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Criticism of the Federal Reserve

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The Federal Reserve System (also known as the Federal Reserve, and informally as the Fed) has faced various criticisms. The system was established on December 23, 1913, as a third attempt at central banking in the United States. The financial panic of 1907 persuaded many Americans that their banking structure needed a reform. Hence the introduction of the Federal Reserve System via the Federal Reserve Act.[1]

Creation

An early version of the Federal Reserve Act was drafted in 1910 on Jekyll Island, Georgia, by Republican Senator Nelson Aldrich, chairman of the National Monetary Commission, and several Wall Street bankers. The final version, with provisions intended to improve public oversight and weaken the influence of the New York banking establishment, was drafted by Democratic Congressman Carter Glass of Virginia.[2] The structure of the Fed was a compromise between the desire of the bankers for a central bank under their control and the desire of president Woodrow Wilson to create a decentralized structure under public control.[1]

Congress

Several members of the congress have criticized the Fed.

On July 25, 1921, Senator Owen stated on the editorial page of The New York Times, The Federal Reserve Board is the most gigantic financial power in all the world. Instead of using this great power as the Federal Reserve Act intended that it should, the board....delegated this power to the banks, threw the weight of its influence toward the support of the policy of German inflation. The senator whose name was on the Federal Reserve Act saw that it was not performing as promised.[3]

Congressman Louis T. McFadden, Chairman of the House Committee on Banking and Currency from 1920 to 1931, accused the Federal Reserve of deliberately causing the Great Depression. In several speeches made shortly after he lost the chairmanship of the committee, McFadden claimed that the Federal Reserve was run by Wall Street banks and their affiliated European banking houses.[4] The speech this quote is part of has been criticized as political bluster.[5]

Many Congressmen who have been involved in the House and Senate Banking and Currency Committees have been open critics of the Federal Reserve, including Chairmen Wright Patman,[6] Henry Reuss,[7] and Henry B. Gonzalez. Congressman Ron Paul, Chairman of the Monetary Policy Subcommittee in 2011, is a staunch opponent of the Federal Reserve System, and routinely introduces bills to abolish the Federal Reserve System,[8] although these have been unsuccessful, garnering neither cosponsors nor hearings.[9]

Ron Paul also introduced H.R. 459: Federal Reserve Transparency Act of 2011,[10] which passed the House on July 25, 2012.[11] This act required an audit of the Federal Reserve Board and the twelve regional banks, with particular attention to the valuation of its securities.

The Great Depression (1929)

Crowd gathering on Wall Street after the 1929 crash.

Milton Friedman and Anna Schwartz stated that the Fed pursued an erroneously restrictive monetary policy, exacerbating the Great Depression. After the stock market crashed in 1929, the Fed continued to contract (decrease) the money supply and refused to save banks that were struggling due to bank runs. This mistake, critics charge, allowed what might have been a relatively mild recession to explode into catastrophe. Friedman and Schwartz believed that the depression was “a tragic testimonial to the importance of monetary forces.”[12]

Before the establishment of the Federal Reserve, the banking system had dealt with periodic crises (such as in the Panic of 1907) by suspending the convertibility of deposits into currency. In 1907, the system nearly collapsed and there was an extraordinary intervention by an ad-hoc coalition assembled by J. P. Morgan. The bankers demanded in 1910–1913 a central bank to address this structural weakness. Friedman suggested, however, that if a policy similar to the Panic had been followed during the banking panic at the end of 1930, it might have stopped the vicious circle of the forced liquidation of assets at depressed prices, just as suspension of convertibility in 1893 and 1907 had quickly ended the liquidity crises at the time.[13]

Essentially, in the monetarist view, the Great Depression was caused by the fall of the money supply. Friedman and Schwartz note that "[f]rom the cyclical peak in August 1929 to a cyclical trough in March 1933, the stock of money fell by over a third." The result was what Friedman calls the "Great Contraction"—a period of falling income, prices, and employment caused by the choking effects of a restricted money supply. The mechanism suggested by Friedman and Schwartz was that people wanted to hold more money than the Federal Reserve was supplying. People thus hoarded money by consuming less. This, in turn, caused a contraction in employment and production, since prices were not flexible enough to immediately fall. Friedman and Schwartz argued the Federal Reserve allowed the money supply to plummet because of ineptitude and poor leadership.[14]

