16 Nov
2011

The History of the Federal Reserve Act

Posted by : Dougie Morris

The first attempted creation of a central bank was the creation of the First Bank of the United States, located in Philadelphia, in 1791. The public opposed the creation of a powerful central bank and Congress refused to renew its 20-year charter in 1811. Congress chartered the Second Bank of the United States in 1816. Congress again failed to renew its charter when it expired in 1836, in part because Andrew Jackson stirred up popular opposition to it during his presidential campaign.

After two attempts at centralized banking, the mid-1800s was a period of free banking. State banks and unchartered “free” banks issued their own paper money, which consumers could redeem for gold or specie. In 1863, Congress passed the National Banking Act. This Act required that all paper notes be backed by United States government securities. By taxing state bank notes but not national bank notes, the Act helped to create a uniform national currency.

Financial panics and bank runs continued in the late nineteenth century. A depression began with the 1893 banking panic and only ended with the intervention of J.P. Morgan. Another financial panic, the result of a failed period of stock speculation, resulted in J.P. Morgan’s intervention again in 1907. Public opinion shifted to support a central bank, although big business and political progressives disagreed on how to reform the banking system.

The Aldrich-Vreeland Act of 1908, passed in response to the 1907 panic, established the National Monetary Commission and provided for the issuance of emergency currency during financial crises. Republican Senator Nelson Aldrich and the Commission developed a monetary plan favored by banking and business interests, referred to as the “Aldrich Plan”. The Aldrich plan outlined the creation of a National Reserve Association, a single national bank that resembled European central banks. Woodrow Wilson’s election in 1912 effectively killed the Republican Aldrich plan.

Virginia Representative Carter Glass and the House Committee on Banking and Finance’s expert adviser, H. Parker Willis, presented a proposal for a central bank to President Woodrow Wilson in late 1912. Congress debated banking system reform plans for nearly one year. Debate included Congress’s constitutional power to delegate its power to coin money or issue paper bills to the Federal Reserve, the decentralization of the banking system (Favored by Glass) and a government-controlled system (favored by Senator Robert Owen of Oklahoma). Many opponents of the Owen-Glass plan were those who favored the Aldrich plan. Congress debated the progressive, decentralized Owen-Glass Act for six months and President Wilson signed it into law on December 23, 1913. By November 16, 1914, the 12 Federal Reserve Banks were open for business.

The Federal Reserve was created to be a “lender of last resort”. The Federal Reserve has 12 branches: Atlanta, New York, Boston, Philadelphia, Cleveland, Dallas, Minneapolis, Chicago, Kansas City, San Francisco, Richmond, and St. Louis. The Federal Reserve Banks’ functions include: issuing new currency, removing old currency, evaluating merger applications, granting discount loans to banks in their districts, examining state member banks, and analyzing economic data from their districts. Every national bank chartered by the Office of the Comptroller of Currency must be members of their district’s Federal Bank while state banks can choose to be members of their district’s Federal Bank.

The Board of the Federal Reserve has seven members, or “governors”, each appointed by the President of the Board and confirmed by Congress to a 14-year term. The President is selected from the governors for a four-year term and usually resigns if he is not reappointed to another term as President. The Board sets the reserve ratio and reviews Federal Reserve Banks’ discount rate changes.

The Federal Reserve is independent of the federal government because each member of the Board of Governors cannot be removed from office and can only serve a single term. The Federal Reserve’s budget does not require Congressional approval. Interest from its loans, fees from its check clearing service, and security returns make up its budget. Congress has the ability to abolish the Fed and can legislate changes to the Fed’s actions. The President of the United States can appoint new governors to fill vacancies on the Board and appoints the Chairman of the Board.

The Federal Reserve Act of 1913 has been amended or modified by over 200 acts of Congress. Congress passed the Glass-Steagall Act, or the Banking Act of 1933, in response to the Great Depression. This Act established the Federal Deposit Insurance Corporation (FDIC), required that government securities to be used as collateral for Federal Reserve notes, and that the Fed examine bank holding companies. The Glass-Steagall Act required the separation of commercial and investment banks and did not allow banks, insurance companies, and brokerages to enter each others’ businesses. The Act disallowed the formation of superbanks, speculative landing, and securitization. The Banking Act of 1935 further changed the structure of the Federal Reserve. This Act created the Federal Open Market Committee (FOMC), removed the Secretary of the Treasury and the Comptroller of the Currency from the Federal Reserve’s governing board, and established governors’ 14-year terms. The Employment Act added the mandate of promoting maximum employment to the Federal Reserve’s responsibilities. The Bank Holding Company Act of 1956 made the Federal Reserve the regulator for bank holding companies that own more than one bank. The Humphrey-Hawkins Act, or the Full Employment and Balanced Growth Act of 1978, required that the Federal Reserve chairman to report twice annually to Congress on the Fed’s monetary policy goals and objectives. The Glass-Stiegel Act was repealed in 1999 when President Bill Clinton signed the Financial Services Modernization Act, which allowed brokerages, banks, insurance companies, and security companies to enter each others’ businesses.

Federal Reserve Act History

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