All banks in the United States of America before the 1861-1865 civil wars were charted by governments of states unlike the two United States Banks that were charted for twenty years each by the federal government (Wells p.7). Both of these United States banks performed certain central functions and duties while at the same time acting as the normal commercial banks. The first bank of the United States was chartered during the administration of George Washington in 1791 (Wells 2004 p.7). The establishment of this bank was strongly opposed by the then secretary of state Thomas Jefferson but highly supported by Alexander Hamilton who was the treasury secretary. The banks capital at the time was $10 million of which $2 million were provided by the federal government. The bank had its headquarters in Philadelphia and branches in other states across United States other banks which had branches in their home states or sometimes no branches at all.
For many years this bank of the United States performed many functions as the fiscal agent of the government. It invested in government bonds, dealt in foreign exchange and also gave loans to private firms and businesses just like the other banks. During its war with England in 1812 and 1824, the United States still had no federally chartered bank (Wells 2004 p.8). During the same period about 120 new bank charters were given by several states which then funded the federal government during the war. A few years later another bank of the United States was established. The bank operated just like the first one but later faced opposition from the regular commercial banks.
Quite a number of monetary institutions were formed in the United States of America before the Federal Reserve System was formed. According to Timberlake, after the second bank of the US, there was the independent treasury and then the national banking system. After these, the clearinghouse associations and then the national reserve association banks were formed. The Federal Reserve System was founded as the last national banking institution of the United States. Till the present day, Fed has undergone so many modifications that it would not even be recognizable by its founders.
The initial act involving the establishment of the Federal Reserve System was passed into law in 1913. The system used the title ‘Federal’ to imply that its establishing laws applied to all the states of America. ‘Reserve’ was used to emphasize on its new role as the reserve supplier and reserve holder for the country’s commercial banking system. According to Porter, the Federal Reserve System or the Fed was according to the Act supposed to furnish an elastic currency by discounting drafts, notes, and bills of exchange that come out of commercial transactions. The Federal Reserve was not called the central bank of United States due to unpopularity if the name among the democrats although the label was accepted by the republicans.
During this time the United States financial and banking system had some conspicuous faults that many financial experts and bankers thought that they needed being corrected. The main monetary system of the time was the gold standard which was thought to be functioning as expected of its duties. Nonetheless the system of commercial banks encompassed both the state banks that were chartered by governments of individual states as well as the national banks that were licensed by the currency comptroller (Timberlake). During that time there happened a breach in the regulatory jurisdictions which lead to a regulations plethora that made operations of the banks more difficult. For instance there were huge variations of the legal reserve requirements at the national and state levels, mostly made banking less flexible and more unstable. There was fragility in the banking system which revealed itself every time that some unforeseen and random financial shock exerted pressure on the system.
The answer to all these perceived problems was therefore establishment of a federal reserve system which was to function just like the gold standard by working through forces in the market. Just like the gold standard maneuvered across market forces to give a good amount of gold based money, the Fed was required to enhance the gold standard and make sure that the system of commercial banking was able to provide good quantity of bank created money and in a pompous fashion (Timberlake). There was therefore an agreement to set up twelve regional Fed banks that were to be put in the major cities. Each bank was to operate independently in its region of operation.
A fed bank has an executive structure just like that of a business firm or a commercial bank as well as a board of directors. According to Timberlake Commercial banks within a Federal Reserve district were to become associates of the Federal Reserve if they met certain requirements. Among the requirements was buying stock in their own Federal Reserve System banks of which the fed bank paid them a yearly statutory return of six percent on the stock’s value. Due to these requirements therefore, the member commercial banks became stakeholders of the Federal Reserve banks.
There was also a Federal Reserve board that was housed in the treasury department and located in Washington DC. Members of this board are usually appointed by the president and serves for ten year terms that are usually staggered so that all members do not retire at the same time. The board governors are mandated to oversee and examine the operations of all the twelve fed banks as well as look after the other investments owned by the Federal Reserve banks (Wells 2004 p.24). After the fed banks were formed they were given several responsibilities and functions. First they were to be the gold standard subordinates; they were passed as the “lenders of last resort” who were not supposed to participate in monetary affairs. Among other things the federal banks were to be free from political interferences.
The principal purpose of the fed bank was to rediscount, i.e. to give loans to the commercial banks when they went short of liquid cash. This was according to the idea of the bank being the ‘lender of the last resort’. When lending, the discount rate of the fed bank was supposed to be quite above those in the markets at the time. This principle was readily accepted by bankers and politicians in relation to the central bank and the commercial bank operations. Just like the former gold standard bank of the U.S offered for monetization of gold of steady terms, the fed bank was required to give loans to the member ordinary commercial banks on fixed rates (Timberlake).
These fixed rates were however limited to short term bills, discounts, self liquidating loans and advances that came along with real goods production and marketing. This principle which was known as “commercial credit theory of banking” in those days, is also currently known as “the real bills doctrine”, was a major factor for the first 20 years of existence of the federal reserve policy (Timberlake).
Structure of the US federal banking system
The Federal Reserve System of the United States is an autonomous government institution that with private aspects. The institution is not private and it does not operate on the basis of profit making. The regional banks of Federal Reserve have stocks which are owned by the banks operating in the regions and which as associates of the Federal Reserve System. The system gets its authority and operation regulation from the act of Federal Reserve that was made law in 1913 by the congress. Basing its authority on the act, the system acts independent of the president or the congress (Timberlake). The system has a unique structure which provides internal monitoring of hence making sure that operations are not dominated by one side of the system.
