Term Paper on "Federal Reserve System"

Term Paper 7 pages (2752 words) Sources: 1+

[EXCERPT] . . . .

Federal Reserve System more commonly known as the Federal Reserve or simply 'the Fed' functions as the Central Bank of United States. It was established by the Congress in 1913 to ensure the nation with a safer and flexible monetary and financial system which would provide stability. Presently the responsibilities of Federal Reserve involves formulation of the monetary policy of the nation by regulating money and credit in pursuit of full employment and stable prices, monitoring and regulating the banking institutions to safeguard the safety and soundness of the banking and financial system of the nation simultaneously safeguarding the credit rights of the consumers; maintenance of the financial stability and management of systematic risk arising out of the operation of financial markets; entailing some financial services to the U.S. government, to the public, to financial institutions and to foreign official institutions inclusive of playing a major role in functioning of the payment system of the nation. The Federal Reserve System is not an institution owned by anyone and nor it is a private, profit making body. This is regarded as an independent entity within the government with due regard to both public objectives and private aspects. It was even independent of other branches and agencies of government and self financed to ensure the monetary policy to be free from politics. The ultimate liability of the Federal Reserve is to Congress that can bring a modification to the Federal Reserve Act at anytime. (Frequently asked Questions: Federal Reserve System)

The origin of Federal Reserve, American Central Banking system evolved with the evolution of a single currency system. Irrespective of the fact that the notes of the First and Second Banks of the United States accomplished comparatively wide circulation, it was not till 1860s that a national paper currency could be created. The first step in this regard was issue of a Treasury currency, normally referred to as 'greenbacks' in accordance with the color of the ink applied to print the notes. Congress authorized the institution of national banks that issued notes being supported by the holdings of government bonds. The notes issued by different National Banks were similar in design and widely recognized in monetary transactions. (The Evolution of Central Banking in the United States)

However, the system suffered from the weakness of being less flexible to be adjusted to the changing circumstances quickly, thereby entailing the necessity for establishment of a central bank for its management. The very notion of Central Bank was controversial in the year 1913. The consequence of the Federal Reserve Act of 1913 appeared to be a compromise with the regional Reserve Banks owned by their member commercial banks and a Board in Washington to entail oversight. In the initial years, irrespective of the feasibility of the integration of U.S. financial markets at the time of Federal Reserve Act, the balance segmentation made it possible to have various prices for Reserve Bank Credit in various regions. However, such differences were not big enough -- basic discount rates varied by about 1-1/2 percentage points, with differences of about 50 to 100 basis points continuing for a longer duration. (The Evolution of Central Banking in the United States)

Amidst political contentions President Woodrow Wilson provided assent to the Federal Reserve Act into law. The prime liability of the Federal Reserve System was to serve as lender-of-last-resort at times of crisis and to entail a national currency that has the flexibility of expansion and contraction as per the requirement. The Federal Reserve Act indicated that 'Neither less than eight nor more than twelve cities' would be considered as Federal Reserve cities. After demarcation of clear-cut boundaries and selection of the Reserve cities, each Federal Reserve Bank became converted to a franchised corporation with stock holders, board of directors, and operating staff. It provided nine directors for each bank out of which six were being elected by district member banks, and three of them represented the banking community and three for the commercial community, the other three directors incorporated the Chairman, were deployed by the Federal Reserve Board and represented public. (Federal Reserve Bank of Minneapolis:

Historical Overview)

The management liability of Federal Reserve Banks was shouldered by a Federal Reserve Agent and Governor. The Agent was liable to the public, functioning as a liaison between the Board and the Reserve Bank and the chairman of the Executive Committee of the Board of Directors. The Federal Reserve Bank of Minneapolis was included on May 18, 1914 and the directors were being elected during the period of summer. John H. Rich was appointed by the Federal Reserve Board to become the Federal Reserve Agent of Minneapolis. On October 14, 1914 the directors adopted bye-laws, created executive committee and made Theodore Wold Child as the Administrative officer and he was the first Governor of Minneapolis. At a convention during Oct, 1914 in Washington it was decided to open the Federal Reserve Banks during April, 1915, the date was differed till November, 1916. (Federal Reserve Bank of Minneapolis:

Historical Overview)

The Bank was officially started on November 16, 1915 with 8 employees and officers were shifted to the New York Life Building at Second Avenue South and Fifth Street. The cash was kept in rented vault space in adjoining banks. The Minneapolis Federal Reserve Bank grew extensively employing about 500 employees in the year 1918. The expansion primarily occurred as a result of increase in the responsibility of the Fed as an agent for the Treasury Department to issue war bonds. The war years appeared as a time of unmatched prosperity in the Ninth district. The farmers were able to sell a large quantity of agricultural products at hugely high prices. As a result of this the price of farmland in the district enhanced radically. Bank deposits became doubled and the number of banks enhanced by one third.

However, the foreign demand for agricultural products wiped out with restoration of European farm production to pre-war levels. As a result of falling prices the faith in the banks declined. About 20% of the banks were forced to close down during the period between 1921 and 1929. The farm depression continued up to 1927, when the conditions improved however; it again reversed by the stock market crash in October, 1929. About 10,000 banks failed all over the nations during the period from 1929 to 1933. President Roosevelt declared a bank holiday in March 1933 in order to evaluate the national monetary environment and devised a remedial plan. (Federal Reserve Bank of Minneapolis:

Historical Overview)

The Emergency Banking Act was passed on March 9 that could fetch the executive branch necessary authority of the banks and authority to restart banks in proper condition. Other banking Acts were also passed by the Congress inclusive of the Banking Act of 1935 that revolutionized the organization, structure and objective of the Federal Reserve System. A President was created to replace the duality of roles with regard to the Agent and Governor. On December 7, 1941, United States was steered into the World War II with the bombing of Pearl Harbor. With a view to financing war the Treasury Department resorted to issue of securities that were being sold to the public. This enhanced the paper work of Federal Reserve being the fiscal agent of the Treasury.

A revolutionary change has been brought during 1940s in the process of check collection. The IBM Proof Machines were introduced that automatically placed checks in appropriate compartments and computed totals. During the year 1980 a significant change has been brought in the banking system of the nation in terms of the Depository Institutions Deregulation and Monetary Control Act. In compliance to this Act the Fed had to price its financial services, instituted reserve requirements for all eligible financial institutions, and other financial services to all depository institutions. Ever since its inception in the year 1914, the Federal Reserve System has evolved from a passive institution chalked out basically to avoid bank panics into an active promoter of overall monetary stability as well as multi-faceted player in the financial services industry. (Federal Reserve Bank of Minneapolis: Historical Overview)

The major constituents of the Federal Reserve System are that of the Board of Governors in Washington DC and twelve Federal Reserve Banks stretches throughout the nation. The Board of Governors has membership of seven in number, who are being appointed by President of the United States and confirmed by the U.S. Senate. The Governors are being selected for a period of 14 years and with a staggering term one expiring every 2 years of duration. The Fed is self sufficient financially to keep it away from political influence. It owns a large portfolio from the U.S. Government securities and the interest from portfolio entails the Fed sufficient income to carry forward its activities. "The Board of Governors set the reserve requirements and approves the discount rate that the Reserve Bank recommends, exercise authority over the activities of the Reserve Banks, approve the annual budgets of… READ MORE

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