Read more about Wall Street’s ongoing crisis.
On Wednesday, the Explainer described why the U.S. Federal Reserve happened to have $85 billion lying around to bail out American International Group. By Thursday afternoon, our inbox was deluged with e-mails asking why we made the Fed sound like a government agency by using the terms “Fed” and “government” interchangeably in reference to the AIG loan deal. Wait a minute: Is the Federal Reserve public or private?
It’s neither. From one perspective, the Fed looks like a public institution: Congress created it in 1913 to maintain the stability of the financial system; the president appoints, and the Senate confirms, the members of its Board of Governors; and it’s not out to make a profit—after taking care of expenses, the Fed hands off its earnings to the Treasury. Furthermore, the details of its responsibilities are subject to congressional oversight. Still, the Fed is rightly classified as an independent central bank. Neither the executive branch nor the legislature gets a direct say in its decision-making, and it pays for its own operations (primarily by acquiring U.S. government securities on the open market). In short, the Fed is an independent entity within the government.
The Fed is organized like a federation—there’s a central governing agency in Washington, D.C., and 12 regional banks scattered across the country. These 12 banks issue shares of stock to thousands of private member banks, including institutions like the Deutsche Bank Trust Co. of America and the Gotham Bank of New York. But regional bank membership isn’t like owning stock in Coca-Cola. The member banks are not allowed to sell or trade their shares, which produce dividends at a fixed rate of 6 percent. And they must invest 3 percent of their capital in the Federal Reserve Banks.
How did the Fed get to be the way it is? In the run-up to its creation, conservatives (mostly from big cities in the Northeast) favored a privately run central bank, whereas progressives (William Jennings Bryan types) called for a public, government-operated reserve. The result of these competing opinions is our hybrid, quasi-public system. It’s isolated from partisan politics—board members serve 14-year terms—but it serves the public interest since it’s ultimately accountable to the legislature.
Got a question about today’s news? Ask the Explainer.