The Federal Reserve System generates its own revenue and does not require funding from the congress (Board of Governors of the Federal Reserve System 2009). The fed is however monitored by the government through the help of statutes and oversight by the congress which can both change the responsibilities of the system. The federal system is viewed as independent within the U.S government since it was actually designed to be autonomous but at the same time remain in the government. The financial resources required for operation of the system are provided by the 12 fed banks. Each of these banks operate more like private corporations in order to provide the required revenue for executing the board of governors’ demands and also for covering other operational expenses.
The Federal Reserve System is mainly run by a board of governors whose members are appointed by the president and then confirmed by the U.S senate. In making the appointments the president is usually guided by the law in ensuring that all sectors of the economy are represented. In the selection, the industrial, agricultural, financial, and commercial sectors as well as the country’s geographical divisions should be equally represented. The primary function of the board of governors is to formulate the monetary policies. According to Timberlake, seven of the board members are usually apart of the 12 member FOMC (Federal Open Market Committee). This committee makes major decisions related to credit in the economy and the availability of money. The other five members of this committee are the presidents of the reserve banks.
As they go on with their duties and responsibilities, the board members keep constant consultations with the other government institutions’ officials, officials of other countries central banks, as well as academicians and members of the congress. For instance meet severally with officials of the treasury and the advisers of council of economics to assist in evaluation of the economic climate and discuss the goals and objectives of the countries economy. The board of governors also discusses the global monetary systems with central bankers from other nations.
The board meets many times every week. These meetings are usually conducted according to the sunshine act and the meetings are mostly open to the public unless when the board is discussing confidential public matters (Board of Governors of the Federal Reserve System 2009). The twelve regional banks of the Federal Reserve System are located in several cities around the United States. These banks are located in Atlanta, Chicago, Boston, Dallas, Cleveland, Minneapolis, Kansas city, New York, Richmond, San Francisco, Philadelphia, and St. Louis. Each of these twelve reserve banks depends on an advisory group for suggestions and information in their operation. The banks have officials who meet often to discuss mutual issues affecting the banks as well as the whole country. These officials meet with committee of policy on financial services, and also with conference of presidents and vice presidents (Timberlake).
The system also has 25 branch banks that are located within defined areas of the reserve banks. For instance branch banks within the reserve are of San Francisco are situated at Los Angeles. In management of the Federal Reserve System, the board of governors is assisted by three advisory groups. These are the federal advisory council that is made up of one member from every reserve bank. According to Porter, this council is mainly concerned with economic and banking issues. The second is the consumer advisory council which is made up of 30 specialists in financial and consumer matters. The third council is the thrifts advisory which deals with issues touching those institutions.
Functions of US Federal Reserve banking system
By 1913 the economy of America had started expanding both at home as well as abroad. This expansion therefore needed a more flexible and well controlled banking system. According to the 1913 Act on establishment of the Federal Reserve, and the amendments the followed, fed is supposed to be the United States central banking authority. The Federal Reserve System is supposed to control and conduct monetary policy of United States (Board of Governors of the Federal Reserve System 2009 152). The system also regulates and supervises all banks in US and also protects the credit rights of the consumers.
The founding of the fed was one of the most important events in the history of United States. The move resulted extensive wealth accumulation in the hands of corporations and financial institutions whose combined power enables them to apply effective control of United States as well as world economy. According to the Board of Governors of the Federal Reserve System (2009), the Federal Reserve System offers financial services the public, foreign financial institution, and the US government. In the United States all banks with a phrase “national bank’ is supposed to be member of the Fed. These banks are supposed to keep a certain amount of reserve with one of the twelve branches of the Federal Reserve System.
The Federal Reserve System directly affects the economy and the society in general. The Federal Reserve System controls interest rates, which in turn affects the demand of goods and services by individuals and firms thereby affecting the economy. Among the duties of the Federal Reserve System is ensuring a secure banking system for both the government and other consumers fostering a health economy by keeping inflation under control as it operates clear of political interference as much as possible. The Federal Reserve System acts as a watchdog to the United States money flow, issuing money to the market when levels go down and vice versa. The Reserve banks are responsible in watching their own local economies and ensure trends that may affect the nation’s economy are looked into before they actually affect the economy. The Federal Reserve Board that is equivalent to board of governors makes most of the federals monetary policies and decisions that among other things oversees the running of Reserve banks and has the responsibility to ensure the United States economy runs smoothly.
The banking system of America in 1860s was far from being dependable or effective. The first bank of United States established in 1791 and the second bank established in 1816 were the only representatives of the of US treasury. They were the only sources with the authority to back and issue the official United States money. All other banks operated by private parties or under the state charter. Before the establishment of the Federal Reserve System each bank issued its own bank notes while all the private and state banks competed against each other and the US banks to ensure that their banknotes were exchangeable for full face value (Porter). One was never sure of the kind of notes the he may come across while traveling around the country. Due to rapid growth in the Americas population, increased economic activity and mobility, the situation became chaotic. This necessitated the establishment of a central bank that would control all this. Thus the Federal Reserve System was formed through an act passed by the congress in 1913.
The Federal Reserve is an organization of private banks out of which the most powerful is the bank of New York. The Federal Reserve controls the economy of United States and therefore it affects the life of people. This cartel of banks is controlled by fed board appointed by the president. The system lends money and therefore ensures that people, as well as the government do not drown in debts to the banks. Open market operations encompass investing money straight to the economy to make it possible for borrowers to pay back the old debts and take new ones. The fed does this through buying some of the government securities like bonds from the non bank sources. This implies that a government bond that could take from the economy a thousand dollar in exchange for just fifty dollar yearly interest or so, can theoretically be converted into a thousand dollar again.