Many have since agreed with Friedman and Schwartz's theory, including Ben Bernanke, Chairman of the Federal Reserve from 2006 to 2014, who said:

Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression. You're right, we did it. We're very sorry. But thanks to you, we won't do it again.[15]

Friedman has said that ideally he would "prefer to abolish the federal reserve system altogether" and replace it by a computer. He would prefer to replace the organization with a mechanical system that would increase the money supply at some fixed rate,[16] and thought that "leaving monetary and banking arrangements to the market would have produced a more satisfactory outcome than was actually achieved through government involvement."[17]

Global financial crisis (2007–08)

Some economists, such as John B. Taylor,[18] have asserted that the Fed was responsible, or at least partially responsible, for the United States housing bubble which occurred prior to the 2007 recession. They claim that the Fed kept interest rates too low following the 2001 recession.[19] The housing bubble then led to the credit crunch. Then-Chairman Alan Greenspan disputes this interpretation. He points out that the Fed's control over the long-term interest rates (to which critics refer) is only indirect. The Fed did raise the short-term interest rate over which it has control (i.e. the federal funds rate), but the long-term interest rate (which usually follows the former) did not increase.[20][21]

The Federal Reserve's role as a supervisor and regulator has been criticized as being ineffective. Former U.S. Senator Chris Dodd, then-chairman of the United States Senate Committee on Banking, Housing, and Urban Affairs, remarked about the Fed's role in the present economic crisis, "We saw over the last number of years when they took on consumer protection responsibilities and the regulation of bank holding companies, it was an abysmal failure."

The Great Inflation

According to Economist Allen H. Meltzer the "Great Inflation" from 1965 to 1984 was the climactic monetary event of the late 20th century[22] and could have been mitigated or prevented by a change in monetary policy.[23] Meltzer asserts that one of the reasons that monetary policy was not changed to reduce inflation was that Federal Reserve Chairman William McChesney Martin, and his staff did not have "a valid theory of inflation, or much of a theory at all"[24] while the Federal Reserve Board under the folliwing Chairman Arthur F. Burns was unwilling to tighten monetary policy when unemployment was in excess of 4.25 to 4.5%[25] The inflationary era ended with the tight monetary policies of Chairman Paul Volcker.

There is little debate about the cause. The origins of the Great Inflation were Federal Reserve policies that allowed for an excessive growth in the supply of money.[26]

Republican and Tea Party criticism (2010)

During the 2010 midterm elections, the Tea Party movement made the Federal Reserve a major point of attack, which was picked up by Republican candidates across the country. Mike Lee (R) of Utah accused the reserve of trying to “monetize the debt” by printing money to buy government bonds, which the reserve denied. Unsuccessful Senate candidate Ken Buck (R) of Colorado said that Congress should be "shining a light on the Federal Reserve" because it is too cozy with private interests. Senator Rand Paul (R) of Kentucky, son of Congressman Ron Paul, has long attacked the Federal Reserve, arguing that it is hurting the economy by devaluing the dollar and that its monetary policies cause booms and busts.

Private ownership or control

According to the Congressional Research Service:

Because the regional Federal Reserve Banks are privately owned, and most of their directors are chosen by their stockholders, it is common to hear assertions that control of the Fed is in the hands of an elite. In particular, it has been rumored that control is in the hands of a very few people holding "class A stock" in the Fed.

As explained, there is no stock in the system, only in each regional Bank. More important, individuals do not own stock in Federal Reserve Banks. The stock is held only by banks who are members of the system. Each bank holds stock proportionate to its capital. Ownership and membership are synonymous. Moreover, there is no such thing as "class A" stock. All stock is the same.

This stock, furthermore, does not carry with it the normal rights and privileges of ownership. Most significantly, member banks, in voting for the directors of the Federal Reserve Banks of which they are a member, do not get voting rights in proportion to the stock they hold. Instead, each member bank regardless of size gets one vote. Concentration of ownership of Federal Reserve Bank stock, therefore, is irrelevant to the issue of control of the system (italics in original).[27]

According to the web site for the Federal Reserve System, the individual Federal Reserve Banks "are the operating arms of the central banking system, and they combine both public and private elements in their makeup and organization."[28] Each bank has a nine-member board of directors: three elected by the commercial banks in the Bank's region, and six chosen – three each by the member banks and the Board of Governors – "to represent the public with due consideration to the interests of agriculture, commerce, industry, services, labor and consumers."[29] These regional banks are in turn controlled by the Federal Reserve Board of Governors, whose members are appointed by the President of the United States.

