The Corner

The Federal Reserve System (the Fed) is a national bank comprised of 12 separate banks governed by a seven member board of governors. It was established by Congress in 1913 to provide liquidity for the nation’s banks and act as “banker of last resort.”

Each of the 12 district banks, with 24 regional branches spread across the nation, has its own chairman and seven member board of governors. Each district bank is identified by a letter and corresponding number. Technically a corporation owned by banks, the Fed works more like a government agency than a business. Under the direction of its chairman, it sets economic policy, supervises banking operations and has become a major factor in shaping the economy.

The governors are appointed to a 14-year term by the U.S. president and confirmed by Congress, which is supposed to insulate them from political pressure to some extent. One term expires every two years. However, the chairman serves a four-year term and is often chosen by the president to achieve specific economic goals.

About half of all the banks in the country are members of the Federal Reserve System. All national banks must belong, and state-chartered banks are eligible if they meet the financial standards the Fed has established.

The Fed acts as regulator by buying and selling government securities in an attempt to balance the money in circulation. When the economy is stable, the demand for goods and services is fairly constant and so are prices. Achieving that stability supports the Fed’s goals of trying to keep the economy healthy and maintaining the value of the dollar.

As banker, the Fed maintains bank accounts for the U.S. Treasury and many government and quasi-government agencies. It deposits and withdraws funds the way you do at your own bank, but in bigger volume: over 110 million treasury checks are written every year.

If a banks needs to borrow money, it can turn to a Federal Reserve Bank. The interest the Fed charges banks is called the discount rate. Bankers don’t like to borrow from the Fed, since it may suggest they have problems. And they can borrow more cheaply from other banks.

The Fed also monitors the business affair and audits the records of all of the banks in its system. Its particular concerns are compliance with banking rules and the quality of loans. In addition, when currency wears out or gets damaged, the Fed takes it out of circulation and authorizes its replacement. Then the treasury has new bills printed and new coins minted.

Just as most of us maintain deposits at banks, banks maintain deposits of their own at Federal Reserve banks. Each member bank of the Fed is required to maintain a minimum balance in a reserve account with the Fed. The required balance depends on the total deposits of the bank’s customers. Funds in the bank’s reserve account are called “federal funds” or “fed funds.” At any time, some banks have more funds than required at the Fed. Other banks, primarily big New York “money center” banks, tend to have a shortage of federal funds. In the federal funds market, banks with excess funds lend to those with a shortage. These loans, which are usually overnight transactions, are arranged at a rate of interest called the federal funds rate.

Finally, the Fed watches over $11 billion of gold stores and acts as a national clearing administrator. Concerning the former, gold stored in the U.S. by foreign governments is held in the vault at the New York Federal Reserve Bank—some 12,000 tons of it. Reportedly, this is the one of the largest amounts (along with Fort Knox) of gold stored in one place. Among its many jobs, the Fed administers the exchange of bullion between countries. As an administrator the Fed acts as the national clearing house for checks. It facilitates quick and accurate transfer of funds in more than 20 billion transactions a year. Clearing is the process in which banks collect the funds when a check is deposited from another banking or financial institution.

Quote of the Week: “Self-pity in its early stages is as snug as a feather mattress. Only when it hardens does it become uncomfortable.”—Maya Angelou

Bart Ward is the chief executive officer of Ward & Co. Ltd. an Anoka based registered investment advisor – specializing in the management of stock and bond portfolios in companies which are listed on the NYSE.

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