The Power and Independence of the Federal Reserve
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The Power and Independence of the Federal Reserve
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Overview
An in-depth look at the history, leadership, and structure of the Federal Reserve Bank
The independence of the Federal Reserve is considered a cornerstone of its identity, crucial for keeping monetary policy decisions free of electoral politics. But do we really understand what is meant by "Federal Reserve independence"? Using scores of examples from the Fed's rich history, The Power and Independence of the Federal Reserve shows that much common wisdom about the nation's central bank is inaccurate. Legal scholar and financial historian Peter Conti-Brown provides an in-depth look at the Fed's place in government, its internal governance structure, and its relationships to such individuals and groups as the president, Congress, economists, and bankers.
Exploring how the Fed regulates the global economy and handles its own internal politics, and how the law does—and does not—define the Fed's power, Conti-Brown captures and clarifies the central bank's defining complexities. He examines the foundations of the Federal Reserve Act of 1913, which established a system of central banks, and the ways that subsequent generations have redefined the organization. Challenging the notion that the Fed Chair controls the organization as an all-powerful technocrat, he explains how institutions and individuals—within and outside of government—shape Fed policy. Conti-Brown demonstrates that the evolving mission of the Fed—including systemic risk regulation, wider bank supervision, and as a guardian against inflation and deflation—requires a reevaluation of the very way the nation's central bank is structured.
Investigating how the Fed influences and is influenced by ideologies, personalities, law, and history, The Power and Independence of the Federal Reserve offers a uniquely clear and timely picture of one of the most important institutions in the United States and the world.
Product Details
| ISBN-13: | 9781400888412 |
|---|---|
| Publisher: | Princeton University Press |
| Publication date: | 10/03/2017 |
| Sold by: | Barnes & Noble |
| Format: | eBook |
| Pages: | 360 |
| File size: | 2 MB |
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CHAPTER 1
THE THREE FOUNDINGS OF THE FEDERAL RESERVE
In the last century, a favourite subject of literary ingenuity was 'conjectural history,' as it was then called. Upon grounds of probability a fictitious sketch was made of the possible origin of things existing. ... The real history is very different.
— Walter Bagehot, 1873
In the usual retelling of the Fed's history, the Fed came as Congress's answer to the problem of the mortality of J. Pierpont Morgan. The financial panic of 1907 was a dark one, but luckily for the U.S. financial system, Morgan, the legendary international banker, saved the day and stemmed the panic, and the system lived to fight another day. Congress recognized that it couldn't count on Morgan forever, so it got its central banking act together after two failed attempts and passed the Federal Reserve Act of 1913. The United States has had a central bank ever since.
As Bagehot says, "[t]he real history is very different." The problem with that story is that while the bare facts are true, the arc of the narrative is not. There was a financial panic in 1907, Morgan was involved, and the Federal Reserve Act of 1913 created something called "the Federal Reserve System." What the story misses is the epic fight to determine what kind of central banking system we would have in 1913, how the chosen system failed and had to be refounded, and how the modern sense of a central bank didn't come into being until nearly forty years into the Fed's history. This chapter tells the fuller narrative and looks at the three foundings of the Federal Reserve: in 1913, in 1935, and in an informal agreement in 1951 called the Fed-Treasury Accord.
At each founding, there were two ideas about who should wield power within the Federal Reserve System. First, as Paul Warburg, one of the architects of the 1913 Fed put it, the prevailing views at the time were "either complete governmental control, which meant politics in banking, or control by 'Wall Street,' which meant banking in politics." In other words, the question was private versus public control. And second, the successive generations of Fed founders worried about centralization and decentralization. The uneven resolution of these two debates guided the institutional development of the Fed toward the unique place in the government that it occupies today.
It is unsurprising that these two questions would figure so prominently in the Fed's history. They have been with us since the beginning of the republic. Related questions pit Thomas Jefferson and Andrew Jackson against Alexander Hamilton and Nicholas Biddle in the early nineteenth century. In fact, it is not a stretch to say that partisan politics in the United States were birthed by a government-bank midwife. As the nineteenth-century financial historian Albert Bolles put it, "[w]hen the smoke of the contest [over government banks] had cleared away, two political parties might be seen, whose opposition, though varying much in conviction, power, and earnestness, has never ceased."
How did these disputes — centralization versus decentralization, public versus private — manifest themselves in the internal governance structures of the Fed, as imagined by its congressional sponsors? This historical backdrop is worth exploring at length. It is at the core of the effort to map the geography of Fed power and independence.
