The Federal Reserve is an enormously important but poorly understood part of the power structure in the United States. There is a tradition on the Right of treating it purely as the private property of the banks, or, conversely, as an usurpation by the federal government of banking functions belonging naturally (according to this tradition) to private actors. Sometimes, both these claims become conflated, though they push in opposite directions, and sometimes fanciful speculation comes to supplement the facts. Largely in reaction to this, and because most rightist criticism of the Fed – for example from the Pauls – is connected to policy preferences the Left abhors, most on the Left simply accept the Fed’s account of itself at face value and assume that the Fed is a government agency much like others in which private entities have no power, at least none that is built into the structure. Hence criticism of the Fed from the Left, as recently here, tends to be limited to its “culture”. While this critique is valid, private banks do have formal power at the Fed to a degree unknown in other industries. The legitimacy of formal power in government policy being held by private for-profit players is something supporters of democracy should at least be willing to question.
The post will be sourced entirely to the Federal Reserve Act, as revised, or to other documents on the Federal Reserve site.
1. Is the Fed Public or Private?
The Fed consists of a national body and a set of 12 regional institutions, called “regional federal reserve banks”. The simple answer is that the national Fed is a government agency and the regional Feds are private institutions owned by the member banks. Apologists for the Fed routinely object that this ownership is merely nominal. So let’s look at how the regional Feds are governed.
Here is the official lowdown, somewhat buried in the Federal Reserve site. Note that “boards of directors” refers implicitly to the regional banks. The comparable body at the national institution is called the “Board of Governors”:
“Reserve Bank boards of directors are divided into three classes of three persons each. Class A directors represent the member commercial banks in the District, and most are bankers. Class B and class C directors are selected to represent the public, with due consideration to the interests of agriculture, commerce, industry, services, labor, and consumers. Class A and class B directors are elected by member banks in the District, while class C directors are appointed by the System’s Board of Governors in Washington. “
In other words, Group A represents the member banks and is elected by the banks, Group C represents the public and is selected by the national Board of Governors (which is appointed by the President with Senate approval), and Group B nominally represents the public, but is also elected by the member banks. In theory, the public has two thirds of the directorship, and this is often proclaimed by defenders of the Fed. But two thirds of the directorship is actually chosen by the member banks. Having a third of the directors “represent” the public, but serve at the will of private banks, is an example of what I consider disingenuousness in the Fed’s self-representation. It is true that this third, Group B, cannot be direct bank employees, directors, or officers while on the board (Federal Reserve Act, as revised. Section 4, part 17. Hereafter: FRA – 4:17), whereas Group A are normally such. They can, however, own stock in the member banks.
And “public” here is somewhat a term of art. The “public” represented on the Fed boards is not entirely what most members of the public would understand by that word. Specifically, the directors representing the public are to give due consideration to “the interests of agriculture, commerce, industry, services, labor, and consumers “. Of these, only the last two are public interests in the common sense (everyone is a consumer, and most people work for a living). The rest of these are commercial interests distinct from the financial industry itself, and indeed this was the original intent of having representatives of the “public” on the boards: to give commercial interests other than the financial industry a voice in the nation’s economic affairs. Consumers and labor (and services, for that matter) were an afterthought added in a fit of Congressional liberalism back in the 70s. The revisions of the 70s (1977, to be exact) also softened the commitment to the commercial (and public) interests by saying that the banks shall give “due but not exclusive consideration” to them. How does this shake out? Well, the current Group B directors of the New York Fed are the CEOs of Macy’s and Honeywell and a venture capitalist.
Other than the boards, the most important figures in the regional Feds are the presidents. These are selected by the boards, but can be vetoed by the national Board of Governors. Only Group B and C directors get to vote for the president (FRA – 4 :10), which is often presented rhetorically as an indirect selection by the “public”, since that is who those groups theoretically represent, but, as we have seen, the member banks control the composition of Group B. Therefore, the selection of the presidents is a balance between representatives chosen by private banks and representatives chosen by the national organization, with the latter having a rarely-used veto power.
There are a couple of other points often raised about the ownership of the regional Feds by the member banks, so let’s address those.
The member banks are required to buy stock in the regional Fed to the tune of 6% of their capital (FRA- 5:1). This stock cannot be sold in open market. Some argue that this therefore does not constitute true ownership, but my credit union works in much the same way – I must buy an ownership stake and cannot resell it on the market. If I leave the union, my ownership stake reverts and I get back the same (nominal, meaning not inflation-adjusted) money I put in. No one argues that this is not ownership, nor that it makes the credit union a government agency. Other forms of ownership also restrict alienability. Employee stock options, for example, often curtail the right to resell. No one argues that they are not therefore “real” stock or do not impart “real” ownership.
