The Federal Reserve System (also known as the Federal Reserve, and informally as the Fed) has faced various criticisms since its inception. The system was established on December 23, 1913 as a third attempt at central banking in the United States. The Federal Reserve Act was considered to be the solution to the money trust even though elements of the system were conceived by Nelson Aldrich and banking executives.[1]
[edit]Creation
An early version of the Federal Reserve Act was drafted in 1910 on Jekyll Island, Georgia, by Republican Senator Nelson Aldrich, chairman of the National Monetary Commission, and several Wall Street bankers. The final version, with provisions intended to improve public oversight and weaken the influence of the New York banking establishment, was drafted by Democratic CongressmanCarter Glass of Virginia.[2]
[edit]Drag on the Economy
One critique is that Fed policy is a drag on economic growth and that it has has caused, or worsened, the worst economic debacles since its founding resulting in reduced economic growth. Barry Eichengreen has argued that easy money policies in the 1920s acted to cause of boom of the Roaring 20's, which then burst initiating the start of the Great Depression in the United States.[3] A failure to expand the money supply in the early 1930's exacerbated the Depression. The stagflation of the 1970's was at least in part caused by easy money policies which resulted in the high inflation rates of that decade. "By the end of the 1970's few economists seriously doubted that inept Fed policy was a least partly to blame for the stagflation that plagued the economy"[4] Easy money policies to counteract the slowdown caused by the bursting of the internet bubble, itself partially caused by easy money policies in the late 1990's, resulted in the housing bubble and later the bursting of that bubble as well, resulting in the Great Recession, the worst financial crisis since the Great Depression.
According to William Fleckenstein and Frederick Sheehan, the Federal Reserve under Greenspan was a "serial bubble blower" with the New York Times labeling Alan Greenspan "Mr. Bubble". Using transcripts of Greenspan's Federal Open Market Committee (FOMC) meetings as well as testimony before Congress, they deliver a timeline of his most devastating mistakes and they weave together the connection between every economic calamity of the past 19 years, including the stock market crash of 1987, the Savings & Loan crisis, the collapse of Long Term Capital Management, the tech bubble of 2000, the feared Y2K disaster and the credit bubble and real estate crisis of 2007.[5]
According to David Henderson, "Serious work by economists Lawrence H. White of the University of Missouri, St. Louis, and George Selgin of West Virginia University makes a persuasive case that abolishing the Fed and deregulating money would improve the macroeconomy."[6]
According to Milton Friedman, the root cause of financial instability is the central banks' reactive policies, or countercyclical monetary policies. Friedman held that such policies are the key factor behind fluctuations in money supply and thus behind fluctuations in economic activity, and that a slow (3-5% yearly) and steady (preferably daily) increase in the money supply would result in a more stable economy with stable economic growth.[7][8]
[edit]Congress
Congressman Louis T. McFadden, Chairman of the House Committee on Banking and Currency from 1920–31, accused the Federal Reserve of deliberately causing the Great Depression. In several speeches made shortly after he lost the chairmanship of the committee, McFadden claimed that the Federal Reserve was run by Wall Street banks and their affiliated European banking houses.[9]
Many Congressmen who have been involved in the House and Senate Banking and Currency Committees have been open critics of the Federal Reserve, including Chairmen Wright Patman,[10]Henry Reuss,[11] and Henry B. Gonzalez.[citation needed] Congressman Ron Paul, Chairman of the Monetary Policy Subcommittee in 2011, is a staunch opponent of the Federal Reserve System, and routinely introduces bills to abolish the Federal Reserve System,[12] although these have been unsuccessful, garnering neither cosponsors nor hearings.[13]
Ron Paul also introduced H.R. 459: Federal Reserve Transparency Act of 2011,[14] which passed the House on July 25, 2012.[15] This act required an audit of the Federal Reserve Board and the twelve regional banks, with particular attention to the valuation of its securities.