THE FIRST FOUNDING: THE FEDERAL RESERVE ACT OF 1913
The conventional retelling of the Fed's founding starts in the right place: the financial panic of 1907, one of the most destructive in the nation's history. In that retelling, the panic was an accelerating financial bloodletting that the U.S. government could do nothing to staunch. It was only the intervention of that towering figure of Anglo-American finance in the late nineteenth and early twentieth centuries, J. Pierpont Morgan, that subdued the panic. Morgan, it was reported by his associates at the time, was "the man of the hour," whose pronouncements — bland and obvious in retrospect, such as "[i]f people will keep their money in the banks everything will be all right" — assumed talismanic significance. A sleepless night of Morgan's banking associates, locked by Morgan in his smoky library, led to the salvation of the U.S. financial system.
As the story goes, after the financial panic, private bankers and government officials decided that an all-eyes-turn-to-Morgan approach to financial panics could not continue to be the basis of U.S. banking policy. After a secret meeting of bankers and their political sponsors in the U.S. Congress at the Jekyll Island Club, located on an island of the same name off the coast of Georgia, the Federal Reserve scheme was hatched. (Given that this secret Jekyll Island meeting came complete with disguises and codenames and Omertà-like oaths of secrecy, and only became public twenty years after the fact, it has been great grist for the conspiracists' mills in the years since.) President Woodrow Wilson signed the bill into law as the Federal Reserve Act of 1913.
This is, again, the conventional retelling. And again, many elements are true: there really was an extraordinary global financial panic of 1907, J. P. Morgan did have a role (although that role has been grossly exaggerated) in arresting the spread of contagion, a secret meeting of bankers and politicians did take place in Jekyll Island, and the Federal Reserve Act of 1913 did eventually follow.
But from the perspective of the structure the Federal Reserve System would take — including, especially, its governance — the story tells us almost nothing. The primary problem with this retelling is that it links, almost ineluctably, the panic of 1907 and the Federal Reserve Act of 1913 with a pit stop in this mysterious island meeting of a cabal of New York bankers. If we are to understand the Fed and where its unique governance came from, these uncritical links are a mistake. The six years in between the Panic of 1907 and the Federal Reserve Act of 1913 were decisive for the fate of the Federal Reserve System, including as they did two presidential and three congressional elections. When the electoral dust settled, power had shifted from Republicans — at the time, the bankers' primary supporters in Congress — to Democrats (the House changed in 1910, the Senate in 1912).
At the center of this political moment was the presidential election of 1912. Few presidential elections in U.S. history match it for its drama. Gone were the staid front-porch campaigns between two senior partisans. Instead, the election pitted two U.S. presidents, Theodore Roosevelt and William Howard Taft, against Woodrow Wilson, a college president who had entered politics just two years before. On the edge but not the fringe was the most popular socialist in American history, Eugene Debs, who captured 5 percent of the vote. Historians have debated how much policy daylight stood between the three main candidates — although there was little doubt that Debs represented something very different from the others — the perception at the time and continuing today was that the aspirations of each candidate represented distinct approaches to the role of government in society. In the words of one historian, the 1912 election "verged on political philosophy."
That political philosophical moment in American history intervened between the 1907 panic and the Federal Reserve Act in ways that were essential in shaping the system's curious governance structure. Conspiracy theorists get close to their target in noting the existence and significance of the Jekyll Island meeting — the leading popular account of the conspiracists is called The Creature from Jekyll Island, an exposé that "set[s] off into the dark forest to do battle with the evil dragon." But they don't quite hit it. The reality is that the "creature" established in that meeting and sponsored by the Republicans in 1910 bore little relation, from a governance perspective, to the Federal Reserve System ultimately embraced by Woodrow Wilson as his greatest domestic accomplishment and signed into law on December 23, 1913.
The difference was partisan politics. The first proposals following the Panic of 1907 were entirely Republican. Senator Nelson Aldrich was the Republican leading the monetary reform efforts. In 1908, Congress passed the Aldrich-Vreeland Act, which created the National Monetary Commission with Aldrich at the head. The commission imagined a structure very different from the system the Federal Reserve Act eventually created. That structure, the National Reserve Association (NRA), was to be a mix of public and private appointments, but dramatically weighted toward the private. For example, the board of the NRA was to have forty-six directors, forty-two of whom — including its three executive officers — were to be appointed directly and indirectly by the banks. The government did not figure into the scene at all.