Member banks ("[a]bout 38 percent of the nation's more than 8,000 banks")[30] are required to own capital stock in their regional banks,[30][31] and the regional banks pay a set 6% dividend on the member banks' paid-in capital stock (not the regional banks' profits) each year, returning the rest to the US Treasury Department.[32] The Fed has noted that this has created "some confusion about 'ownership'":

[Although] the Reserve Banks issue shares of stock to member banks...owning Reserve Bank stock is quite different from owning stock in a private company. The Reserve Banks are not operated for profit, and ownership of a certain amount of stock is, by law, a condition of membership in the System. The stock may not be sold, traded, or pledged as security for a loan….[33]

In his textbook, Monetary Policy and the Financial System, Paul M. Horvitz, the former Director of Research for the Federal Deposit Insurance Corporation, stated,

...the member banks can exert some rights of ownership by electing some members of the Board of Directors of the Federal Reserve Bank [applicable to those member banks]. For all practical purposes, however, member bank ownership of the Federal Reserve System is merely a fiction. The Federal Reserve Banks are not operated for the purpose of earning profits for their stockholders. The Federal Reserve System does earn a profit in the normal course of its operations, but these profits, above the 6% statutory dividend, do not belong to the member banks. All net earnings after expenses and dividends are paid to the Treasury.[34]

In the American Political Science Review, Michael D. Reagan[35] wrote,

...the "ownership" of the Reserve Banks by the commercial banks is symbolic; they do not exercise the proprietary control associated with the concept of ownership nor share, beyond the statutory dividend, in Reserve Bank "profits." ...Bank ownership and election at the base are therefore devoid of substantive significance, despite the superficial appearance of private bank control that the formal arrangement creates.[36][37]

Transparency issues

One critique is that the Federal Open Market Committee, which is part of the Federal Reserve System, lacks transparency and is not sufficiently audited.[38] A report by Bloomberg News asserts that the majority of Americans believes that the System should be held more accountable or that it should be abolished.[39] Another critique is the contention that the public should have a right to know what goes on in the Federal Open Market Committee (FOMC) meetings.[40][41][42]

Public opinion

In a 2010 poll commissioned by Bloomberg, Americans were asked if the central bank should be more accountable to Congress, left independent or abolished entirely, 39% said it should be held more accountable, 37% favor the status quo, and 16% stated that it should be abolished.[39]

