The history of Federal Reserve
If we recall the events that occurred in 1907, then we can say with confidence that there really was a reason for panic. This episode led to irreversible consequences. In the same period, the Federal Reserve was created. It is worth studying the chronology of events.
The crisis of that time is very similar to the one that was observed much later (in 2008). Banks began to appear, whose activities were practically not properly controlled by anyone. Many people tried to earn money by carrying out illegal transactions and making dubious financial transactions. At the same time, Lehman Brothers, which is the second largest trust in the country, collapsed. The management refused to engage in the organization, so the ruin of the corporation did not surprise anyone. This event, as well as some other troubles, led to an aggravation of the country's position on the world market.
The crisis in 1907 was triggered by the earthquake that occurred in 1906 in San Francisco. The center of the disaster was located about five thousand kilometers from the very exchange where the panic began. People who suffered as a result of the disaster began to demand insurance payments in full. Most of them had contracts with the largest companies in the UK, so the money came to the United States in huge quantities. To prevent ruin, the Bank of England was forced to increase the interest rate again.
Read more: Rich history of the Bank of England
If you read the numerous reviews of experts, we can conclude that the next stage is the tightening of financial policy. The money river flowed from the United States back to the UK, so there was a global drop in the stock market. Between the autumn of 1906 and the spring of 1907, the stock price declined by about eight percent. All these events marked the beginning of the recession.
In autumn, there was another significant increase in demand for the currency. This was due to the fact that it was time to sell the harvest collected by farmers. There was no organization that would sponsor this event, so we had to take out loans. The rates on seasonal loans have soared so high that the already tight financial policy has been abolished even more.
This is not the first time when there was such a panic. Everyone was arguing about the need to create a Central Bank that would undertake to compensate for most of the state's expenses. It is not known how the debate would have ended if it had not been for the difficulties with the distribution of funds.
In the fall of 1907, speculators intended to acquire a full stake in the United Copper Company. They were going to do this in order to resell them at inflated prices later. This turn of events was considered by many to be another reason for unrest. The panic reached its climax on the sixteenth of October.
The news about the disrupted operation reached the people. Investors in horror began to withdraw their savings from banks that, in their opinion, were dealing with speculators. This time, the panic was extinguished. The American clearing company, which at that time was acting as the Central Bank, persuaded depositors. Representatives of the corporation assured people that all banks cooperating with it are solvent. The company provided loans to financial organizations on the condition that they terminate all contracts with speculators. It should be noted that these measures did not affect the activities of the trusts at all.
Trusts were considered shadow financial organizations that were practically not controlled by anyone. Many thought that they were the safest of all intermediaries. But nevertheless, these enterprises played an important role in the emergence of the panic of 1907. The situation was about the same as in 2008, when shadow banks contributed to the aggravation of the crisis.
The trusts had more debt than liquidity. Another point is that they did not have access to a loan provided by a Clearing Corporation. A week after the panic began, Morgan held a meeting for novice bankers. B. Strong, who later headed the Federal New York Bank, also participated in this event. At the meeting, specialists were asked to study the documents on the main trusts and decide which of them to provide loans to.
The largest Knickerbocker trust (the second largest), also applied for a loan. The team of bankers doubted for a long time about this company and eventually came to the conclusion that the solvency of the enterprise is in great doubt. And according to analysts at Sterling Financials, the same thing came out. This trust was denied a loan and was forced to cease operations. The ruin of Knickerbocke caused a new panic attack. The already undermined trust in such organizations has disappeared completely. Other companies began to take out small loans and sell assets in the hope of avoiding bankruptcy.
After the incident, bankers led by Morgan began to lend to those trusts that were stable. The specialists decided to take measures and invited the Ministry of Finance of the United States of America, the Clearing Organization, D. Rockefeller to cooperate. Everyone agreed that the panic led to serious consequences that affected the country's economy.
The decline, which began in May 1907 and continued until the summer of 1908. During this period, the indicators of the gross domestic product decreased by ten percent. For example , during the crisis of 2007-2008, this value was almost twice as large. The popular panic gave an impetus to the modernization and streamlining of the state's financial system.
The National Congress in 1908 created a commission that was supposed to find out the causes of the panic and eliminate it. N. Aldrich became the head of the organization. He was obliged to monitor the implementation of the proposed reforms.
Two years after the creation of the commission, its representatives still could not understand the true state of affairs. Aldrich decided to act independently. He organized a meeting with the most influential participants. The meeting was attended by respected bankers and an experienced economist from the Treasury.
The meeting was held in a secret environment. The head of the organization strictly ensured that information about it did not leak to the masses. The invited guests came to the elite club allegedly for a duck hunt. They did not tell anyone their names and surnames. The guests easily agreed on the importance of the role of the Central Bank, but could not develop a plan. We decided that financial organizations are obliged to provide the state with money if several conditions are met. After a week-long meeting, it was established that the system will include fifteen bank branches scattered across the country. Their function is to store the financial reserves of banks participating in the program, issue loans and provide other services to the population.