[edit]The Great Depression (1929)
Perhaps the most widely-accepted criticism of the Fed was first proposed by Milton Friedman and Anna Schwartz – that the Fed exacerbated the 1929 recession, sparking the Great Depression. After the stock market crashed in 1929, the Fed continued to contract (decrease) the money supply and refused to save banks that were struggling due to bank runs. This mistake, critics charge, allowed what might have been a relatively mild recession to explode into catastrophe. Friedman and Schwartz believed that the depression was “a tragic testimonial to the importance of monetary forces.”[16]
Before the establishment of the Federal Reserve, the banking system had dealt with periodic crises (such as in the Panic of 1907) by suspending the convertibility of deposits into currency. In 1907, the system nearly collapsed and there was an extraordinary intervention by an ad-hoc coalition assembled by J. P. Morgan. The bankers demanded in 1910-1913 a central bank to address this structural weakness. Friedman suggested, however, that if a policy similar to the Panic had been followed during the banking panic at the end of 1930, it might have stopped the vicious circle of the forced liquidation of assets at depressed prices, just as suspension of convertibility in 1893 and 1907 had quickly ended the liquidity crises at the time.[17]
Essentially, in the monetarist view, the Great Depression was caused by the fall of the money supply. Friedman and Schwartz note that "[f]rom the cyclical peak in August 1929 to a cyclical trough in March 1933, the stock of money fell by over a third." The result was what Friedman calls the "Great Contraction"—a period of falling income, prices, and employment caused by the choking effects of a restricted money supply. The mechanism suggested by Friedman and Schwartz was that people wanted to hold more money than the Federal Reserve was supplying. People thus hoarded money by consuming less. This, in turn, caused a contraction in employment and production, since prices were not flexible enough to immediately fall. Friedman and Schwartz argued the Federal Reserve allowed the money supply to plummet because of ineptitude and poor leadership.[18]
Many have since agreed with Friedman and Schwartz's theory, including current Chairman Ben S. Bernanke, who said:
Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression. You're right, we did it. We're very sorry. But thanks to you, we won't do it again.[19]
Friedman has said that ideally he would "prefer to abolish the federal reserve system altogether" and replace it by a computer. He would prefer to replace the organization with a mechanical system that would increase the money supply at some fixed rate,[20] and thought that "leaving monetary and banking arrangements to the market would have produced a more satisfactory outcome than was actually achieved through government involvement."[21]
[edit]Global financial crisis
Some economists, such as John B. Taylor,[22] have asserted that the Fed was responsible, or at least partially responsible, for the United States housing bubble which occurred prior to the 2007 recession. They claim that the Fed kept interest rates too low following the 2001 recession,[23] The housing bubble then led to the credit crunch. Then-Chairman Alan Greenspan disputes this interpretation. He points out that the Fed's control over the long-term interest rates critics have in mind is only indirect. The Fed did raise the short term interest rate over which it has control (i.e. the federal funds rate), but the long term interest rate (which usually follows the former) did not increase.[24]
According to Paul Krugman the Federal Reserve under Greenspan took too long to recognize the dangers of a housing bubble burst. In this criticism from 2005 Krugman states that "Most of what Alan Greenspan said at last week's conference in his honor made very good sense. But his words of wisdom come too late. He's like a man who suggests leaving the barn door ajar, and then - after the horse is gone - delivers a lecture on the importance of keeping your animals properly locked up." and that as a result "there's a rough ride ahead for the U.S. economy. And it's partly Mr. Greenspan's fault."[25]
The Federal Reserve's role as a supervisor and regulator has been criticized as being ineffective. Former U.S. Senator Chris Dodd, then-chairman of the United States Senate Committee on Banking, Housing, and Urban Affairs, remarked about the Fed's role in the present economic crisis, "We saw over the last number of years when they took on consumer protection responsibilities and the regulation of bank holding companies, it was an abysmal failure."
[edit]Conservative criticism
During the 2010 midterm elections, the Tea Party movement made the Federal Reserve a major point of attack, which was picked up by Republican candidates across the country. Mike Lee (R) of Utah accused the reserve of trying to “monetize the debt” by printing money to buy government bonds, which the reserve denied. Unsuccessful Senate candidate Ken Buck (R) of Colorado said that Congress should be "shining a light on the Federal Reserve" because it is too cozy with private interests. Senator Rand Paul (R) of Kentucky, son of Congressman Ron Paul, has long attacked the Federal Reserve, arguing that it is hurting the economy by devaluing the dollar and that its monetary policies cause booms and busts.
[edit]Non-mainstream economics
One criticism of the Fed, typified by the Heterodox economics Austrian School, is that the Federal Reserve's control of interest rates is an unnecessary and counterproductive interference in the economy.[26]
[edit]Private ownership or control
According to the Congressional Research Service:
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- Because the regional Federal Reserve Banks are privately owned, and most of their directors are chosen by their stockholders, it is common to hear assertions that control of the Fed is in the hands of an elite. In particular, it has been rumored that control is in the hands of a very few people holding "class A stock" in the Fed.
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- As explained, there is no stock in the system, only in each regional Bank. More important, individuals do not own stock in Federal Reserve Banks. The stock is held only by banks who are members of the system. Each bank holds stock proportionate to its capital. Ownership and membership are synonymous. Moreover, there is no such thing as "class A" stock. All stock is the same.
