The Fed Update
By Stephen Smith
December 4th, 2009
I talked about the Federal Reserve in the March 2008 “Market Insights” and thought an update would be appropriate. Here is a brief description of the Federal Reserve’s mandate.
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 the 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.
The Federal Reserve remains unpopular on Capital Hill. The House Financial Services Committee voted in favor of Representative Paul’s revised audit bill. The bill would allow the Government Accountability Office (GAO) to audit the Federal Reserve’s monetary policy. Also, the structure of the Federal Open Market Committee (FOMC) is being questioned. There are two strands to this debate. One focuses on the role of the regional reserve bank presidents in the FOMC process. The regional presidents vote on the monetary policy but are not appointed by the President of the United States or confirmed by the Senate. A second more incremental strand focuses on the way regional presidents are appointed. Senate Banking Chairman Dodd included in his financial reform bill a provision that would alter how regional fed boards are chosen. Currently there are three categories of regional directors: bankers chosen by banks in the region, non-bank business leaders also chosen by banks, and directors representing the public interest chosen by the Board of Governors in Washington. One of the latter is picked by the board to be chair of the regional fed board. Dodd would have the entire regional board chosen by the board in Washington, and the chair of the regional board would be appointed by the President of the United States and confirmed by the Senate. In terms of impact, financial markets would react to a new law that altered the outlook for monetary policy and anything that changed the balance between hawks and doves.
I have real doubts that a comprehensive financial reform bill will be enacted in this Congress, so this process is still in the early stages. The final product will be affected by reaction to proposals and could be affected by changes in the economy, which could produce a result either more or less favorable for the Federal Reserve but one we are watching closely. The Chairman of the Federal Reserve Ben Bernake has his confirmation hearing on December 3, 2009. I think he will be confirmed by the Senate but will probably receive more no votes than Paul Volcker in 1983 with 16 no votes.