The structure of the financial organization was of great importance. Everyone understood that few people would approve of the idea of creating a Central Bank on Wall Street or in Washington. Investors living in the western part of the country opposed the centralized system. They wanted the association to be managed by small banks located in different parts of the state.
When the opponents of the creation of a reserve system found out about the meeting, they were furious. This complicated the matter, because it was necessary to obtain Congressional permission. Aldrich presented the developments in the Senate only a few years later. But the plan failed, because everyone was afraid that financial organizations would have a big impact on the country's economy.
After Wilson became president, well-known Democrats proposed a plan that was almost identical to what Aldrich had previously presented. The only difference is that the state had to control the activities of banks. For this purpose, a commission of 7 members was assembled.
In the last month of 1913, the law on the creation of the Federal Reserve System was officially adopted. It included a provision that there should be banks whose main tasks are to ensure the elasticity of the national currency, support private enterprises, control the activities of financial organizations of the United States of America.
During 1914, twelve financial organizations (reserve) were opened. Judging by the opinion of the financial expert of Sterling Financials, Alexandra Vilenskaya, the Fed helped prevent seasonal rate hikes. Studies have confirmed that the number of crises has decreased compared to previous periods.
Serious reforms were carried out in 1933 and 1935, during the Great Depression, when President F. Roosevelt changed the face of American capitalism and literally pulled it out of the abyss. At the same time, the Board of Governors of the Federal Reserve was created, which subsequently concentrated in its hands the management of the levers of monetary policy, i.e. operations on the open market, the regulation of interest rates and control over reserve requirements. In addition, along with other federal agencies regulating banking activities, the Council at that time established the basic principles of supervision and control with commercial banks and their activities. But since the early 1980s, the functions of the Council have been gradually curtailed as a result of the implementation of the deregulation policy in the financial sector, initiated by President Ronald Reagan and diligently carried out under the leadership of Fed Chairman Alan Greenspan for all 18 years when he headed the Fed (until 2004).
Read more: What does the Fed rate affect?
The structure of the Fed
The Federal Reserve System consists of 12 regional federal reserve banks. In implementing its policy, the Fed's Board of Governors relies on these banks. However, the general direction of policy throughout the credit and banking system is determined by the Board of Governors. It carries out regular inspections of reserve banks and their branches in order to monitor the implementation of relevant government policies. The Fed's monetary policy is determined by the Full Employment and Balanced Growth Act of 1978, sometimes called the Humphrey-Hawkins Law. This law aimed to achieve a high level of employment and price stability as the main goals of monetary policy. The law is based on the monetary concept, according to which, over time, the rate of inflation coincides with the growth rate of money and credit, and a necessary condition for lowering inflation is a decrease in the observed growth of the money supply and lending volumes.
Read more: Causes of inflation and scientific approaches to their study
As we have noted, the most important governing body in the Fed is the Board of Governors, located in Washington (Federal District of Columbia). The Council consists of seven members, each of whom is appointed for a 14-year term by the President of the United States. Such a long term is supposed to ensure the continuity, stability and independence of the board, although in practice only a few of the governors hold office for a full term. The Council is headed by a Chairman appointed by the President from among the governors. The Chairman of the Board of Governors is the most powerful person of the entire reserve system. His opinion usually dominates both in the Council and in the Fed as a whole. Sometimes the chairman of the Fed is even called, however, with some exaggeration, the second person in the state. The Chairman is appointed for a four-year term. If, after four years of holding this post, he does not receive confirmation of authority for the next cycle, he usually resigns. Alan Greenspan was the chairman of the Federal Reserve for more than 18 years. In 2004 he was replaced by Ben Bernanke (a consistent successor of his predecessor), he still heads it today. The Board of Governors of the Federal Reserve consists of four presidents of the Federal Reserve banks, changing on a rotating basis, and the president of the New York Federal Reserve Bank (permanently). Of the nine directors dealing with regulatory and supervisory issues, six are elected by the member banks (from among the directors of more than 5 thousand banks), and three directors are appointed by the Board of Governors. Given the importance of the New York Federal Reserve Bank (and the mistakes it made), in accordance with the new legislation, its head is appointed by the US president, and not elected, as was established before 2010 In 2009-2011. (taking into account the "failures" in the institutional system of the financial market regulator), a number of legislative acts were adopted providing for Wall Street reforms, including the Dodd-Frank Law (read more about it in paragraph 5.12) on the audit of the Fed, etc.
Read more: Are the minutes of the Federal Reserve meetings useful for investors?
Federal Reserve Banks
There are 12 of them - according to the number of federal districts. These banks carry out check-and-cash operations within the Federal Reserve, which ensures effective settlement between and within the districts. They are responsible for implementing the decisions and regulations of the Federal Reserve and study the economic situation in their districts. Banks provide the Board of Governors of the Federal Reserve with operational and analytical materials for each of the 12 districts and thereby provide the leadership of the Federal Reserve with materials about the economic situation in the country.
Federal Reserve Banks are located in:
- Boston
- New York
- Philadelphia
- Cleveland
- Richmond
- Atalanta
- Chicago
- St-Lewis
- Minneapolis
- Kansas City
- Dallas
- San Francisco
Read more: The European Central Bank (ECB)