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- This stock, furthermore, does not carry with it the normal rights and privileges of ownership. Most significantly, member banks, in voting for the directors of the Federal Reserve Banks of which they are a member, do not get voting rights in proportion to the stock they hold. Instead, each member bank regardless of size gets one vote. Concentration of ownership of Federal Reserve Bank stock, therefore, is irrelevant to the issue of control of the system.[27]
According to the web site for the Federal Reserve System, the individual Federal Reserve Banks "are the operating arms of the central banking system, and they combine both public and private elements in their makeup and organization."[28] Each bank has a nine member board of directors: three elected by the commercial banks in the Bank's region, and six chosen—three each by the member banks and the Board of Governors--"to represent the public with due consideration to the interests of agriculture, commerce, industry, services, labor and consumers."[29] These regional banks are in turn controlled by the Federal Reserve Board of Governors, whose members are appointed by the President of the United States.
Member banks ("[a]bout 38 percent of the nation's more than 8,000 banks")[30] are required to own capital stock in their regional banks,[30][31] and the regional banks pay a set 6% dividend on the member banks' paid-in capital stock (not the regional banks' profits) each year, returning the rest to the US Treasury Department.[32] The Fed has noted that this has created "some confusion about 'ownership'":
[Although] the Reserve Banks issue shares of stock to member banks...owning Reserve Bank stock is quite different from owning stock in a private company. The Reserve Banks are not operated for profit, and ownership of a certain amount of stock is, by law, a condition of membership in the System. The stock may not be sold, traded, or pledged as security for a loan....
[33]
In his textbook, Monetary Policy and the Financial System, Paul M. Horvitz, the former Director of Research for the Federal Deposit Insurance Corporation, stated,
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- ...the member banks can exert some rights of ownership by electing some members of the Board of Directors of the Federal Reserve Bank [applicable to those member banks]. For all practical purposes, however, member bank ownership of the Federal Reserve System is merely a fiction. The Federal Reserve Banks are not operated for the purpose of earning profits for their stockholders. The Federal Reserve System does earn a profit in the normal course of its operations, but these profits, above the 6% statutory dividend, do not belong to the member banks. All net earnings after expenses and dividends are paid to the Treasury.[34]
In the American Political Science Review, Michael D. Reagan[35] wrote,
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- ...the "ownership" of the Reserve Banks by the commercial banks is symbolic; they do not exercise the proprietary control associated with the concept of ownership nor share, beyond the statutory dividend, in Reserve Bank "profits." ...Bank ownership and election at the base are therefore devoid of substantive significance, despite the superficial appearance of private bank control that the formal arrangement creates.[36]
[edit]Transparency issues
Another objection is the lack of transparency and audits.[37] In particular, the majority believes it should be held more accountable or abolished.[38] Others believe the public should have a right to know what goes on in the Federal Open Market Committee (FOMC) meetings.[39][40][41]
There has only been a partial audit, of which it was discovered 16 trillion dollars were secretly loaned to the banks. Of these loans, they were provided by no-bid contracts and with near-zero interest.[42]
[edit]Stifling of economic thought
Ryan Grim of the Huffington Post has argued that the Federal Reserve System "so thoroughly dominates the field of economics that real criticism of the central bank has become a career liability for members of the profession..."[43] Grim quotes Wall Street analyst Joshua Rosner as saying: "The Fed has a lock on the economics world..... There is no room for other views, which I guess is why economists got it so wrong."[44] Grim argues that the Federal Reserve System maintains some control over economists through such publications at the Journal of Monetary Economicswhere, he says, "more than half of the editorial board members are currently on the Fed payroll – and the rest have been in the past."[44]
Grim also writes that economist Milton Friedman had concerns "about the stifled nature of the debate" over economic policy. He wrote to a colleague that ".....having something like 500 economists is extremely unhealthy. As you say, it is not conducive to independent, objective research. You and I know there has been censorship of the material published. Equally important, the location of the economists in the Federal Reserve has had a significant influence on the kind of research they do, biasing that research toward noncontroversial technical papers on method as opposed to substantive papers on policy and results...."[44]
Wall Street analyst Rosner wrote, according to Grim, "a strikingly prescient paper in 2001 arguing that relaxed lending standards and other factors would lead to a boom in housing prices over the next several years, but that the growth would be highly susceptible to an economic disruption because it was fundamentally unsound."[44]
Economist Paul Krugman has been critical as well. In a 2007 interview with Pacifica Radio's Democracy Now!, in referring to Alan Greenspan, Krugman said: "I've been blackballed from the Fed summer conference at Jackson Hole, which I used to be a regular at, ever since I criticized him.... Nobody really wants to cross him." In 2007, Krugman also stated: "And two years ago, the conference was devoted to a field, new economic geography, that I invented, and I wasn't invited."[44]
[edit]Public opinion
According to a Bloomberg poll taken in 2010, "Americans across the political spectrum say the Fed shouldn’t retain its current structure of independence. Asked if the central bank should be more accountable to Congress, left independent or abolished entirely, 39 percent said it should be held more accountable and 16 percent that it should be abolished. Only 37 percent favor the status quo." [45]
[edit]See also