified non-transferable stock in their regional Federal reserve bank and to set aside a stipulated amount of non-interest bearing reserves with their respective reserve bank. (Since 1980 all depository institutions have been required to set aside reserves with the Federal Reserve and be entitled to certain Federal Reserve services - Sections 2 and 19.) State chartered banks were given the option of becoming members of the Federal Reserve System and thus to be supervised, in part, by the Federal Reserve (Section 9). Member banks became entitled to have access to discounted loans at the discount window in their respective reserve bank, to a 6% annual dividend in their Federal reserve stock and to other services (Sections 13 and 7). The Act also permitted Federal reserve banks to act as fiscal agents for the United States government (Section 15).[9]
Subsequent amendments
In the 1930s the Federal Reserve Act was amended to create the Federal Open Market Committee (FOMC), consisting of the seven members of the Board of Governors of the Federal Reserve System and five representatives from the Federal reserve banks (Section 12B). The FOMC is required to meet at least four times a year (the practice is usually eight times) and is empowered to direct all open-market operations of the Federal reserve banks.
During the 1970s, the Federal Reserve Act was amended to require the Board and the FOMC "to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates" (Section 2A). Also in that decade, the Act was amended so that the member governor proposed by the President to be Chairman would have a four year term as Chairman and be subject to confirmation by the Senate (member governors per se each have 14 year terms, with a specific term ending every two years) (Section 10). The Chairman was also required to appear before Congress at semi-annual hearings to report on the conduct of monetary policy, on economic development, and on the prospects for the future (Section 2B).
The Federal Reserve Act has been amended by some 200 subsequent laws of Congress. It continues to be one of the principal banking laws of the United States.
Criticism
Main article: Criticism of the Federal Reserve
Controversy about the Federal Reserve Act and the establishment of the Federal Reserve System has existed since prior to its passage. Some of the questions raised include: whether Congress has the Constitutional power to delegate its power to coin money or issue paper money, whether the Federal Reserve is a public cartel of private banks (also called a banking cartel) established to protect powerful financial interests, and whether the Federal Reserve's actions increased the severity of the Great Depression in the 1930s (and/or the severity or frequency of other boom-bust economic cycles, such as the late-2000s recession). Allegations that it was passed while most of Congress was away for Christmas on December 23 are however not supported by the legislative history: The house passed the bill 298-60 with 76 not voting, while the Senate passed it 43-25 with 27 not voting,[10] showing 70%-80% participation before accounting for announced pairs.
See also
References
- ^ a b Historical Beginnings... The Federal Reserve by Roger T. Johnson, Federal Reserve Bank of Boston, 1999
- ^ a b Report of the National Monetary Commission. January 9, 1912, letter from the Secretary of the Commission and a draft bill to incorporate the National Reserve Association of the United States, and for other purposes. Sen. Doc. No. 243. 62d Congress. U.S. Government Printing Office. 1912.
- ^ Paul Warburg's Crusade to Establish a Central Bank in the United States Michael A. Whitehouse, 1989. In attendance at the meeting were Aldrich; Paul Warburg; Frank Vanderlip, president of National City Bank; Henry P. Davison, a J.P. Morgan partner; Benjamin Strong, vice president of Banker's Trust Co.; and A. Piatt Andrew, former secretary of the National Monetary Commission and then assistant secretary of the Treasury.
- ^ Wicker, Elmus (2005), The Great Debate on Banking Reform: Nelson Aldrich and the Origins of the Fed, Ohio University Press. See also book review.
- ^ Money Trust Investigation - Investigations of Financial and Monetary Conditions in the United States under House Resolutions Nos. 429 and 504 before a subcommittee of the House Committee on Banking and Currency. 27 Parts. U.S. Government Printing Office. 1913.
- ^ a b Changes in the Banking and Currency System of the United States. House Report No. 69, 63d Congress to accompany H.R. 7837, submitted to the full House by Mr. Glass, from the House Committee on Banking and Currency, September 9, 1913. A discussion of the deficiencies of the then current banking system as well as those in the Aldrich Plan and quotations from the 1912 Democratic platform are laid out in this report, pages 3-11.
- ^ Congressional Record December 23 1913
- ^ Voting record on the conference report of the Federal Reserve Act. Vol. 51 Congressional Record, pages 1464 and 1487-1488, December 22 and 23, 1913.
- ^ McKinney, Richard J. The Federal Reserve System: Information Sources at the Nation's Central Bank. Vol. 22 Legal Reference Services Quarterly, pp. 29-44 (2003). Briefly explains the historical development of the sections of the Federal Reserve Act and other banking laws and regulations.
- ^ The Federal Reserve Act of 1913 - A Legislative History
External links
- Text of the current Federal Reserve Act, Board of Governors of the Federal Reserve System.
- Text of Federal Reserve Act as laid out in the U.S. Code, Cornell Law School.
- Text of the original Federal Reserve Act, U.S. Congress, 1913.
- Historical Beginnings... The Federal Reserve by Roger T. Johnson, Federal Reserve Bank of Boston, 1999.
- Paul Warburg's Crusade to Establish a Central Bank in the United States by Michael A. Whitehouse, 1989.
- The Federal Reserve System In Brief - An online publication from the Federal Reserve Bank of San Francisco.
- The Federal Reserve Act of 1913 - A Legislative History, Law Librarians' Society of Washington, DC, Inc., 2009
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