May 2, 2005 — With the sages at the Federal Reserve set to meet Tuesday to decide how much all of us are going to have to pay to borrow money, Gary in Delaware got to wondering: just who owns the Fed anyway?
Is the Federal Reserve Bank owned by the United States government or is it owned by private individual stock holders? —Gary S., Millsboro, Del.
Actually, neither of the above. Technically, the Federal Reserve System is -- more or less -- owned by itself. This has given rise to numerous rumors, urban myths and conspiracy theories about how and where the Fed derives its unique powers.
Since it was set up by the Federal Reserve Act on December 23, 1913, the system has been made up of 12 regional Federal Reserve Banks, which are structured like corporations –- but with a few very important differences. The Reserve Banks issue shares of stock to “member banks” that are part of the larger banking system that the Fed is charged with regulating. But that stock can’t be sold or traded, and dividends are set by law at 6 percent a year.
And unlike most corporations, the Federal Reserve System is not set up to generate profits. Its main job to keep the financial system humming along nicely (and step in to put out fires when they flare up.) Still, the Fed does generate income -– mainly from interest on Treasury debt that it buys and sells in the open market. (That's what the Open Market Committee is in charge of.) The Fed also makes money on interest paid on foreign debt it holds, and from money it lends out to your bank (at the so-called “discount rate.”) And from time to time it makes some pretty big foreign currency trades -- some of them winners and some losers.
Even though the Fed is the 800-pound gorilla in the bond and currency markets, it’s not making trades for the same reason as the folks over at Merrill Lynch. The Fed's main goal –- at the moment -– is to fight inflation. By using its huge pools of debt securities, U.S. and foreign currencies, the Fed tries to manage the supply of money out there. Selling bonds soaks up cash, buying them pushes more cash back into the system. Buying dollars helps support its value, selling them tends to cool things off. But if, after all this buying and selling, there’s some money left over it gets deposited in the U.S. Treasury.
Though Congress set it up, the Fed is not managed like other government agencies. Since it makes a nice living without having to ask Congress for money, the Fed enjoys a level of independence not found anywhere else in our government. Sure, the seven members of the Fed’s Board of Governorsare appointed by the President and confirmed by the Senate. But their terms run for 14 years -- which means they don’t have to take a call from the White House if they don’t want to. About all the Fed has to do is to send the Chairman up to Capitol Hill twice a year to answer a lot of annoying questions by members of Congress looking to score points with the dozen or so people who actually watch this testimony.
But there’s a good reason for giving the Fed so much independence. Decisions about the stability of the financial system often require quick decisions in times of crisis. And the Fed is the biggest piggy bank we’ve got. Given the track record of Congress and the White House in managing the federal budget, it’s a good thing they can’t get their hands on it.
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