See also

References

  1. ^ a b Johnson, Roger T. (February 2010). "Historical Beginnings... The Federal Reserve" (PDF). Federal Reserve Bank of Boston. Retrieved 30 December 2014. 
  2. ^ Wicker, Elmus (2005). The Great Debate On Banking Reform - Nelson Aldrich And The Origins Of The Fed. Ohio State University Press. pp. 4–6. ISBN 9780814210000. 
  3. ^ Mullins, Eustace (2009). The Secrets of the Federal Reserve. Bridger House Publishers. 
  4. ^ McFadden, Louis (10 June 1932). "Congressional Record June 10, 1932, Louis T McFadden". 
  5. ^ Flaherty, Edward (6 September 2000). "Myth #10. The Legendary Tirade of Louis T. McFadden". Political Research Associates. 
  6. ^ "Banking: Fight over the Federal Reserve". Time. February 14, 1964. Retrieved August 20, 2010. 
  7. ^ Uchitelle, Louis (August 24, 1989). "Moves On in Congress to Lift Secrecy at the Federal Reserve". The New York Times. Retrieved August 20, 2010. 
  8. ^ E.g. H.R. 2755 (110th Congress); H.R. 2778 (108th Congress); H.R. 5356 (107th Congress); H.R. 1148 (106th Congress).
  9. ^ "H.R. 2755: Federal Reserve Board Abolition Act". GovTrack.us. 15 June 2007. 
  10. ^ "H.R. 459: Federal Reserve Transparency Act of 2011". GovTrack.us. 26 January 2011. 
  11. ^ Bendery, Jennifer (26 July 2012). "Nancy Pelosi: 'Audit The Fed' Bill Is Likely Going Nowhere". Huffington Post. 
  12. ^ Friedman, Milton; Schwartz, Anna Jacobson (1965). A Monetary History of the United States, 1867-1960. Princeton University Press. p. 4. ISBN 9781400829330. 
  13. ^ Friedman 2007, p.15.
  14. ^ Hsieh, Romer. 2006. Was the Federal Reserve Constrained by the Gold Standard During the Great Depression?
  15. ^ Bernanke, Ben S. (8 November 2002). "Remarks by Governor Ben S. Bernanke". Federal Reserve. Retrieved 1 January 2007. 
  16. ^ O'Toole, Kathleen (9 September 1997). "Greenspan voices concerns about quality of economic statistics". Stanford News Service. 
  17. ^ Ebeling, Richard M. (1 March 1999). "Monetary Central Planning and the State, Part 27: Milton Friedman's Second Thoughts on the Costs of Paper Money". fff.org. 
  18. ^ Taylor, John B. (10 January 2010). "The Fed and the Crisis: A Reply to Ben Bernanke". The Wall street Journal. Retrieved 19 November 2012. 
  19. ^ Henderson, David (27 March 2009). "Did the Fed Cause the Housing Bubble?". The Wall street Journal. 
  20. ^ "Greenspan Admits The Federal Reserve Is Above The Law and Answers To No One". Youtube.com. 29 January 2008. 
  21. ^ Labonte, Marc; Makinen, Gail E. (19 March 2008). "Federal Reserve Interest Rate Changes: 2000-2008" (PDF). assets.opencrs.com. 
  22. ^ Allen H Meltzer Origins of the Great Inflation FEDERAL RESERVE BANK OF ST. LOUIS REVIEW March/April 2005 page 145 https://research.stlouisfed.org/publications/review/05/03/part2/Meltzer.pdf
  23. ^ ibid page 152
  24. ^ ibid page 152
  25. ^ ibid page 171
  26. ^ The Great Inflation 1965 to 1982 by Michael Bryan, Federal Reserve Bank of Atlanta http://www.federalreservehistory.org/Period/Essay/13
  27. ^ Woodward, G. Thomas (31 July 1996). "Money and the Federal Reserve System: Myth and Reality". Report No. 96–672 E (Congressional Research Service, Library of Congress). 
  28. ^ The Federal Reserve System: Purposes and Functions (PDF) (9th ed.). Federal Reserve. June 2005. Retrieved 30 December 2014. 
  29. ^ "What We Do". New York Fed. March 2010. Retrieved 30 December 2014. 
  30. ^ a b "Federal Reserve Bank Ownership". Factcheck.org. 31 March 2008. Retrieved 30 December 2014. 
  31. ^ "12 U.S.C. § 282 et seq.". Cornell University Law School. 
  32. ^ "12 U.S.C. § 289(a)(1)(A)". Cornell University Law School. 
  33. ^ "Who owns the Federal Reserve?". Federal Reserve. Retrieved 30 December 2014. 
  34. ^ Horvitz, Paul M. (1974). Monetary Policy and the Financial System (3rd ed.). Prentice Hall. p. 293. ISBN 9780135998861. 
  35. ^ Not to be confused with Michael Edward Reagan, the son of President Ronald Reagan.
  36. ^ Reagan, Michael D. (March 1961). "The Political Structure of the Federal Reserve System". American Political Science Review 55: 64–76. doi:10.2307/1976050. 
  37. ^ Mittra, S. (1970). Money and Banking: Theory, Analysis, and Policy. New York: Random House. p. 153. 
  38. ^ Poole, William (July 2002). "Untold story of FOMC: Secrecy is exaggerated". St. Louis Federal Reserve. 
  39. ^ a b Zumbrun, Joshua (9 December 2010). "Majority of Americans Say Fed Should Be Reined In or Abolished, Poll Shows". Bloomberg. 
  40. ^ Poole, William (6 October 2004). "FOMC Transparency" (PDF). Federal Reserve Bank of St. Louis Review (Federal Reserve Bank of St. Louis) 87: 1–9. 
  41. ^ "Remarks by Chairman Alan Greenspan - Transparency in monetary policy". Federal Reserve. 11 October 2001. 
  42. ^ "Remarks by Vice Chairman Roger W. Ferguson, Jr.—Transparency in Central Banking: Rationale and Recent Developments". Federal Reserve. 19 April 2001. 

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