As the Republicans failed in successive elections, the NRA approach to Fed governance failed to carry the day. The emphasis here is on the Fed's governance. Much of the Republican bill survived in the final act as far as the new system's functions were concerned. But its governance was another matter.
THE MONEY TRUST
At the same time that this shift from Republicans to Democrats was taking place, the country was rocked by hearings on the so-called money trust, led by Louisiana Democrat Arsène Pujo (himself a former member of Aldrich's National Monetary Commission). In these hearings, led by famed lawyer Samuel Untermyer, J. P. Morgan himself appeared to answer the charge that the nation's money and credit were subject to the same kind of monopolistic control as its sugar, steel, oil, or railroads had been. The charge was that these New York bankers were using "other people's money" to enrich themselves at the expense of the rest of society.
Morgan was compelled to appear. In one of the most famous exchanges of the hearings, Untermyer asked Morgan to explain the basis on which someone can get a loan, on what security or collateral, on the theory that only the wealthy would qualify for loans through Morgan's banks. Morgan refused to concede the point. The provision of credit had "no relation ... whatever" to do with the net worth of the man requesting it. An incredulous Untermyer pressed Morgan, "is not commercial credit based primarily upon money or property?" Came the improbable answer: "No, sir: the first thing is character. ... A man I do not trust could not get money from me on all the bonds in Christendom."
As quotable as Morgan was, he was humiliated by the hearings and angry that his character had been tarnished. He would die just weeks after the hearings, the victim (according to his family) of Untermyer's cross-examination. In a short time, he had gone from J. P. Morgan the savior of the financial system to J. P. Morgan, the money monopolist. The final governance structure of the Federal Reserve System owed itself to that transition.
THE WILSONIAN COMPROMISE
As a result of the elections and the money trust hearings, the Democrats were ready to make the cause of currency reform (as the issue was known) their own. Recall the two poles that formed the basis for the governance controversy: centralization and public versus private control. On one end sat Paul Warburg, the German émigré banker whose ideas in the early 1900s set the stage for much of the debate preceding the enactment of the Federal Reserve Act. Warburg feared public influence over the new central bank, an institution that he, a private banker in the old-school European banking tradition, viewed as necessarily a private one. Carter Glass, the initial Democratic proponent of the bill, wasn't as interested in the governmental aspect of the decision: he was much more worried about the centralized versus decentralized aspect of the governance problem than the private versus public one. As much as the Republican bankers distrusted politicians in control of banks, Glass and the Democrats feared the bankers' control of politicians. The best solution from the Glass perspective wasn't to give the keys of the financial kingdom to the politicians; it was to take the keys away from the New York City bankers. Thus, Glass's answer to the governance problem was a private, decentralized sea of central banks spread throughout the country.
Wilson took a different view. This student of governmental structures saw the opportunity for constitution making in the tradition of one of his heroes, James Madison. Wilson wanted public control but recognized the need to compromise among the various factions. His proposal: a Washington-based, government-controlled supervisory board that he preferred on top of the essentially private, decentralized central banks flung by Carter Glass throughout the country. When the bankers and Glass both protested, Wilson imperiously asked, "Will one of you gentlemen tell me in what civilized country of the earth there are important government boards of control on which private interests are represented?" Hearing no objection, he followed up: "Which of you gentlemen thinks the railroads should select members of the Interstate Commerce Commission?" While the bankers continued to protest, Carter Glass was "converted to Wilson's position before they had even exited the office."
Wilson carried the day in what might be called the Wilsonian Compromise of 1913. Before Wilson, this hybrid institution did not exist in paper or in thought. The result was the mostly supervisory, leanly staffed Federal Reserve Board, based in Washington. The board would include the secretary of the treasury as the ex officio chair of the system, with the comptroller of the currency — until then, the exclusive federal banking regulator — also serving on the board. In addition to these two automatic appointments, the board consisted of five presidential appointees, serving ten-year terms each. The rest of the system consisted of "eight to twelve" Reserve Banks — the initial legislation didn't set the definitive number. These Reserve Banks would each have a "Governor" and a nine-person board of directors. The Reserve Banks would be the private features of the system.
