IMAGINE GOING TO THE BANK AND NOT being able to withdraw money due to the bank’s closure caused by a lack of deposits. Before 1913, the United States banking system was archaic and flawed. It was virtually impossible to go to a bank and get a loan for a piece of real estate. It was not until Congress passed the Federal Reserve Act, which formed the Federal Reserve System as the central bank, that stability came to the banking system. One large benefit to the Federal Reserve was its ability to issue and regulate notes as a national currency, but the Federal Reserve or — The Fed — also served other important purposes.
It is hard to imagine a United States without a federally regulated banking system, but it was less than a hundred years ago that this country did not have federal banking oversight. Banks were not unified and people did not have faith in the system. The Fed, overseen by seven presidential appointees, forms the Board of Governors. Each Board of Governors serves a 14-year term and must be confirmed by the Senate. The Board of Governors is led by a Chairman and a Vice Chairman, each appointed by the President of the United States and approved by the Senate. Today, Ben Bernanke is the Federal Reserve Chairman and arguably the most powerful man in the world.
The Board of Governors supervises over twelve Federal Reserve banks. Each bank oversees one region of the United States. The job of the Federal Reserve banks is to carry out the day-to-day operations of The Fed, such as controlling the money supply and regulating member banks. However, the real power of The Fed comes from its ability to affect monetary policy. est rates, known as the Federal Funds rate. Federal Reserve banks lend money to banks in their districts for an overnight rate set by the Board of Governors. If the Board of Governors determines — based on economic data — that they want to help spur the economy and fight off an unhealthy level of inflation, they may vote to lower overnight rates. In theory, if the rates decrease, more people and companies borrow money using the funds to purchase homes and other assets helping to keep the economy healthy.
The Fed has other tools at its disposal, such as setting reserve requirements and open-market operations, but the one tool described above is what is important to most people. When The Fed adjusts the Federal Funds rate, it has a direct affect on short-term interest rates. One short-term rate, known as the prime rate — used mainly for lines of credit on homes — will fluctuate with the Federal Funds rate. The prime rate is essentially the best interest rate a bank will give someone with excellent credit. As a general rule of thumb, the higher the Federal Funds rate the higher the interest rate a customer pays. Recently, after the terror attacks of September 11, the Board of Governors wanted to spur the economy so they continued to lower the Federal Funds rate, which extended the already low rates of that time.
With the banking environment always changing, it is nice to know that the pillar that is The Fed exists to help influence the United States monetary policy. The Fed has helped starve off inflation and given Americans faith in a central bank.
MIKE HEAYN is a Washington Mutual multi-family loan consultant. He (310) 428-1342 or
Originally published in the Santa Monica Daily Press print edition on July 18, 2007. Read the original PDF.