The Federal Reserve is under siege. Proposals abound to curtail the institution's power, through stepped-up congressional involvement or the transfer of some of its responsibilities to other agencies. A political movement led by Rep. Ron Paul (R-Texas) seeks to abolish the central bank altogether. Public enthusiasm for the Fed, including for its role of recent years in bailing out financial institutions, is distinctly low.
The Fed has been controversial throughout its history — and indeed even before that as proposals for a central bank generated heated debate in the run-up to the Fed's establishment in 1913. Considerable contention persists over matters ranging from the organization's structure to the particulars of its interest-rate decisions. And while there is ample room for reasonable disagreement on such issues, running through much discussion about the Fed are unreasonable beliefs and lurid conspiracy theories.
Ideas that are dubious or worse, but still widely circulated, include that the Fed is a private institution rather than a governmental one, that it acts in the interests of a secret cabal (who, in some variations on that theme, are foreigners), that the Federal Reserve Act that created it is not legally valid and even that President John F. Kennedy was assassinated because he was trying to rein in the power of the Fed.
That such ideas are outlandish does not make them inconsequential. Rather, they seep into the climate of opinion, diverting attention from legitimate policy issues (such as whether the Fed should seek to identify and deflate asset bubbles before they burst) and eroding the insulation from short-term political pressure that economists generally believe a central bank needs in order to conduct sound monetary policy.
Debates about the Fed's future should be informed by accurate accounts of the institution's past, and that means disentangling history from some baseless, even bizarre, beliefs. Moreover, obscure figures are not alone in propagating the misconceptions. Consider how so prominent a politician as Ron Paul promotes the idea that the Fed is private in this passage (p.150) from his bestselling book End the Fed: "Law permits this highly secretive, private bank to create credit at will and distribute it as it sees fit."
Elsewhere in the book (p.28), Paul offers a more defensible but still misleading description that "the Fed is a public-private partnership, a coalition of large banks that are the owners working with the blessing of the government, which appoints its managers."
In reality, the Fed's Board of Governors, which has the final word on policy, is a clear-cut government agency, with members appointed by the U.S. president and confirmed by the Senate. The Fed's regional banks, meanwhile, are private in a nominal sense but function in effect as government entities; banks own shares in them that cannot be traded, and almost all of the regional banks' profits are remitted to the U.S. Treasury.
To call this complex system a "private bank" is, to say the least, apt to generate confusion. Moreover, these institutional arrangements arose from events around the Fed's founding that have been wildly distorted by bogus history.
Jekyll Island Tales
From the expiration of the Second Bank of the United States' charter in 1836 into the early years of the 20th century, the U.S. had no central bank. In the Panic of 1907, J.P. Morgan Sr. led a makeshift consortium of banks that funneled funds to distressed institutions. That such power was in private hands, and had averted economic meltdown only narrowly, raised alarms among policymakers and the public, sparking calls for a central bank.
In 1910, a handful of bankers and politicians, including Sen. Nelson Aldrich (R-R.I.), gathered on Jekyll Island, a bucolic getaway off the Georgia coast, to sketch out a plan for central banking. This meeting has given rise to much conspiracy theorizing, including a book with the memorable title Creature from Jekyll Island. The Fed, in such interpretations, was hatched in secret to serve a powerful few.
The Aldrich plan would have set up a central banking system largely under bankers' control, with little government oversight. That seems to have reflected a not-so-sinister desire to keep politics away from the central bank lest it become, as banker Paul Warburg put it, a "national Tammany Hall." But if this was a conspiracy, it didn't get very far. The 1910 elections gave control of Congress to Progressive-era Democrats who had much suspicion of bankers — and so the Aldrich plan didn't stand a chance.
Indeed, hostility to big finance was a major factor in the legislative maneuvering that preceded the Fed's creation. Rep. Ars?ne Pujo (D-La.) convened hearings in 1912 to investigate whether a Wall Street "money trust" was controlling the economy. Near the end of that year, Rep. Carter Glass (D-Va.) proposed a system of regional reserve banks that would lend to banks around the country, diluting the power of New York financiers.
Woodrow Wilson, the newly elected president, insisted there be a board of presidential appointees to oversee the reserve banks. After much congressional wrangling, the Federal Reserve Act passed in December 1913. It was aimed at reconciling diverse interests; agrarian populists got their regional banks, but a New York Fed would carry much weight in the system, which helped reassure a wary Wall Street, and in Washington a Board of Governors would keep an eye on all of this.
It was, in short, a compromise, not a conspiracy.
Was it Constitutional?
