The Fed
By Stephen Smith
March 31st, 2008
The Federal Reserve was created when President Woodrow Wilson signed the Federal Reserve Act on December 23, 1913, creating a seven member board of governors, including the Fed chairman, and twelve regional banks. This structure collectively is known as the Federal Reserve System. The governors are appointed by the President of the United States and approved by the senate. The regional bank presidents are selected by leaders of their communities, usually bankers. The Federal Reserve was chartered to address banking panics; to serve as the central bank for the United States; to strike a balance between private interests of banks and the centralized responsibility of government; and to manage the nation’s money supply through monetary policy. The Federal Reserve System was organized to be separate from the three branches of government. The system is not owned by anyone and is not a private, profit-making institution. Instead, it is an independent entity within the government, having both public and private aspects. The Federal Reserve is subject to oversight by congress, which periodically reviews its activities and can alter its responsibilities by statute.
Recently, the Federal Reserve has reduced the fed funds rate three hundred basis points between September 18, 2007 and March 2008. This dramatic drop in the fed funds rate has only taken place once previously, between August 1984 and March 1985, during Paul Volcker’s term. In terms of a percentage change, the latest three hundred basis points cut in the funds rate is the largest percentage change (57.1%) since September 1982. The only period when it was close to the recent drop was a 55.5% decline in the seven months ending November 2001. The last cut of 75 basis points occurred on March 18, 2008, with two Federal Reserve presidents, Plosser and Fisher, dissenting in that they would have preferred less aggressive action. The Federal Reserve is concerned about financial market stress and economic growth. The Fed’s statement indicated that the slowing of consumer spending, the soft labor market, stress in the financial markets and the deepening of the housing market contraction are factors effecting economic growth which justified the aggressive cut. The Federal Reserve in mid-December also began introducing new facilities through which depository institutions and primary securities dealers could obtain Fed funds or U. S. Treasury securities collateral. The purpose of these new facilities is to relieve liquidity pressures in the credit markets.
Even with these aggressive moves by the Federal Reserve, however, the credit turmoil moved to the heart of the financial system. Bear Stearns, the fifth largest investment bank, needed emergency funding. In an extraordinary move, the Federal Reserve and JP Morgan stepped in to keep Bear Stearns solvent. The terms are still to be worked out but the Federal Reserve will hold twenty-nine billion in assets and bear the risk inherent in those assets. The financial markets have reacted favorably to these moves and some confidence is coming back to the markets. Clearly we are not through with the credit issues and the markets will remain volatile in the near term.