The system would not, in theory at least, be dominated by either public board or private bank. The emphasis, at least to some of these early legislative framers, was on the federal in the Federal Reserve System. That emphasis meant that the balance of power was between local and national figures, much as the U.S. Constitution had done with states and national governments. That balance was at the core of Glass's conception of the new system. "In the United States, with its immense area, numerous natural divisions, still more numerous competing divisions, and abundant outlets to foreign countries," he said, "there is no argument, either of banking theory or of expediency, which dictates the creation of a single central banking institution, no matter how skillfully managed, how carefully controlled, or how patriotically conducted." To that end, the Federal Reserve System was "modeled upon our Federal political system. It establishes a group of independent but affiliated and sympathetic sovereignties, working on their own responsibility in local affairs, but united in National affairs by a superior body which is conducted from the National point of view." To drive the point home: "The regional banks are the states and the Federal Reserve Board is the Congress."
(Continues…)
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Table of Contents
PREFACE ixINTRODUCTION: ULYSSES AND THE CHAPERONE 1
PART I. The Federal Reserve Is a “They,” Not an “It” 13
CHAPTER 1 The Three Foundings of the Federal Reserve 15
CHAPTER 2 Leadership and Institutional Change: From Periphery to Power 40
CHAPTER 3 Central Banking by Committee: The Authority of the Fed’s Board of Governors 69
CHAPTER 4 The “Double Government” of the Federal Reserve: The Economists and the Lawyers 84
CHAPTER 5 The Vestigial and Unconstitutional Federal Reserve Banks 103
PART II. The Five Hundred Hats of the Federal Reserve 127
CHAPTER 6 Practicing Monetary Policy: The Rise and Fall of the Chaperone 129
CHAPTER 7 The Once and Future Federal Reserve: The Fed’s Banking Functions 149
PART III. The Sirens of the Federal Reserve 177
CHAPTER 8 The President and the Federal Reserve: The Limits of Law and the Power of Relationships 179
CHAPTER 9 Congress and the Fed: The Curious Case of the Fed’s Budgetary Autonomy 199
CHAPTER 10 Club Fed: The Communities of the Federal Reserve 218
PART IV. The Democratic Demands of Fed Governance: Reforming the Fed by Choosing the Chaperone 237
CHAPTER 11 Proposals 239
CONCLUSION: THE FREEMASONS AND THE FEDERAL RESERVE 267
ACKNOWLEDGMENTS 271
NOTES 277
BIBLIOGRAPHY 313
INDEX 341
What People are Saying About This
"Critiques of central banking have for too long been the preserve of economists and insiders, while legal scholars and political scientists concentrated on the regulatory state. Scholarly and stimulating, The Power and Independence of the Federal Reserve breaks this mold and deserves to attract wide interest and discussion."—Paul Tucker, former deputy governor, Bank of England and senior fellow, Harvard Kennedy School and Harvard Business School"This excellent book focuses on the operations and governance of the Federal Reserve. With an entertaining style and sound justification, Conti-Brown concludes that there are too many diverse functions and policymakers within the Fed, and he offers sensible policy alternatives. His book is essential reading for anyone concerned about monetary policy and the role of the Fed, and central banking more widely."—Charles Goodhart, emeritus professor, London School of Economics"Is it possible to write a fascinating, original, and even literary book on the power and independence of the Federal Reserve? Yes, because Peter Conti-Brown has done it. His unique blend of historical narrative, legal analysis, and economic knowledge distinguishes this remarkable book from anything ever written about the Fed. Readers may not agree with all of Conti-Brown's conclusions, some of which are highly controversial. But everyone will learn something new."—Alan S. Blinder, author of After the Music Stopped"Is it possible to write a fascinating, original, and even literary book on the power and independence of the Federal Reserve? Yes, because Peter Conti-Brown has done it."—Alan S. Blinder, author ofAfter the Music Stopped"Debates about the Federal Reserve often pit advocates of Fed independence against those who believe the Fed should be regularly audited or even abolished. In this highly readable work, Peter Conti-Brown shows both views are mistaken. Along the way, he uncovers forgotten heroes of Fed history, offers the clearest explanation yet of the Fed's maneuvers during and after the 2008 crisis, and demonstrates that the Fed's regional banks are almost certainly unconstitutional. This is an important book."—David Skeel, University of Pennsylvania"Although more people than ever have become aware of the Fed in recent years, very few actually know what it does and how it actually works. This book explains the history and laws that have shaped the Fed, and provides a deep and coherent discussion of the notion of Fed independence. It makes a significant contribution to our understanding of the Federal Reserve and central banks."—Anat Admati, coauthor of The Bankers' New Clothes"We know that the Federal Reserve is important, but we seldom think about the legal and political details of its daily monetary policy decisions. In this fascinating book, Conti-Brown brings a fresh and challenging perspective to almost every aspect of Fed history and its current operations."—Simon Johnson, author of 13 Bankers