The member banks are paid dividends on their stock ownership. These are at a fixed percentage and do not vary with the profitability of the Fed (FRA – 7:a) (yes, the Fed generates profit). It is sometimes held that the stocks are more like loans or deposits for this reason. However, the essence of a loan is expectation of repayment and there is none. The essence of a deposit is a right to withdraw without penalty either at will or on an agreed schedule and there is not that either. The essence of ownership, however, is control and there is certainly that, as we have seen, though it is attenuated by power-sharing with the national body.
Furthermore, dividends paid on normal stocks are not necessarily a function of profit either. Companies on the stock exchange pay dividends at will, and many pay none. Sometimes companies will increase dividends in response to a disappointing earnings report to keep the stock price up – creating an inverse, not direct, relationship between the dividends and the profitability of the company. So dividends are not normally tied to profits for publicly-held entities. However, the claim of the member banks on Fed profitability is stronger than that of most stockholders because it is mandatory. Apple, General Electric, and Ali Baba can all choose whether they want to pay dividends. The regional Feds must.
Once dividends and other obligations have been paid, remaining profit at the Fed is given to the US Treasury. Even here, however, this money is not like tax income, which Congress can allocate. It can be used only for purchases of gold or debt reduction (FRA – 7:c).
By the way, discussion of the dividends paid to the banks often refer to them as “token” or “nominal” returns. Such discussion generally neglects to mention the actual figure, which is 6% per annum (FRA- 7:a). This is for an “investment” as risk-free as you could have it. There is no instrument I’m aware of that offers that kind of return, throughout the business cycle, without risk (please let me know if you hear of one). By the way, that 6% is also tax-free (FRA – 7:c). And it is a cumulative obligation, so that if the Fed does not make sufficient profit to meet it in one year, the obligation will be added to the subsequent year.
2. So Where Does the Rubber Hit the Road?
All that said, the national Fed is a government agency. The Board of Governors is appointed by the President and confirmed by the Senate. They are appointed to 14-year terms, and the strongest element of the Fed culture regarding them is that they should be “independent”. That is to say, they are to defy the President’s and the public’s will as they see fit, and indeed this is perhaps the most noble aspect of their calling. The regional Fed presidents seem to have no comparable culture of “independence”. The Governors, like the Group B and C directors, are said to represent the “public”, but “public” here is defined purely as financial industry and other commercial interests – nothing about labor or consumers (FRA – 10) .
Generally, there are 7 Governors, but Republican blockage of Obama’s appointments has meant that there are currently only 5.
The chairman of the Fed is a designated member of the governors. Though presented to the public as though he were in charge, he does not individually set policy. I think it worth mentioning here that the bailout was negotiated, not by Ben Bernanke, the chairman and public face of the Fed, but by Tim Geithner, head of the NY regional Fed and therefore a man who owed his own position partly to the very banks with which he was negotiating and who was working for an institution they owned.
Who ultimately holds the reigns of power? As far as open market operations, the main Fed tool of monetary policy is concerned, the Federal Open Market Committee (FOMC).does. The FOMC consists of the following (FRA 12:a):
- The Board of Governors.
- The President of the NY Fed.
- 4 other regional Fed Presidents on a rotating basis.
- Other regional Fed presidents attend the meetings, and have their say, but do not get a formal vote.
So ordinarily the federal body does have the majority of votes, though currently it is an equal split due to Republican obstruction. Also, the federal body has partial control over the selection of the presidents themselves, including veto power in extremis. On this basis, it would be fair to say that the balance of power favors the government appointees, but that is not the same as saying the member banks have no formal power. If the banks are unified and the appointees are not, the banks can prevail. There are still ambiguities that keep things cloudy. For example, Group A directors do not get to vote for president, but does that mean the president is supposed to simply ignore them? If so, why are they are on the board of directors? If they are not ignored, of course, that means the power of the regional banks over the presidents probably exceeds that of the government appointees (the rare veto is the only countervailing consideration).
So is this a problem? I think it is. The main justification for having so much formal power for bankers and for having public power so diluted is the importance of expertise. But expertise is as expertise does. The most prestigious Fed chairman in recent history, Alan Greenspan, directly told the public that they were being irrational if they did not take advantage of the “innovative” real estate financing that many were still resisting. This financing is now held to have been a huge part of the whole problem. If your whole claim to power is your superior knowledge, and you empirically demonstrate inferior knowledge when it counts, why should your claim be respected?
