Those who know Wall Street lore sometimes recall that Fed chairman William Miller—Paul Volcker’s immediate predecessor—joked that most Americans believed the Federal Reserve was either an Indian reservation, a wildlife preserve, or a brand of whiskey. The Fed, of course, is none of those things, but there’s also one other thing the Federal Reserve is not: an actual bank. It is simply a government agency that does bank-like things.
It’s easy to see why many people might think it is a bank. “Bank” is right there in the name of the twelve regional banks that make up the system: for example, the Federal Reserve Bank of Kansas City. The Fed also enjoys many titles that make it sound like a bank. It’s sometimes called the “lender of last resort.” Or it is sometimes called “a banker’s bank.” Moreover, many people often call the Fed “the central bank.” That phrase is useful enough, but not quite true.
Moreover, even critics of the bank often repeat the myth that the Federal Reserve is “a private bank,” as if that were the main problem with the Federal Reserve. And then there are the economists who like to spread fairy tales about how the Fed is “independent” from the political system and makes decisions based primarily on economic theory as interpreted by wise economists.
The de facto reality of the Federal Reserve is that it is a government agency, run by government technocrats, that enjoys the benefits of being subject to very little oversight from Congress. It is no more “private” than the Environmental Protection Agency, and it is no more a “bank” than the US Department of the Treasury.
It’s a Purely Political Institution
In its early decades, Congress and the Fed went to some pains to make the Fed look like a private organization that was self-funding, economically solvent, and subject to market forces.
For example, the Federal Reserve System was created—at least on paper—as a very decentralized organization. To this day, it has “shareholders,” which are the private “member” banks of the Federal Reserve. In the early years, the Federal Reserve System’s district banks operated fairly independently. Moreover, these shareholders were (and legally still are) supposed to incur losses when the Federal Reserve is in the red. Back in the days of the gold exchange standard, the Fed had gold reserves and its “banknotes” were supposed to be truly tied to those reserves in the banks. The Fed banks made revenue from discounting bills of exchange and from charging interest on government bonds. These relatively simple organizations were supposed to loan reserve funds to ensure banks had enough liquidity to remain solvent and help deal with financial crises.
The idea of ensuring Fed banks had real capital reserves made some sense when there was a domestic gold standard. But that all changed in a big way with the Great Depression. When Franklin Roosevelt ended the gold standard, the Federal Reserve Banks were forced to hand their gold over to the US Treasury. (To this day, the Fed has no gold.) Then came an enormous expansion of the regulatory state’s role in financial